Market structure
The regression results show that the coefficient of determination is slightly above average. This implies that the model explains the demand for the product well. The elasticity for advertisement is positive. This shows that advertisement plays a slight role in the demand of the product. The two elasticties eliminate a monopoly and a perfectly competitive market because these market structures do not require advertisement to sell their products.
The cross price elasticity is above average. It implies that the demand of the commodity depends on the price of the competitive products. It also eliminates a monopoly market structure because the products sold by a monopoly firm lack close competitors. Thus, the market structure for the product is a monopolistic competition. In this market structure, there are a large number of firms that have some monopoly power. Also, the firms sell heterogeneous products that have close substitutes. Further, the product differentiation grants the firms some power over their pricing. Finally, there is a low barrier to entry into this market structure (Moon, 2013).
Effectiveness of market structure
In the previous assignment, the evaluation of the market was based on the assumption that the firm is operating in a perfectly competitive market. However, the discussion in the previous section shows that the firm is operating in a monopolistically competitive industry. Under perfect competition the equilibrium price and quantity was arrived by equating quantity demanded and supply. However, under monopolistically competitive industry, the firm will be able to set its own prices, thus it will not be a price taker.
Thus, the market structure will be effective for the company’s operations. This can be attributed to a number of factors. Over the years, there has been a significant increase in the microwavable food product in the market. This trend can be explained by the fact that they are convenient and require little time to prepare. The upsurge in microwavable food has also increased the popularity of microwaves.
Since the industry has significantly grown, consumers look for healthy options that have low calories and are rich in nutrients. In the low calorie microwavable food, the two top players are Lean Cuisine and Healthy Choice. A review of the industry shows that the market is divided based on psychographic, behavioral, and profile. Psychographic criteria group consumers based on their standard of living. Behavioral criteria classify the market based on the attitude of the consumer towards the product. Finally, segmentation on the basis of profile looks at attributes such as economic status and geographical locations among others (McGuigan, Moyer, & Harris, 2014).
Factors that would cause a change in market structure
As discussed above, the market structure of the company will change from a perfectly to monopolistically competitive market structure. This implies that the company will have some monopoly power. Specifically, it will have some level of control on prices. Under monopolistic competition, the company will be able to make some abnormal profits. This is based on the fact that the demand curve is downward sloping.
There are a number of factors that can cause the change in the market structure. The first significant factor is the ability of the company to differentiate its products. The second factor is the change in the disposable income of the target market. As discussed in assignment one, the product is quite responsive to changes in income. Thus, an increase in income will allow the company to successfully differentiate its products (McGuigan, Moyer, & Harris, 2014).
In the new market environment, the company needs to continue being innovative. In order to maintain the market share, the firm should produce commodities that keep them ahead of competition at all times. Thus, the cost of research and development is likely to go up under the new market structure. Another aspect of operation that can be affected by the change is pricing policy that is used by the company. Under the old market structure, the company was a price taker. However, in the new market structure, the company will need to change its prices depending on the market trends. To achieve this, the company should constantly monitor competition by looking at their prices, quantity produced and new products that they introduce in the market (Saada, 2009).
Cost functions
Analysis of short and long run cost functions
TC = 160,000,000 + 100Q + 0.0063212Q2s
Average Total Cost
ATC = TC / Q
ATC = (160,000,000/Q) + 100 + 0.0063212*Q
Total Fixed Cost
TFC = 160,000,000
Average Fixed Cost
AFC = TFC / Q
AFC = (160,000,000) /Q
Total Variable Cost
VC = 100Q + 0.0063212Q2
Average Variable Cost
AVC = TVC / Q
AVC = 100 + 0.0063212 * Q
Marginal Cost
MC = ΔTC / ΔQ
MC= 100 + 0.0126424Q
Suggestions
The cost structures for companies that operate in the Frozen food production industry highly depend on the size of the manufacturer, technology, and scale of operation. The information about the short and long run cost structures can help the company make a number of decisions. In the short run, the price of a monopolistic firm is greater than the marginal cost. Thus, the company can earn profits.
Further, the demand curve of the firm is downward sloping and there are limited barriers to entry and exit. Thus, in the short run, the abnormal profits will attract new firms in the industry. This will cause an increase in supply and a consequent decline in price. This explains the downward sloping demand curve. Thus, the company will experience a constant change in price and demand in the short run. In the long run, equilibrium is attained at the point where the difference between marginal revenue and marginal cost is zero. Thus, the profits are zero. In the long run, the prices should exceed the average total cost while in the short run the price charged should cover the average variable costs (McGuigan, Moyer, & Harris, 2014).
Discontinuation of operations
Generally, a firm is profitable if the price is greater than the average total cost. Profitability in the short run occurs if the price exceeds the average variable cost while in the long run it occurs if the price exceeds the average total cost. Thus, the firm should shut down if the price is lower than the average variable cost. Some of the factors that can cause average variable costs to exceed prices are inability to compete with other players in the market, lack of reliable suppliers, and lack of adequate funds (McGuigan, Moyer, & Harris, 2014).
