The Reasons of the Firms Collusion - Assignment Example

Assignment The Industry Environment Institute Part: A Why did the firms collude and what are the problems faced by the firms when they act as a cartel? ‘Game theory’ is a theory of mathematics that is extensively employed by economists to present the solution of a firm behavior in oligopoly or duopoly. The firms colluded due to the following reasons: To earn maximum profit by either entering into cooperative or non-cooperative games. In case of cooperative games, the firms enter into a contract by carrying discussions to plan their strategies regarding advertisement, the style of product and other investments. On the other hand, in case of non-cooperative games, competitor firms evaluate the likely behavior of each other and make independent market decisions about variables, like advertisement, determination of price, etc. Another very important reason behind making collusions is to make market strategies after assessing the behavior of other competitive firms in the market. The firms may face the following problems after making cartels: Stealth price cuts by any of the firms in the cartel, in order to reap more profit than its competitor. There are cost differences between the firms of cartel. For example, the firm with lower cost will sell more output and earn more profit, but this is not possible in the cartel, as cartel firms are obliged to share the profit irrespective of their cost structure. The monopoly profit of the firms in cartel may decrease because all firms have to sell the product at the settled price. The cartel firms may lose a big portion of their profit due to unrestricted entry of a new firm. The Commission strategy under the light of game theory The commission has adopted a dominant strategy by threatening price fixers with extremely large fines on one hand, and at the same time, promising the whistle-blower an escape from the huge fine of 331 million pounds. This strategy is dominant because it will provide optimal results to the commission. This is because no firm will collude again due to the fear of having to pay a big amount of fine. Moreover, the existence of whistle-blowers like Micron is another negative factor. Pay off matrix for the annual profits from different bidding strategies Pay off Matrix for Bidding Game MeFirst High Bid Low Bid WildWest High Bid £150000, £150000 £0 , £220,000 Low Bid £220,000, £0 £100,000, £100,000 The advantage to the local authority This matrix gives the following results: If both companies bid high, then the local authority have to pay an amount equal to £300000. If both make a lower bid, then the authority will have to pay the amount equal to £200000. If one bids lower than the other, then the company will have to pay an amount equal to £220,000. If both corporations make high bids, then each will earn an amount equal to £150000. If both make low bids, then each will earn an amount equal to £100,000. If one makes a low bid than the other, then that corporation will earn an amount equal to £220,000. The authority will try to allot a contract to the lower bidder, because in this case it will have to pay £ 200000 only. Whilst, bidders will try to earn maximum profit by cutting down each other, so if the contract is split up into two companies, then the authority has to pay £220,000 which is less than £ 300000 and more than £ 200000. However, if one company succeeds in obtaining the contract, then the authority will have to pay £220,000 which is again lower than £ 300000 but greater than £ 200000. In short, two possibilities can prove beneficial to the authority: If both companies make the same low bid. If one company bids lower than the second company. Result analysis The result of the secret competitive tendering was observed by repeated games, because the bid involves two competitors with many bidding options. Both bidders will try to earn the maximum profit by cutting back the other. Both will be afraid of making high bids, because in that case, one of them will end up losing the contract. In short, a final decision can be reached after playing repeated strategies and assessing the moves of each other. Part: B Industry environment analysis by using the Porter 5-forces Introduction The concept of beauty care industry is as old as mankind. A man is born with the wish to look beautiful and in order to satisfy his wish, he utilizes all his resources. The beauty industry is the manufacturer of many beauty enhancing products like perfumes, make-up items, hair items, creams, etc. There is a general concept that women have more interest in this industry than men. Joan Holleran, who is the director of research at Mintel stated, “Many women have a deep emotional tie to their appearance, so cosmetics have a highly significant place in their lives. These women may not spend money on other purchases and forgo expensive vacations, but they will still treat themselves to small, feel-good luxuries like make-up and beauty products." (Mintel, 2009) Nowadays, the beauty industry takes care of every aspect of women’s appearance. Today, investors like to invest in this industry in spite of the extremely tough competition. However, the belief that beauty industry is related to women only, is fast transforming. This can be viewed by