(1) The market structure of low-calorie microwavable foods has changed. The market was initially a competitive market where the existing market players were the price takers, and equilibrium price was to be determined by the interaction of demand and supply curve. But now Katrina Candies has more market power to set up its own optimal price. In perfectly competitive market structure, the competitors provide identical products (Arnold, 2014). But now the existing market players are now offering differentiated products.

 

            The market structure of low-calorie microwavable foods industry can be determined from the results of regression model equation for demand.  The regression equation of demand in low-calorie microwavable foods is as follows (From Assignment 1):

QD = -5200 - 42P + .20A + 20PX + .25M+5.2I

                                            (2002)   (17.5) (6.2)    (2.5)      (0.09)        (0.21)

R2= .55   n = 26   F = 4.88

 

             From the regression model the price elasticity of demand is estimated as -1.19. This elasticity measures indicate that demand in low-calorie microwavable foods market is highly price sensitive. Elastic price of the products is an indication of the fact that small change in the price of the product will lead to a large change in quantity demanded. Also, the coefficient of advertisement to market demand is 0.20. This means that the demand for products is sensitive to advertising expenditure. Positive coefficient of advertisement indicates that change in advertisement expenditure will increase the demand for products in the market. 

 

             The demand in the perfectly competitive market is price elastic. Also, the demand in the perfectly competitive market is less sensitive to the advertisement. But the price elasticity of demand is higher with changed market structure. The market for the low –calorie frozen microwavable food can be considered as monopolistically competitive market structure. This is a form of an imperfect competition. The market has many sellers with market power, numerous buyers, differentiated products, high advertising costs of existing competitors, and moderate entry barriers (Boyes & Melvin, 2013). The high price elasticity of demand of the market if the reflection of the fact that due to the existence of differentiated products price is now responding more than previous. High coefficient of advertisement to market demand is an indication that more advertising is prevalent in the market on the part of sellers. Monopolistically competitive market can be defined as a market structure with the existence of many sellers, differentiated products, the market power of some sellers, and considerable non-price competition.

 

            In the monopolistically competitive market, the company has substantial market power in setting its own optimal price. Thus, Katrina candies can charge its own price. The company is price setter rather than a price taker. In the previous market structure, the decrease of price does not positively affect the market demand as other competitors react in the same way as that of the company, but the increase of price negatively affect the market demand as other competitors do not raise price following the price change of the company. In the current market structure, Katrina candies is capable to change market demand by changing the prices of products.

 

 

           (2) The market structure of low-calorie frozen, microwavable food industry may shift from perfectly competitive market to imperfectly competitive market. The likely factors that may cause to shift of the market structure from perfectly competitive market to imperfectly competitive market are as follows.

• If the government approves of mergers and acquisitions and merger & acquisition take place in the extensive level, the market would become less competitive. After mergers and acquisitions, the acquiring or merged company will have more market share and power in the market.
• If the loss occurs in the long run (price is less than average total cost), the operation of the business will not feasible for the company. If in the long run, the existing players of low-calorie frozen microwavable food industry fails to achieve normal profit, these will leave the industry. Only competent firms will survive in the industry. Due to the reduction of the total number of competitors, the market will be less competitive and the existing surviving players will have power in the market.

           Shifting of market structure from perfectly competitive market to imperfectly competitive market will have an impact on the business operations. The likely impact of the new environment on the operation of the company are pointed out below.

• The market will now be less competitive. Katrina candies will be now price setter instead of the price taker.
• The inter-dependence among the firms and their diversity will be increased. The market concentration of the big firms will be increased.
• As existing market player will have pricing options, these will try to differentiate their market offerings. There will be less price war in the market. Existing firms will prefer to product differentiation strategy over piece leadership strategy.
• The existing competitors will focus on high advertising and promotional efforts. Focusing on high advertising and promotional efforts will enable the companies to represents their products as differentiated products.

 

            (3)  In the short run, the company will run the operational until the price is greater than variable cost. And, equilibrium point will be set up where marginal cost is equal to margin revenue. Thus, in the short run, the company will have focus on the average variable cost and marginal cost function. In the marginal cost function, there are components of both fixed cost and incremental cost. For each successive unit, there is a variable component of $0.0126424 along with the fixed component of $100 (MC= 100 + 0.0126424Q). The profit maximization will be achieved if marginal revenue from each additional unit can recover this fixed portion and the variable portion of the marginal cost (the market is in equilibrium at MR= MC). Another important cost function is the variable cost function. There is no fixed component in the variable cost function (VC = 100Q + 0.0063212Q2). The variable cost is directly proportional to increase of production unit. The company should concentrate on recover this cost incurred by its sales price. If the sales price is less than the variable cost, running of production will not be optimal.