One action that the management can take so as to stay in the business is to constantly monitor the actions of the competitors. The company should gather information on the prices and cost structures of the competitors. This will ensure that the prices set are competitive and allow the company to recover costs. Secondly, competitive methods should be used to evaluate and select suppliers. This will enable the company to pay reasonable and competitive prices for supplies.
The company needs to evaluate all the possible factors that can make average costs to exceed price. These factors need to be analyzed and feasible solutions should also be found before the firm reaches the point where it needs to shut down (McGuigan, Moyer, & Harris, 2014).
Pricing policy
Estimation of equilibrium values
Direct demand equation
Qd = 38,650 – 42P
Inverse demand function
P = (38,650 / 42) – (Q / 42)
P = 38,650 / 42 – Q/42
P = 920.238 – 0.238 Q
Total Revenue
TR = P *Q
TR = 920.238 Q – 0.238 Q2
Marginal Revenue
MR = ΔTR / ΔQ
MR = 920.238 – 0.476 Q
The general rule for profit maximization is that marginal revenue (MR) should be equal to marginal cost (MC) irrespective of the market structure.
MC= 100 + 0.0126424Q (from part 3 above)
MR = 920.238 – 0.476 Q
MR = MC
920.238 – 0.476 Q = 100 + 0.0126424Q
820.238 = 0.4886Q
Q = 1,679
P = 920.238 – 0.238 * 1,679
P = 521
A comparison of prices under the two market structures shows that the price under monopolistic market structure is higher than under perfect competition. This can be attributed to the fact that under perfect competition, there are no barriers to entry and exit. Therefore, the firms are price takers. However, under monopolistic competition, firms have some monopoly power and therefore they have control over prices.
This gives them more pricing options such as randomized pricing, and penetration pricing among others. The calculations in assignment one showed that the demand of the product is inelastic. Thus, the most suitable pricing policy that the company should use is marginal cost pricing. Under this strategy, the company is will add a mark-up to the direct cost of production. The mark-up added should guarantee that the price exceeds average variable costs in the short run and average total costs in the long run.
This will ensure that the firm is profitable both in the short and long run. It will also eliminate the possibility of shut down. This strategy is commonly used when a company is experiencing low sales and it is suitable because demand is quite sensitive to changes in prices (Mankiw, 2011).
Evaluating financial performance
The financial performance of the company will be evaluated by comparing the profit or loss that is generated both in the short and the long term. The calculations are presented below.
Short run
Old market structure
TC = 160,000,000 + 100Q + 0.0063212Q2
= $122,234
TR = 920.238 Q – 0.238 Q2
= $469,413
Profit = TR – TC
= $469,413 – $122,234
= $347,179
New Market structure
TC = 160,000,000 + 100Q + 0.0063212Q2
= 261,209
TR = 920.238 Q – 0.238 Q2
= 874,759
Profit = TR – TC
= 874,759 – 261,209
= $613,550
Average total cost = 156
Average fixed cost = 45
Average variable cost = 111
Marginal cost = 121
Long run
Profit = TR – TC
= 389,002 – 224,296
= $164,707
The calculations above show that the profit generated under the new market structure ($613,550) is higher than that under the old market structure ($469,413). This implies that the company is more profitable operating under monopolistic competition. Besides, the short term profit is higher than the long term profit. Further, it can be noted that the average variable cost and average fixed costs are lower than the price.
This shows that the company is profitable. The results of financial performance are quite significant in making managerial decisions. For instance, in the short run, the company can invest heavily on advertisement so as to improve the market share and increase sales. This can be attributed to the fact that the high profits that are generated in the short run will attract new firms and it will have an effect of reducing profits. However, intensified advertisement can enable the company to maintain this level of profitability. In the long run, the company has very little control over the prices. Therefore, it should focus on managing costs with an aim of sustaining the current level of profitability (Jain & Khanna, 2011).
Ways of improving profitability
One strategy that the company can use to increase profitability is through innovation. The frozen food industry is quite competitive and consumers are health conscious. Innovation can be achieved by analyzing market trends with an aim of responding to consumers’ needs. As a plan, the company can consider introducing gluten-free goods in their product line. The second strategy that the company can use is practicing price discrimination. As a plan, the company should divide its market based on the income level and offer their commodities at different prices in each of the market segments. These two strategies have a potential of increasing both the bottom line of the company and shareholders’ value (Hirschey, 2012).
References
Hirschey, M. (2012). Fundamentals of managerial economics. Mason, OH: South.
Jain, T. R., & Khanna, O. P. (2011). Business economics. New Delhi: V K Publications.
Mankiw, G. (2011). Principles of economics. Mason, OH: South-Western Cengage Learning.
McGuigan, J. R., Moyer, R. C., & Harris, F. H. deB. (2014). Managerial economics: applications, strategies and tactics (13th ed.). Stamford, CT: Cengage Learning.
Moon, M. (2013). Demand and supply integration: the key to world-class demand forecasting. New York, NY: Pearson Education Inc.
Saada, S. (2009). Elasticity: theory and application. New York, NY: Ross Publishing.