Q1. Government Regulation On Alcohol Products
An excise tax is a domestic tax on the sale or the production of a specific commodity. The tax is paid when a purchase is made on a specific good. Alcoholic products are liable to be charged an excise duty by the government to discourage people from consumption. The rate that is charged will depend on the type of product, its effects, and the strategy by the government for revenue maximisation.
Alcoholic products comprise of beer, wines and spirits. These products are different in taste, smell, colour, alcohol content and prices. To observe the effect of a higher excise tax on alcoholic products, we will consider their price elasticity.
Price elasticity shows how responsive the quantity demanded of a commodity is to how its price changes (Salvatore, 2011). A commodity’s price will be affected by an excise tax imposed on the commodity. An increase in excise tax will most likely increase the price of the commodity.
According to Salvatore (2011), the coefficient of the price elasticity of demand is the percentage change in the quantity demanded divided by the percentage change in price. Since quantity demanded and price usually have an inverse relationship for normal commodities such as alcoholic products, the coefficient will bear a negative sign. However, we are more interested in the coefficient rather than the sign and thus we can ignore the sign.
Srivastava et al (2014), calculated estimates of compensated price elasticity of demand for beer, wine, and spirits. For beer, the compensated price elasticity of demand was 0.718, while it was 0.968 for wine, and 0.254 for spirits.
According to these figures, the general price elasticity of alcohol products is inelastic. This is because the coefficients of price elasticity all lie between zero and one for the three products in context meaning that the percentage change in demand is smaller than the change in price(demand is unresponsive to price).
The figure above shows the shift in equilibrium due to the government setting an excise tax on consumption of alcohol products. When a tax is imposed on alcohol products, the price of the products will increase from P* to P1. Consequently, the supply will shift to the left from SS to SISI. This shift of the supply curve will move the market equilibrium to E1. The area AEE1 represents the deadweight loss to the consumers due to the reduction in the quantity demanded from Q* to Q1. Because the consumers have little or no options to the alcohol products, the tax burden will be borne by the consumers.
As an alternative to imposing an excise tax on individual commodities, the government can put a minimum price. Minimum pricing is directly related to the price of alcohol products. A minimum price will set a floor price that the units of alcohol products will be sold at or above. No unit can be sold below this price. Because a minimum price is not a tax, the retailers will retain the revenue together with the profits that will increase.
For a minimum price to work, it has to be set above the equilibrium price otherwise the market will not sell below the equilibrium hence the minimum price will be ineffective. In the figure above, the minimum price is set at Pf. the consumers will not be willing to pay more and thus the quantity demanded will fall from equilibrium quantity Q* to Qd. on the other hand, the suppliers will bring more of the commodity to the market and the quantity supplied will increase from Q* to Qs. This will create a problem where the quantity supplied is more than the quantity demanded hence a surplus in the market. The surplus is the difference between Qs and Qd.
The area ABE represents the deadweight loss to both the producers and the consumers due to the minimum price set by the government. The consumers lose due to the reduced quantity that they will consume while the producers lose on the surplus that they will avail to the market but will not be consumed in the end. The area represents the amount of money that the society loses due to inefficient trade in the market.
A minimum price setting presents a deadweight loss to both the suppliers and the consumers: the society in general. It creates a surplus in the market where the producers will supply more to the market and the consumers will not be willing to purchase. Such a scenario can lead to some producers exiting the market. However, the price elasticity of demand for the consumption of alcoholic products is inelastic and the changes in the quantity consumed will change slightly with the changes in price. A big change in price will not affect consumption in a significant way. In addition, the revenue received by the government can be used to compensate for the inefficiencies in the market through subsidies in case the supply falls below demand.
In this case, of controlling the consumption of alcohol products, it will be better for the government to impose an excise tax rather than to set a minimum price (Salvatore, 2011)
Q2. Long Run Equilibrium Under a Monopolistically Competitive Market
Under a monopolistic competition, firms are price makers and have the freedom to fix prices and thus make price decisions as if they were a monopoly. In addition, for the firm to maximise profits, it will produce at the point where marginal cost equals marginal revenue. The point where the profit maximising quantity lies on the average revenue curve will determine the profit maximising price (Chand, 2017).
In the figure above the lowest point of the average cost curve is the point where the marginal cost curve cuts it. At this point, the cost of producing one table is $200. The monopolist being a price maker will set the price equal to the $200 because of the effect of monopoly like pricing.
The effect of monopolistic like pricing causes the demand of the tables made by the firm to reduce. This is opposed to the case in the short run where the firm can make economic profit. The fall in demand of tables will increase the need of the firm to differentiate its tables hence in the process increasing its average total cost of production. The increase in production cost coupled with the fall in demand will cause the demand curve and the LRAC curve to form a tangent at the point where the profit maximising price of the tables lies.