 

           In the long run, the company will run the operational until the price is greater than average total cost. And, equilibrium point will be set up where marginal cost is equal to margin revenue. Thus, in the short run, the company will have focus on the average total cost cost and marginal cost function. As already discussed, marginal cost function has both fixed cost and incremental cost components (MC= 100 + 0.0126424Q). In the long run also (like as short run) profit maximization will be achieved if marginal revenue from each additional unit can recover (is equal) this fixed portion and the variable portion of the marginal cost (the market is in equilibrium at MR= MC). Total cost components has both fixed and variable components (TC = 160,000,000 + 100Q + 0.0063212Q2). Thus, average total cost components will have both- fixed and variable components. The company will have to charge such profit to recover this fixed and variable components to make the normal profit and continues the production. Other production activities will be required to shut down (if the price is less than average total cost).

 

(4) Under monopolistic competition, a firm’s price must cover average variable costs in the short run and average total costs in the long run to continue operations. In in the short run, if the price is less than average variable cost, production should be shut-downed, and in the long run, if the price is less than average total cost production should be shut-downed.

 

            The company will minimize the economic loss in the short run by shutting down the production if the price charged is less than the average variable cost (Mankiw, 2013). Shutting down of operation does not mean that the company is quitting the industry, rather the company is temporarily stopping the production. The company is supposed to start production again after price increase or decrease of variable cost so that price charged exceeds the average variable cost.

             Until price charge is more than average variable cost, production should not be stopped. The production of the company should be run until the price set up can cover the average variable cost (Boyes & Melvin, 2013). In such a situation, the price can be less than average total cost, and the company will incur the normal loss. But, even with normal loss production should not be shut downed as shutting down of production will require to bear up the fixed cost. Rather the company should try to recover the fixed cost incurred with the contribution margin (per unit selling price less per unit variable cost). But if the price is less than average variable cost, contribution margin will be negative, and fixed cost cannot be recovered. In that case, production should be shut-downed.

          The company will minimize the economic loss in the short run by shutting down the production if price charged is less than the average total cost. In such a situation, the business of the company seemed to not profitable and feasible. With the revenue generated, the cost incurred cannot be recovered. In such a situation, the running of the operation will not be an optimal decision for the company. The company should exit the industry by permanently shutting down the production.

(5) The profit of the company will be dependent on its pricing strategy. As the market is monopolistically competitive market now, the company should set up its price where marginal revenue is equal the marginal cost. At the price level where marginal revenue is equal to margin cost, profit is maximized.

 

Profit Maximization Point

 

MR = MC

Profit, π = Total Revenue (TR) – Total Cost (TC) = (PQ – TC)

 

Demand, Q = 38650-42P

Or, P = (38650 – Q) /42

Or, P = 920.2381 – 0.02381Q (Inverse Demand Equation)

Here, P= 920-0.102381Q

MC= 100 + 0.0126424Q

 

Total Revenue: TR = (PQ) = (920-0.102381Q )* (920.2381 – 0.02381Q)

                                           = 846619.1 -116.12 Q + 0.002438 Q²

Marginal Revenue: MR = d/dq (TR/Q) = d/dq (846619.1 -116.12 Q+ 0.002438 Q²)

                                       = -116.12 + 0.004875 Q

 

Now at market equilibrium point,

          MR=MC

Or, -116.12 + 0.004875 Q = 100 + 0.0126424Q

Or, 216.12 = 0.007767Q

Or, 0.007767Q = 216.12

Or, Q = 216.12/0.007767

Or, Q = 27823.98 Units (Approximately)

 

Price, P = 920.2381 – 0.02381Q

= 920.2381-(0.02381*27823.98)

= 920.2381 – 662.489

= 257.75 cents

 

         With previous market structure (perfectly competitive market), profit maximizing price and quantity were 22501 (3 units pack), and 384.5 cents 3 units pack. Now, with monopolistically competitive market structure, the profit maximizing price and quantity are 257.75 cents (approximately) (3 units pack), and 27823.98 Units (Approximately) respectively. With monopolistically competitive market structure the price is lower (as the company has now more control over price) and quantity are higher than that of price and quantity were as with monopolistically competitive market structure the company has more market power and pricing option.