observing the launch of beauty products for men as well .In addition, the number of salons and beauty pageants for men is also going up with the each growing day. Black (2009, p. 2) states that “During the past few years, I have looked through the beauty salon windows in every town of every part of the world I have visited and received beauty treatments and collected endless price lists for a huge variety of these treatments.” In the beginning of the 20th century, the commercial cosmetics industry started growing substantially. Between the period of 1910s and 1950s, print media initiated the campaign to inform women about the ways to enhance their looks. This was the time when the demand for cosmetics and other beauty products started growing. With the improvement in technology and increased awareness, people have now become more conscious about beauty care. This self consciousness accelerates the importance of the beauty industry. Today, this industry is making a good contribution to the national income of the country. The cosmetics industry therefore, is one of the few industries that have successfully endured the recent economic downturn. In this paper, I will analyze the environment of this industry by employing Porter 5-forces. Threats of New Entrants The high returns of beauty industry attract new entrants, due to which the profit of the existing firms is divided. Recently, many new firms entered into this industry. Due to these new entrants, there is now a higher degree of competition. However, a few factors can still limit this development, such as the increase in government taxes, high fixed or variable costs of production, product differentiation and scarcity of resources. Due to new entrants, many financially weak firms are now forced to leave the beauty industry, whilst giant companies like Procter & Gamble and Unilever, etc are still ruling the market. Power of Supplier The manufacturers of the cosmetics industry have a very strong market power because of the growing demand of cosmetics and other beauty products, all over the world. Mentel forecasted “healthy growth for sun care products, with sales expected to increase 36% from 2008 to 2013” (Mintel, 2009). There are many factors that contributed to the increase in strength of the suppliers such as: Consumer’s confidence on the brand, for example, the Procter & Gamble Company takes away a large portion of the profit margin of this industry every year. The quality of the product plays a very significant role. For example, in case of beauty care products, a consumer always buys a quality product from a reliable company like Unilever, Johnson and Johnson, etc. Power of Buyers In case of the beauty industry, the power of buyers is less than that of suppliers. This is because some beauty products like lipsticks have become a necessity for women. Joan Holleran stated in the same online press release, “Mintel expects sales of anti-aging skincare products to increase 20% over the next five years. However, Mintel forecasted a 44% five-year growth last year, but given the current economic climate, the new market forecast is considered more significant” (Mintel, 2009). However, the presence of unlimited beauty care brands has increased the power of buyers. A consumer is always responsive towards prices, so as a result, he can easily exploit suppliers. Availability of Substitutes The beauty product industry is densely populated with the number of buyers of all ranges. There is a very strong possibility of brand switching in this market. For example, if prices of the products by Unilever increase, then consumer can easily shift to the products of Procter & Gamble Company. Joan Holleran stated, “Personal care companies now need to focus on value, feel-good benefits and new product innovation to keep shoppers interested" (Mintel, 2009). Competitive Rivalry The industry of beauty products is extremely competitive market, due to the availability of thousands of substitutes. In industries where competition is higher, the firm earns normal profits. This is also the case with the beauty industry. Although, the competition level is high in this industry, but the demand of beauty products is high as well. Therefore, many giant companies of this industry are earning enormous profits every year. There are many reasons behind the high competiveness of the beauty industry: Presence of a large number of homogenous products and absence of a single giant firm. The low level of the product differentiation. Conclusion Porter 5-forces have widely covered the factors influencing the charm of an industry. For instance, it highlights the competiveness of this industry from almost all important aspects. Moreover, it also highlights the positions of buyers and suppliers separately in detail, by explaining the determining factors of the two constituting market figures: the producers and the consumers. Although, the beauty industry is already very appealing but the Porter 5-forces analysis makes this industry more attractive, especially for investors. There are many factors behind the growing appeal and value of this industry, such as globalization, consciousness, urbanization, modernization and the rapid change in fashion trends. One of the most prominent characteristic of a rational investor is