Perfect Competition

In perfect competition, the demand is constant because producers are price takers, rather than price setters.  Firms can only receive normal profits out of their transaction and there is the products from all firms are indifferent (ex: wheat).  The market is made out of large amount of firms, and a firm entering or exiting the market will not affect the price or demands.  There are minimal to no movements in short run.

Monopolistic Competition

The graph illustrated above represents a long run monopolistic competition market.  In a short run, it is possible for firms to earn economic profits.  For example, the lone gas station in the middle of nowhere will earn economic profit, but in a long run monopolistic competition market, only normal profits can be made.  The demand slope is always in a downward sloping, and where the average cost and average revenue meets is the break even points.  Entry into the monopolistic competition market is easy and almost unrestricted.  Examples are restaurants and retail stores.

Oligopoly

Oligopoly is dominated by a few large firms.  It is extremely difficult to enter into the market and the firms have significant control over its price, hence there are chances for price war and price competition.  The kinked demand curve shows how the demand can change from elastic and inelastic as a direct effect of the marginal revenue.  As illustrated in the game theory, nonprice competition and price agreements are often found in this type of market, even though it is a practices deemed as illegal in many countries.

Monopoly

The last graph is a monopoly.  There are no competition, and near impossible for new firms to enter into the market, therefore, monopoly is always making economic profits.  As illustrated in the text book, increasing the supply will not affect the demand, but it will only cause monopoly firms to lower their price to avoid a surplus.  The maximum profit is where the marginal revenue meets the marginal cost.  As listed in the table above, Government are not on side with the monopoly market, and tries to control using the price setting method, taxing, and nationalization.

The Game Theory

The game theory is defined as a method of analyzing firm behavior that highlights mutual interdependence among firms.  In an easier way as explained on Wikipedia, it is "the study of mathematical models of conflict and cooperation between intelligent rational decision-makers”.  Game theory was developed by economists John Neumann and Oskar Morgenstern in the 1940s to analyse strategic behavior.  The game theory is developed base on a firm’s greed, how they cheat strategically to gain more market shares and earn revenue for their own organization. 

Although collusion is illegal in our society, game theory exists in today’s world.  Some of the most obvious examples are in the food industry.  Think of two coffee shops opening right across the street from each other, competition is inevitable for the two shops to survive.  When coffee shop A sells coffee for $2, coffee shop B will also try to match their price to stay in competition.  Once the market share has been split between the two shops, one of the firm will eventually become greedy, and try to lower their price by a slight margin to attract more customer and obtain more market shares.  Eventually, this may or may not start a price war between the two shops, depending on both firm’s reaction to the price change and competition.  This is where a payoff matrix comes in.

A payoff matrix calculates what happen in different scenarios.  In the example above, four different scenarios are identify, and it shows what happens when Yellow and white keep their pricing balanced, then what happened when one of the firms cheat, and what happened when they both cheat and lower their product’s price.  It is clear that the best scenario for both firms is when they keep a balanced price level, maximizing their revenue by selling maximized quantity, splitting the market share evenly.  However, in the right bottom corner, when both firms cheat, they both lose.  In the real world, a perfect scenario rarely exist, and firms plan and act strategically to maximize their profit, and the best strategy will win the most revenue and market shares within the field.  There are a few ways companies can make agreement to ensure they work with each other, while competing against each other, to maximize their profits.  They are collusive and cartel actions.  Collusive and cartel actions are similar.  Collusive is when firms unofficially split the market share, limiting their production and setting a price level at the highest possible price to maximized jointed profits.  Cartel action is similar, but it is a formal agreement of cooperation between competitors, and they are usually divided up between regions, demographics, an existing client list or a quota.  

Monopolistic Competitive Companies

Monopolistic Competitions are usually smaller firms in retailing, and services that caters directly to the customers.  For example, travelling agencies, hairdressers, clothing stores, gas stations... etc. would be considered a monopolistic competitor.

Characteristics of monopolistic competitions would include; freedom of entry into the market, has minor control over their price, and usually sells differentiated products.  Entry and exit of a monopolistic store will usually not affect the economy, as monopolistic competition rarely gain from economic profits.  There are, however, rare cases of monopolistic competition that can gain from economic profits, those exception are usually due to an excellent location of the business, or exceptional services.

