Principles of Economics - Research Paper Example

? Principles of Economics Assignment October 31 You own a local sub shop in a college town. You primarily servetwo groups of people: local residents (both students and other local residents) and visitors to your town. Devise a price discrimination strategy that will increase your revenues compared to a single-pricing strategy. The first order of business will be to identify the fast moving food items (fast movers) in our menu and the slow moving food items (slow movers). For the fast movers, visitors will pay 25 percent more than locals whereas for the slow movers visitors will pay 15 percent more than the locals. Locals pay less because the shop aims to develop deeper relationship with them and make them repeat customers. Our belief is that from the repeat purchases, the shop will be able to make good returns from the locals. Visitors, on the other hand are one-off purchases and that is the reason why the shop will charge them 15 percent and 25 percent more. An example of the effect of our strategy is described below: Say we sell the following two kinds of sub sandwiches: Italian sub sandwich – fast mover and a Veggie sub sandwich – a slow mover. Table 1: Price Discrimination of sub sandwiches Local Visitor Italian 4.00 5.00 Veggie 3.00 3.45 Say on a given day we sell to 25 locals and 20 visitors, the revenues are shown in the tables below: Table 2: Revenue earned with price discrimination Revenue with price discrimination Local Visitor Italian 100.00 100.00 Veggie 75.00 69.00 Sub total 175.00 169.00 Total 344.00 Table 3: Revenue earned without price discrimination (Italian sold at US$ 4 and Veggie US$ 3) Revenue without price discrimination Local Visitor Italian 100.00 80.00 Veggie 75.00 60.00 Sub total 175.00 140.00 Total 315.00 Percentage revenue increase due to price discrimination is  = 9.21% 2. Suppose the cable TV industry is currently unregulated. However, due to complaints from consumers that the price of cable TV is too high, the legislature is considering placing a price ceiling on cable TV below the current equilibrium price. If the government does make this price ceiling law, diagram and explain the effects with supply and demand analysis. If the cable TV company is worried about disgruntling customers, suppose that the company may introduce a different type of programming that is cheaper for the company to provide yet is equally appealing to customers. Explain what would be the effects of this action. The law of demand states that, ceteris paribas, the higher the price of a commodity, the less the demand will be. On the other hand, the law of supply states that, all factors being constant, sellers are more willing to supply goods at a higher price than at a lower price. This theoretical point at which sellers are willing to supply goods and buyers are getting all the commodities they are demanding is referred to as the equilibrium. The equilibrium is depicted in the figure below: Figure 1: Market equilibrium chart (“Economics Basics: Demand and Supply,” 2011) If the government make a price ceiling law on cable TV that sets the price below the current equilibrium price two things will happen immediately: (1) cable TV sellers will find the business less attractive because of increased possibility of lower revenues and thus they will lower their supply. (2) Consumers will find the lower prices attractive and thus they will increase their consumption and demand for cable TV. After some duration, the huge consumer demand and low supply will cause consumers to compete for the few cable TVs available. This is depicted below: Figure 2: Effect of price ceiling (Taylor, 2006) In a free market economy, the consumer competition for cable TVs will push the prices up, which will make sellers want to supply more and hence bring the price closer to its equilibrium. However, in this case, the price ceiling prevents suppliers from increasing the supply because of the low marginal benefits compared to marginal cost of supplying cable TVs. This eventually results in cable TV shortage (in the diagram the shortage = Q*sup – Qdem) (Taylor, 2006). The danger of shortages is that they will lead to a rise in cable TV black market. If, on the other hand, the cable company introduces a different type of programming that is cheaper for the company to provide yet is equally appealing to customers the company will be able to absorb the huge demand for cable TV while beating the prior negative effects of the price cap for the following reasons: (1) the cheaper type of programming will be subject to a different supply curve with a lower equilibrium price. In a best-case scenario the new equilibrium price may equal the price ceiling. (2) The marginal benefits will supersede the marginal cost thus the cable company will have the incentive to supply more. (3) The customers will get their demand satisfied at a price they are willing to pay. 3. Consider a perfectly competitive market. Analyze and explain in detail using graphical tools to show what you expect to happen to the number of firms and firm profitability in the short run and long run a) if demand for the product falls and b) if demand for the product rises. In a perfectly competitive market the following is true: (1) both buyers and sellers are price takers; (2) the number of firms is large; (3) there are no barriers to entry; (4) the firms’ products are identical; (5) there