his strong vision and his vast knowledge about the latest market trends. Under the light of these market trends, investors make investments in industries that have a promising future and the growing beauty industry therefore, is a good place to make a healthy future investment. There are many other factors affecting the appeal of this industry like modernization, the effect of demonstration, the rapid change in fashion trends, the increase in civilization and the recent advancement in technology. The recent global economic downturn hit every sector of the economy, but the manufacturers of beauty products endured recession fairly well. This is because of the increased value of this industry and the vast product range. Today, all giant companies in the beauty industry are introducing a wide range of products for men as well. There are some beauty products like anti-ageing creams that are equally popular among men and women. These anti-ageing products include solutions and supplements to remove/ reduce wrinkles from your face. In short, marketers and advertisers are not only focusing women for their beauty care products, but at the same time also encouraging men to use their products. Assignment: 2 The Macro Environment Name Institute The EU Stability and Growth Pact Some leading economists have devised a few indictors- so that they can check the health of different economies. These indicators are based on gross domestic product, gross national income, government debt and deficit worldwide. Gross domestic product is the total estimation of the income that is earned by the residents of the country during a year. This measure excludes the incomes earned by the nationals, living outside the geographical boarders of the country. The countries with increasing national debt prefers GDP calculation over GNP; as the former doesn’t decrease if a country sells off its resources to entities outside their country. Likewise, government deficit means the fall in government revenue against its spending. It is one of the components of a balance of payment (BOP) that is a record sheet of country’s all monetary transactions. A government will face deficit when its revenues fall short of its income; whilst the surplus occurs when government revenues exceed its income. Government debt is the total amount of money that is borrowed by the government from international or domestic financial institutions. The ratio of government debt to gross domestic product is a measure to indicate that governments going bankrupt. Therefore, the treaty of Lisbon was signed by Member States of Economic and Monetary Union (EMU), to ensure the sustainable economic and monetary union (EMU). In this treaty it was decided that the ratio of government deficit to gross domestic product must not exceed 3% and the ratio of government debt to gross domestic product must not exceed 60%. High levels of government deficit and debt are detrimental for the health of any economies worldwide. The economies that face persistent deficit along with high debt are deemed as underdeveloped and under-developing. Persistent deficit in developing countries is caused by the way these governments have to borrow either from international or domestic financial institution to meet their expenditure. The increased borrowing along with persistence deficits sabotages the growth and development in the country. The governments borrow money for the state if the ratio of deficit of the member state to gross domestic product exceeds to the set percentage of 3%, then the states, in order to finance their deficit, have to borrow. Resultantly, the ratio of government debt to gross domestic product will exceed the limit of 60%. This all will not only reflect adversely on the growth rates of the economy but also lead a country to bankruptcy. The list of EU states that are violating the rules is given below: Belgium with the ratio of 96.7% debt to gross domestic product. Germany with the ratio 73.2% debt to gross domestic product. Austria with the ratio of 67.5% of debt to gross domestic product. Ireland with the ratio of 64.0% of debt to gross domestic product. Greece with the ratio of 115.1% of debt to gross domestic product. France with the ratio of 77.6% of debt to gross domestic product. Italy with the ratio of 115.8% of debt to gross domestic product. Hungary with the ratio of 78.3% of debt to gross domestic product. Malta with the ratio of 69.1% of debt to gross domestic product. Netherlands with the ratio of 60.9% of debt to gross domestic product. Portugal with the ratio of 76.8% of debt to gross domestic product. United Kingdom with the ratio of 68.1% of debt to gross domestic product. Graphical Representation of the relationship between National Income and Aggregate Demand An aggregate demand is a curve that is composed of consumption, investment, government spending and net export; whilst National Income is the money value of all goods and services produced in a country within a year. Mathematically AD is written as: AD = C + I +G + (X – M) C = Consumption. I = Investment. G = Government Spending. (X-M) = Net Export. All the above stated components of aggregate demand are the building factors of national income. The increase in any component of aggregate demand means an increase in national income. To