 

             6. The financial performance of the company can be judged and evaluated by observing capacity of the company in achieving economic profit in short run, and in achieving normal profit in the long run.

 

Short Run Performance Measurement

In the short run, Katrina Candies has achieved economic profit besides normal profit.

Economic Profit = (Price – Average Total Cost)* Quantity

                          = Total Revenue – Total Cost

                          = (257.75* 27823.98) – (160,000,000 + 100*27823.98 + 0.0063212*27823.98²)

                          = 21,100(98757.35) – 0.10 (98757.35)2 - 160,000,000 + 100(98757.35) + 0.0063212(98757.35)2

                           = $3396.83

 

 

           The key drivers of the economic profit for the company in short run are as follows.

Controlling of variable cost: Katrina Candies is very efficient in managing its variable cost of production. Lower variable cost of production enables it to enjoy high economic profit. Lower variable cost managing is attributable by properly managing of raw materials costs (maintaining of a lot of less expensive but high quality suppliers), and cost of labors (hiring of skilled workers with comparatively less payment).

Utilization of Technology: Katrina Candies is technologically more efficient than that of other competitors in the market. Better utilization of technology enables it to design production method and product formula resulting lower production cost (less time and less wastage in the production process). 

Long Run Performance Measurement

             In the long run, Katrina Candies has achieved normal profit.  Economic profit is not achievable in long run in monopolistically competitive market.

Normal Profit = (Average Total Cost – Variable Cost)* Quantity

                       = (160,000,000 + 100*27823.98 + 0.0063212*27823.98²) – (100*27823.98+ 0.0063212*27823.98*27823.98)

                       = $18396.83

 

The key drivers of the normal profit for the company in long run are as follows.

• Katrina Candies has achieved substantial market power in setting its own optimal price. In the long run, the company can adjust its price to achieve desired profit.
• Katrina Candies has highly differentiated its products highly. High product differentiation enables the company to easily attract the customers and sustain its market share.

             The company is generating economic profit in the short run. Due to such economic profit, the industry is expected to be competitive in the long run. Economic profit in the short run will attract new players in the market. Entrance of new players in the long run will make the market competitive, and economic profit will not be sustained in the long run.

 

             7. In a monopolistically competitive market environment, profitability and delivering of high value to shareholders can be ensured by creating a dominant market position. Followings are two specific recommendations for the Katrina Candies to create a dominant market position as well as to improve profitability & deliver more value for the stakeholders.

 

• Katrina Candies should extensively focus on the product development and differentiation. The products of the companies should be unique in terms of design, related services, quality, location, or other attributes. It should devote substantial financial resources to support product development & differentiation. In a monopolistically competitive market structure, product development & differentiation is the key competitive strategy to combat in the market. The success of the product development & differentiation will be dependent on the research & development, and technology development & utilization capacity of the company. Thus, the companies should devote enough financial resources for the research & development, and technology development & utilization.

 

• Katrina Candies should extensively focus on the advertising and promotional efforts. Advertising and promotional efforts ensure informing of information about competing goods offered to the customers. Without proper advertising and promotion, the news of differentiated products of the companies will not be spread out to the customers. The success of advertising will be dependent on product message design and communication efficacy of the company. Thus, the companies should devote enough efforts and financial resources to ensure good product message design and communication to targeted customers.

 

 

 

 

Arnold, R. A. (2014). Microeconomics. New York: South Western Cengage Learning .

Boyes, W., & Melvin, M. (2013). Microeconomics. New York: Cengage Learning.

Harper College . (2014). Retrieved August 16, 2016, from MONOPOLISTIC COMPETITION: http://www.harpercollege.edu/mhealy/eco211/lectures/impcomp/impcomp.htm

Mankiw, N. G. (2013). Principles of Microeconomics. New York: Thomson/South-Western.

This Matter. (2015). Retrieved August 25, 2016, from Monopolistic Competition: Short-Run Profits and Losses, and Long-Run Equilibrium: http://thismatter.com/economics/monopolistic-competition-prices-output-profits.htm

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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