Size:	Small Company	Medium Company	Large Company
Features:	Neighbourhood store – Shangri-La Home Decor	Canadian Furniture Store - The Brick	World Wide furniture store - IKEA
Differentiated products	Home Furniture, Unique home decor from Asia	Normal home furniture and electronics, Luxury with multiple locations	Furniture, signature designs, logo, signature locations, well known cafe, signature easy assembly.
Control over price	Some	Some	Some
Mass advertising	Internet and Word of mouth	Weekly Flyer, Internet, TV and radio ads,	Weekly Flyer, Signature Wacky Wednesday, Media, awards, annual catalogue
Brand name goods	None	Minimal	Tons
Freedom of Entry	Very easy	Tough	Nearly impossible without foundation

Competing as Starbucks

In order to be considered as part of a Perfect Competition market, a business must reach four criteria, including:

1.      Many small buyers and sellers all of whom are price takers

2.      No preference shown

3.      Easy entry and exit by both buyers and sellers

4.      The same market information available to all

In our case study, Starbucks cannot be considered as part of a perfect competition market.  Although hitting three of the four criteria, Starbucks cannot be considered as a perfect competitor because their customers have preference.  In a marketing report by SEO Analysis (https://sites.google.com/site/seoanalysisnow/case-study-caribou-coffee-vs-starbucks) 46% of Starbuck’s customers are between the age of 18-34, while the majority of the consumer base is Caucasian and Asians.  Starbucks tends to attract the richer audience due to its high priced coffees and expensive merchandise.  Compared to its competitors, Starbucks charges $2.30 for a large (venti) cup of coffee, while Second Cup is priced at $2.05, followed by Tim Horton’s $1.50. (http://www.canadianbusiness.com/blog/consumer_insight/18140--which-coffee-gives-the-biggest-bang-for-the-buck)

In 2007-2009, Starbucks closed down over 600 stores in the US alone.  The reason for the realignment of its stores is mostly due to a few reasons; non-profitable stores, badly managed stores, and stores being too close to each other.  As these stores are being shut down, over 12,000 employees will lose their job.  Although Starbucks mention that these affected employees will be quickly rehired and retrained, it is almost impossible to fulfill every position as at least 2400 of these positions will be management, and there are limited positions available in each district. 

In an email from Starbucks CEO Howard Schultz, Schultz stated that Starbucks had lost its heritage and identity through the years with new technologies and store designs.  For example, in an attempt to improve quality, speed of service and consistency of their product, Starbucks introduced automatic espresso press machines.  These machines are larger, build for industrial grade, better in many aspects, but the communication between baristas and customers are gone, due to the large build and height of these machines.  In Pike Place Seattle, where the Starbucks was first founded is the only store remaining to still use the classic brewing style, hand grind beans and stove top espresso presses.   Closing 600 stores is an attempt to save the “heritage” and “the Starbucks experience”.

Over the years, Starbucks have been criticized for its expensive coffees.  For hand crafted speciality coffees like the famous “Caramel Macchiato”, a venti (large) can cost as much as $5.88 while a pound of Espresso beans only cost $14.99 on Starbucks Shelves.  One of the reason why Starbucks coffee are high in price is because you can customize your drink and always have it prepared the way you wanted it.  When you do a comparison, it is like having a $3.50 burger at MacDonald’s verses going to an actual restaurant like Red Robins to have a $13.00 burger, but unfortunately, people don’t compare it that way, and only the real coffee drinkers will understand why their coffees are worth the price they pay.

So, is it not possible to tune down the price to attract more business and increase the sales quantity?  Of course, Starbucks can decrease their price.  In return, they will have an increase in quantity demanded, and it would also increase their quantity supplied.  However, by doing so, the quality of service will also decrease, customer service and quality of beans supplied will decrease, and in an exact opposite direction as Howard Schultz want it, and the “Starbucks experience” and “Heritage” will never be the same again.  Eventually, the market will re-adjust itself, and a new equilibrium will be created.  If Starbucks were to lower their prices to match competitor’s level, then it will eventually become a “Perfect Competitor”, reaching its last criteria, “No preference shown”.

-Panda

My Dream Business

If I were to open a business, I would like to open a small convenient store in a business building that is mid to large size.  Not only do I have a passion to make good quality coffee, but I believe this type of business has the monopoly for tenants within and surrounding the building.  The store would be roughly 1000 square feet, and it will sell small chips, small dry snacks, magazines, some basic daily products like headphones, ties, toothbrushes, shaving blades…etc.  the reason I wanted to include these products is because when people go to work in a rush, they often forget to do little things in their life, which would make it convenient for them to shop at my tiny store.  Near the entrance of the store, I would sell speciality coffees, including house made latte, mocha, cappuccino or regular coffee for a fair price, so customers would continue to return as it is more convenient to shop within their own building, especially in the cold Canadian winter.