is complete information; (6) firms are profit maximizers. The profit-maximizing condition of a firm in a perfectly competitive market is that marginal cost (MC) equal to marginal revenue (MR) which is equal to marketing price (MP). This is shown in the equation below: MC = MR = P. When the demand for products falls (D0 to D1) the following scenarios play out. In the short run, prices will decrease (from B to A) and then output will decrease. Firm profitability goes down but firm numbers do not change. As shown below: Figure 3: diagram showing effect of fall in demand in the short run In the long run, the decrease in demand will have caused firm to have economic losses. Over time the economic losses will lead some existing firms to exit the market. When they have exited the market, supply reduces (from S0 to S1) and prices increase towards their previous level (from A to N). Figure 4: diagram showing effect of fall in demand in the long run When the demand for products rises the scenario plays out the inverse of the above. In the short run prices will increase and then output will increase. In the long run, the increase in demand will have caused firm to experience economic profits that will attract new firm to enter of the existing firm to expand their production. This will increase supply that will eventually lead prices to decrease to their previous level. 4. Discuss why some long-run average cost curves are steeper on the downward side than others. Discuss fully. The average cost curve is a line on a graph that shows the cost per product at each possible scale of operation from the minimum to the maximum. When looked at over a long duration, all the costs that a firm incurs are variable. The downward side of the cost curve shows how unit costs decrease from the point when the firm starts out with producing minimum output to the point at which the firm operates at optimum capacity. At optimum capacity the firm is fully utilizing its scale of production and therefore the average cost is at its least-cost point (minimum). A steeper downward side implies that unit costs decline rapidly for that firm in comparison to one that has a less steep downward curve. This generally depends on the type of firm and also on the industry that the firm operates in. For example a software company will have a different downward curve from a mining company. 5. If you purchased a new model of a digital camera right after it is released, you will likely pay more than if you purchase it six months after release. Explain why this is an example of price discrimination on the part of the firm. Some customers believe in being the first to own a product or experience a service especially over lifestyle categories of goods and services. To this group of consumers the drive to be the first to own supersedes price to the extent that they are always on the lookout for new offerings. If a particular product has a critical number of consumers that are driven towards becoming the first owners e.g. the iPhone, Harry Potter series of books, blockbuster movie etc. then the company can profitably price discriminate over time (Carlton & Perloff, 2004). Pure price discrimination over time is where the product is sold at a premium price during its launch and then the price goes down after a few weeks without change in production costs or increased competition. 6. Explain the rationale and the implications of the new guidelines used by the Department of Justice and the Federal Trade Commission for evaluating proposed mergers. The rationale for releasing the new guidelines to be used by the Department of Justice and the Federal Trade Commission for evaluating proposed mergers is to provide more clarity and transparency to businesses seeking to engage in mergers and acquisitions (Quinn, 2010). This way business can tell beforehand whether they will be successful with their application or not. Additionally, the new Guidelines take into account changes that have taken place in the legal and economic arenas since the last revision in 1992 . From the guidelines one thing that stands out is the Department of Justice’s and the Federal Trade Commission’s focus on protecting competition and innovation within the American business sector. Mergers and acquisitions (M&As) that may substantially lower competition, or to tend to create a monopoly will be rejected. So too will those M&As that are viewed as done to kill innovation. Some of the major implications of these guidelines are that: (1) it will enable companies save on resources that they may have wasted on a merger or acquisition that ends up being disapproved; and (2) it provides the legal fraternity with more clear guidelines for those who would like to seek legal redress. References Carlton, D. W., & Perloff, J. M. (2004). Chapter 9: Price Discrimination. Modern Industrial Organization (4th ed.). London: Pearson Education. Economics Basics: Demand and Supply. (2011, October 31).Investopedia. Retrieved November 1, 2011, from http://www.investopedia.com/university/economics/economics3.asp#axzz1cRYV7C3Z Quinn, G. (2010, August 22). FTC and DOJ Issue Revised Horizontal Merger Guidelines. IPWatchdog.com. Retrieved November 1, 2011, from http://ipwatchdog.com/2010/08/22/ftc-doj-revise-horizontal-merger-guidelines/id=12157/ Taylor, B. (2006). Price Ceilings - Economics. economics.fundamentalfinance.com. 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