Managerial Economics: A Game Theoretic Approach

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1 September 2015

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Using computations from Assignment 1, determine the market structure in which the low-calorie frozen, microwavable food company operates.

The market structure that this company is likely to be in is the oligopoly structure whereby it could be in a duopoly or not. A duopoly is a market structure in which there are few firms in the industry. It is a market structure that lies between two market structures, that is, perfectly competitive market and monopoly. There are two or more sellers but the number of sellers is not as large as that of the ones present in a perfectly competitive market. The firm can be categorized as a monopoly mainly because of the cross sectional demand of the firm. The cross price elasticity demand of this particular firm is 0.68. This simply means that an increase in the prices of the competitors ’ product by one unit implies a 0.68 unit increase in terms of the quantity demanded. This basically implies that the cross sectional demand in inelastic. As such, the increase in price, decrease in price or generally the change of prices by this particular firm will not have a significant effect in terms of the quantity demanded. This is the ideal representation of a firm in an oligopoly. The scope for individual action can be said to be way greater than in the case that the product was differentiated. In other words, one individual seller does not stand to lose in the case that he or she decides to charge a higher price. For this reason, this firm is definitely under an oligopoly market structure.(Webster, 2003)

Outline a plan that will assess the effectiveness of the market structure for the company’s operations

The issue of prices is basically the basis of the plan that is to be formulated. Generally, the price quantity combination depends upon the actions that are taken by the rest of the firms in the duopoly. In other words, the profit that is accrued by each and every seller is a result of the decisions that have been reached by each individual seller. The monopoly price that will be charged under this market structure could come with a series of consultations or simply individual experiments. For this particular firm to maximize its profits it needs to fix its price through an analysis with the assumption that there exists only one firm in the market. In the event that the firm fixes its price higher than this price, it will make gains. In the event that it fixes the price lower, it will lose.

Given that business operations have changed from the market structure specified in the original scenario in Assignment 1, determine two (2) likely factors that might have caused the change. Predict the primary manner in which this change would likely impact business operations in the new market environment.

The assumed market structure was that the firm was under a perfectly competitive market. It however turns out that the firm is in an imperfect market, a duopoly precisely. There are a number of f actors that are likely to have caused the change in this market structure. One of the reasons is that there probably existed one factor of production that is owned by a few firms only. As a result, not many firms are able to produce the product. Besides, it is also a possibility that there existed many firms initially in the market under a perfectly competitive market. These firms could have decided to merge thereafter and consolidated themselves into one major firm with the aim of reducing competition. In this way, the number of sellers reduces.

Analyze the major short run and long cost functions for the low-calorie, frozen microwaveable food company given the cost functions below. Suggest substantive ways in which the low-calorie food company may use this information in order to make decisions in both the short-run and the long-run.

TC = 160,000,000 + 100Q + 0.0063212Q2

VC = 100Q + 0.0063212Q2

MC= 100 + 0.0126424Q

The total cost function is an increasing function of quantity produced. This implies that an increase in the quantity produced results to an increase in the cost of production. This is consistent with economic theory. The intercept of the total cost function is 160,000 meaning that when no quantity is produced, or rather when the quantity produced is zero, the fixed cost is 160,000. The Marginal Cost function is also an increasing function of quantity produced. It gives the effect of producing an extra unit. The firm should thereby produce up to a level whereby the cost of producing an extra unit does not exceed the returns from that particular unit.(Hirschey, 2008)

Determine the possible circumstances under which the company should discontinue operations. Suggest key actions that management should take in order to confront these circumstances. Provide a rationale for your response

The firm should discontinue its operations in the case that the Total costs are more than the total revenue. This would imply that the firm is making losses. The firm should also discontinue its operations in the event that the marginal costs are greater than the marginal revenue. That is, the cost of producing an additional unit is greater than the cost of selling that additional unit. The firm should also discontinue its operations in the event that the marginal revenue is zero or less. This is with regard to the law of diminishing marginal revenue which holds that the revenue from selling an additional unit will increase to a point where an additional unit of input will not increase the quantity produced. In this case therefore, extra costs will be incurred in the process of producing an extra unit but revenue will not change. This is an unproductive phase of production.

Suggest one (1) pricing policy that will enable your low-calorie, frozen microwavable food company to maximize profits. Provide a rationale for your suggestion.

At ceteris Paribus, the demand function of the market is

The demand equation will be as shown below, with all other factors held constant:

Q = -5200 – 42*(P) + 20*600 + 5.2*5500 + 0.2*10000 + 0.25*5000

Q = 38650 – 42(P)

P = 38650/42 – (Q)/42

The equilibrium prices and quantities are;

5200 + 45P=38650 – 42P

33,450=87P

P = 384.48

Q = 5200 + 45*(384.48) = 22,501.6

Total Revenue = Price X Quantity = {38650/42 – (Q)/42 }Q

MR= 38650/42 = 920. 23 = P

The average revenue should be equal to the price and give the demand function. The best pricing solution that this firm can and should make is to produce at this price.

Outline a plan, based on the information provided in the scenario, which the company could use in order to evaluate its financial performance. Consider all the key drivers of performance, such as company profit or loss for both the short term and long term, and the fundamental manner in which each factor influences managerial decisions.

Being a firm under the oligopoly market structure, the firm should put the concept of price leadership into practice. Essentially, this simply implies that the firm should be able to put itself out as a dominant firm and as such it should be able to command the authority to set the prices in the market. It should also be able to be the firm that commands any change when it comes to prices in such a way that it has the ability to change prices while the other firms follow suit. The firm therefore is in a situation in which it is able to control prices to its benefit. As a consequence, the other competing firms will not be able to maximize their own profits unless they follow the prices that are set by this firm. In other words, a special monopoly is created in the duopoly. (Washick, 2005)

Recommend two (2) actions that the company could take in order to improve its profitability and deliver more value to its stakeholders. Outline, in brief, a plan to implement your recommendations.

Due to the homogenization of products, there is the problem of competition especially among the buyers. This simply implies that there will be one single price for sellers. As a result, the best recommendation with regard to the action that the firm should take is to ensure that they maximize on output. A change in terms of output by the seller has a very significant effect in terms of the prices of the good that is produced. As much as the actions of his or her rivals could be somewhat unknown, it is most definite that the other sellers will change or alter the prices in a way that they will match the output. An increase in terms of the output also implies that the firm will also increase its revenue.

The Collusion Solution is also another recommendation that could be used by this particular firm in question. This basically implies that the market participants could always try and join together in the event that the participants find that the competition is too much, they could join together so as to create one competitive firm. (Waschick,2005)

References

Fisher, T., & Waschick, R. (2005). Managerial Economics: A Game Theoretic Approach. London : Routledge.

Hirschey, M. (2008). Managerial Economics. New York: Cengage Learning.

Webster, T. J. (2003). Managerial Economics: Theory and Practice. London: Academic Press.

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