In a business building, there are usually only a few stores, or cafeteria.  It is extremely hard for other competition to enter into the market.  A clause is usually stated in the rental agreement that the tenant will be the only operator in the building, but the trade-off is rental can be higher in most cases.  To start off this type of business, the short-run cost is usually very high.  Renovations will have to be completed prior to opening, and the first store stock and small appliance will always be a challenge.  Most of these short-run costs will eventually turn into a long-run cost, including maintenance of the coffee machines, tilts, and machinery depreciation.  Some of the fixed cost would include salaries, rent, and business licence and business tax.

If the business is proven to be a success, then I can open a second store, while hiring extra people to take care of the two stores, it will allow me to do most of the training, stockings, and the background finance while exploring new options to continue to expand.  With each new store, I will have to ensure that all my stores are in good running and meeting tenant standards, while still be able to make a constant profit.

An example of this type of business would be “Treats”, founded in 1977.  When the first treats store was opened, they open sold three types of coffees and tea.  Today, Treats can be found all over the country, selling over 130 different types of coffee and tea, serving muffins, cookies, and even a full size lunch in some of the popular locations.

(http://www.treats.com/)

Law of Diminishing Returns

In the article “The Diminishing Returns to Tobacco Legislation” by Pierre Lemieux, it points out a lot of good arguments and stated what is working and what is not with all the Tobacco legislation set forth by different countries and region in the World. 

One of the most interesting point I find is the fact that people who are heavily influenced, bothered, and affected by the negative health warnings on the packages, and excessive taxes on tobacco sales has already quit.  Those who are still regular tobacco users cherish and value smoking even more.  They have grown to ignore the health signs, and the gradual increase of taxes has not reduced consumption.  The Government and health groups have to think of new idea and approach, so they can further eliminate the use of tobacco.  As stated in the second paragraph, “most fo the potential improvements in consumer awareness have already been achieved.”  These warnings and awareness on tobacco packages have been implemented for over a decade in most countries, so why are new ideas and awareness methods not introduced?

According to Smoke Free Canada (http://www.smoke-free.ca/pdf_1/totaltax.pdf), The Government of Canada, both Provincial and Federal combined, have generated total revenue of $7.5 Billion in the calendar year 2010- 2011, a billion dollar increase within a five year period from 2006, and the number continues to rise.  If the Government is finding ways to warn people about smoking and try to encourage smokers to quit, why is this number moving upwards? 

In Germany, the tobacco tax increase in mid-2011, and reports shows that higher tobacco tax only helps smugglers (http://www.thelocal.de/society/20110807-36803.html) .  This is an example of diminishing return.  When tobacco taxes were on the rise, and when health signs were introduced, a small percentage of tobacco users gave up smoking; however, a large portion of smokers remained.  With all the tax hikes on tobacco, the Government eventually pushed consumers to the point where more people are consuming illegal tobacco, which in turn will increase the amount tobacco smuggles due to the new high demand.  As suggested in the news article, the number of cigarettes sold legally in Germany between 2003 and 2009, sank from 133 billion to 87 billion, while officials believe the majority of the rest have turned to illegal tobacco.

When we turn to Chapter 4, page 128, the book brilliantly point out that most Government implement and continuously increase sin taxes is because it generates nifty revenue for the Government.  As sin taxes increase, tobacco will slowly turn into the same category of drugs as we identify today (marijuana, cocaine…etc), and the increase of sin taxes will only encourage more smokers to turn to smugglers and illegal cigarettes.

Changes to Demand

There are four main determinants of demand.  They are:

-       Preference

-       Income

-       Prices of related products

-       Future expectations

There are also a few other determinants, including Size of the market population (a growing population means demands goes up) and change in distribution of income.

A great example of changes to demand would be Tim Horton’s.  During the cold winter in Canada, people are often stopping by Tim Horton’s for a hot coffee.   But when summer hits, the demand for an ice cap rises dramatically.  This is due to the consumer’s preference toward the product.  With the same scenario, Tim Horton’s can also experience a change of demand (decrease) if their competitors were to put a similar product on sale, or boost in advertisement towards their brand.  For example, second cup’s Chiller, Starbuck’s ice Frappuccino, or even McDonald’s Ice Blended latte.  This would be an example of “substitute product”.