The tangential relationship between the demand curve and LRAC has two effects on the firm. First, it implies that the firm operating under the conditions of a monopolistically competitive market will produce a surplus of tables in the long run. The second implication is that the firm will not be able to make any economical profit in the long run. By setting the price equal to the cost of production at $200, the firm will only be able to break even in the long run and recover its costs.
As opposed to the monopoly where only one firm dominates the market, an oligopoly market structure falls between the monopoly and the monopolistic competition market structures. It is a market where there are a few firms dominating the market. An oligopoly is a highly concentrated market in the sense that it is shared between only a few firms. Despite a few firms being dominant, there could be other small firms operating in the market.
A firm under an oligopoly can be either pure/perfect or imperfect/differentiated. Pure/perfect oligopolies deal in the production of homogenous products especially industrial products such as steel and aluminium. Imperfect/differentiated oligopolies deal in heterogeneous products such as consumer goods.
Features of An Oligopoly Market Structure
1. Few sellers
An oligopoly is characterised by a few sellers selling homogenous or differentiated products to many customers. The few firms that dominate the market enjoy a huge share of the market and have a significant control over the prices of the commodities.
This is one of the most distinguishing feature of an oligopoly, wherein, firms within the market have to take into consideration the activities of their rival in making decisions concerning prices and output. Since there are a few firms in the market and each firm has control over a share of the market, the activities of one firm will highly determine how the other firm does its decisions. For a firm to remain relevant competitively, it will have to consider, act and react to the activities of its rivals that may include changes in price, or increased advertising and promotional expenses. Because of this, there is complete interdependence among the players in the oligopolistic market in terms of prices and output policies.
Advertising and product promotion is very important to an oligopoly perhaps even more than the other market structures. Firms in an oligopoly have to maintain and acquire more of their share of the market and this is done through advertising. Tis will ensure that it competes intensely with the other rivals and remains in the market. The firms spend many resources in advertising and product promotion activities.
Whenever we have a few players in the market, there is bound to be intense competition between them. This competition is made fiercer by advertising in order to increase the customer base and in turn gain more sales and revenue than the competitors. Every seller in the competition keeps an eye on the activities of the other and makes moves and countermoves to remain relevant and outdo the other.
5. Entry into, and exit out of the market
There is easy exit of the firms from the market whenever they feel like. However there are barriers to entry albeit not as high as those in the case of the monopoly.
These barriers may include government regulations that favour the existence of a few large companies such as licensing fees that are too high and only a few can afford. Other barriers include economies of scale, complex technology, patents, trademarks and copyrights, capital requirement and many more.
Examples of oligopolistic markets in Australia include the market for motor vehicles, the mining sector, and the soft drink retail where coca cola and Pepsi dominate. These industries have few firms dominating the market with high barriers to entry due to a large capital requirement.
Monopolistic markets refer to those markets that are a hybrid or an intermediary market structure that merges two extreme ends of market structures; namely perfectly competitive markets and monopolist markets.
The number of sellers is adequate to create competition. However, the products are not homogeneous but are close substitutes for each other. This gives them some monopoly power. A monopolistic competition market is different from perfect competition in the sense that products are differentiated.
Features of a monopolistic competition market
- There are many buyers and sellers in the market.
- The products are heterogeneous and slightly differentiated.
- Since each product is slightly differentiated, the firm has control over the price at which it sell. Hence, the firm is a price maker.
- Participants in the market rare free to enter and exit the market at their own will.
- Advertising is important in this market structure. Firms have to incur costs of promoting their products and locking in the customers.
- Differences in prices, quality of products, and the slight differentiation of products leads to imperfect information in the market among both buyers and sellers.
- the products are substitutes.
- When one firm changes the prices of its commodities, it causes little or no effect on the demand and supply of the products of the other firms.
- each firm makes no profit in the long-run
Examples of firms operating under a monopolistic competitive market in Australia include restaurants, hairdressers and general specialist retailing. These industries have freedom of entry and exit because of low barriers such as low costs of establishment. In addition, the firms are able to differentiate their products through advertising.
High barriers to entry into the market may bring about a duopoly. Such barriers include huge capital requirement to set up, patents, and control over resources and raw materials by only two firms. Another condition that may cause a duopoly to occur is government policy that will regulate a sensitive industry and license only two firms to operate in the market. This is usually to protect the consumers and avoid exploitation of certain resources that are important to the entire society.
The market demand curve and the cost curves for a duopoly are shown in the figure below.
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