The following graph is a mock example of changes in demand for Tim Horton’s Ice cappuccino:

The "Game"!!!!

In the "Game On" exercise, we have to pick one of three online flash games to play.  Without hesitation, I picked the "MacDonald's game. (http://www.mcvideogame.com/game-eng.html) In this game, the player, as "God of MacDonald's" have four screens to manage:

- The farm
- The feedlot
- The Restaurant
- The Office

In this flash game, you have to control the company, from the farm to the feedlot, the restaurant, and deal with all other concerns like negative news, fundraiser or even unhappy employees.  Although it looks like a simple game, but there are so many small details that you have to pay attention to in order not to bankrupt the company.

This game has taught me a great lesson, in both economics and management.  I started out with a small farm, one small cow barn and seeded two pieces of land to provide pasture for the cows when they go into the feedlot.  I hired two employees in the restaurant, one to make burger patties, and one to take care of the cashier. It was smooth sail, and I felt very comfortable with how the business was going.  In time, some of the cows in the feedlot will get sick, and I have to ensure I destroy them before they hit the meat patty machine.  In time, the business started growing.  With constant line up in the restaurant, I had no choice but to hire another cashier.

And the nightmare begins.

It was all a domino effect.  With the new cashier in place, the kitchen is no longer supplying enough burgers to sell.  The only way to create more burgers is to go to the feedlot and to create more meat patties. To create more meat patties, I had to increase the barn size in the farm, and with more cows, I had to harvest more pasture for the cows.  I almost bankrupted the company with all the additions, but I survived.
The storm started again within months; I was getting fines from the government, upset employees won't work, environmentalist protesting...etc and nobody is eating at the restaurant anymore due to all the negative news.  I had to make a choice, to advertise using a fundraiser, or slow down all productions, lay off employees, and stop harvesting pastures to save cost.  And finally, the decision was made, I decided to spend thousands of dollars on a MacDonald's - Disney foundation for kids, and it was a very expensive decision, but it worked and customers started coming back again.  Unfortunately, it still weren't enough to recover from the hit, and the company declared bankruptcy after 16 years in business.

Although this is a game, but it actually reflected a lot of problem on running a business.  It is always easy to manage a small business, but in time, the demand will grow and with the rise of demand comes a shortage of supplies.  In history, we learn that a quick growing business without a solid foundation are very likely to fall and unable to recover.  If I can go back in time in my game, I will probably ignore the line ups and try to build a more solid financial background before expending again.  Well created game!!

Production Possibilities Curve

Production Possibilities Curve graphs is graphical representation of the various combinations of maximum output that can be produced from the available resources and technology.  In the example, the society only produces two products; wheat and car.  To produce a high amount of cars, you will only have enough resource to produce low amount of wheat, visa versa, to produce high amount of wheat, a low production of cars will be the result in the opposite end.  Production possibilities graph help us define and calculate which production level would maximize outcome and profit, and it helps us identify the gain and loses of increasing or decreasing a certain production line.

An example of how scarcity and choices that has affected my life would be deciding on whether to travel during the summer holidays, or take summer courses.  The choices I made will affect many criteria, including: loss of income (on my day job), time (travelling will delay my expected graduation date furthermore), and the amount of money necessary to spend on a vacation.  With the help of the production possibilities curve, we better understand how to make these decisions.  For example, can I take a shorter vacation instead so I can still complete summer courses and not miss as much work? What is the maximum time (days) I can go on this small trip before it affects my school and work? With the graph, I can maximize and plan my schedule with the available resources, so I can get the most out of what is available to me.

There were quite a few significant opportunity cost I experienced by returning to school.  There are actually significant effects on both side of the equation.  By returning to school, I no longer have time to play soccer because of class conflicts, I can no longer work a second job, school is very expensive and I spend less time on Video games and hanging out with my friends. However, with the loss of these luxury items, I’ve earned knowledge through school, a diploma, better career opportunities, and I will be able to support and provide a better living for my family.  It might be a challenge now, but it will benefit me in a long run.  Like the book suggest, there is no free lunch, and every decision I make will affect not only me, but everyone around me for a very long time.

Micro vs. Macro!!

Microeconomics to me is when you receive your first pay cheque and have a hard time deciding where to spend it.  Macroeconomics is when the parents have to set the rules in the house, delegate house work, utilizing the money they bring home properly, and make smart investment decisions!!