show the relationship between aggregate demand and national income we have to use the Keynesian cross diagram: The effects of increase tax and reduce spending on an economy in short run A Value added tax is the type of tax that is imposed to cut down consumption in an economy. With the implementation of VAT the consumption level of the country will decrease, whilst the government revenue increases drastically. The primary purpose of this tax is to restrict consumption in order to face the repercussion of the recent global crisis. The effects of austerity measures are graphically represented below: In the above figure, after imposition of VAT the prices will go up, resultantly demand will squeeze in an economy. As VAT is consumption tax, so it will cut down the consumption. Investments and employment level will also go down as the result of VAT. Therefore, the economy will attain the new equilibrium position shown by (e’) in the figure, at comparatively high prices and lower output. Usually there care more chances of an increase in inflation after implementation of VAT, but in short run these chances of increased inflation will be comparatively murky. The lining area in the figure shows the total consumer surplus, while the dotted area depicts total producer surplus. The dead weight loss will increase which is shown by the area of blue dots. The government will be one of the biggest beneficiaries of this tax as it drastically increases tax revenue, shown by the area of red dots in the figure above. By implementation of VAT, the income earning group will suffer the most. Moreover, with the implementation of VAT, the imports will decrease. The effects of VAT on import and export depends on the nature of the good , for example, if VAT is levied on the goods that UK imports then, then it will give boost to country’s export and indigenous products. On the other side, if the tax is charged on the commodities that UK exports then VAT affects country’s trade pejoratively. Discussion on the austerity measures in UK A value added tax is one of the consumption taxes that greatly contribute to the total revenue of the UK. If we look at the history of UK taxation structure; it may be concluded that it is imposed on the final consumption of particular goods as well as services in the country. This tax is levied on the production and distribution levels of the products alike. Therefore, all kinds of businesses should be ready to face this big increase. Recently, the VAT rules have been revised in the United Kingdom- and the new rate of tax has been increased from 17.5 % to 20%. There are many economists who oppose this decision of the government by presenting their view, that this increase in VAT will worsen the economic conditions of the state instead of showing any improvement. For many economists this increase in the rate of VAT will swallow millions of jobs in the UK as it always has a significant effect on employment. A VAT has always been an attractive tool for governments as it is the largest source of government revenues, especially in the UK. Undoubtedly the tax will increase the government revenue significantly but at the cost of unemployment. This increase in unemployment will create more problems for the UK government, because it is already trying to cope with the intense downfall. Besides this, if the increase in unemployment rate persists for the longer time period, it could cause a severe rate of inflation in the country. Resultantly, the high inflation accompanying with high unemployment level will push the country into stagflation (assuming all the other factors remain constant). Joseph Stiglitz, a Nobel Laureate economic professor, opined that such austerity measures could be harmful for the UK economy in the situating when the country is already combating with many aftermaths of global economic downturn. Moreover, he is of view that the income earning group will suffer as the result of this increase. He believes that such policies can drag European economy to the new recession that would be more intense than the previous one. In the situation, when the ratio of government debt to the country’s GDP is growing, this step could intensify the crisis instead of dissolving. Undoubtedly, the recent global crisis hit the European economy very hard after the great depression of 1930, but in order to come out of this fragile situation, European countries need to devise their economic policies very delicately. Moreover, the governments should not make use of aggressive economic policies; as such policies cannot help any government in any way. In short, the time is the biggest measuring scale to check the validity of all economic moves. Time will indicate whether these steps proved helpful to cope up the challenges of global economic crisis or they worsen the situations. Reference Black. P.,2004. The beauty industry: gender, culture, pleasure. Routledge BBC, 2010. Budget: Osborne defends decisive plan on tax and cuts. [Online] Available at: http://www.bbc.co.uk/news/10385052. [Accessed 27 November 2010]. BBC, 2010. Joseph Stiglitz concerned about second recession. [Online] Available at: http://news.bbc.co.uk/2/hi/programmes/world_news_america/8698396.stm. [Accessed 27 November 2010]. Europa, 2010. Europa Glossary Convergence criteria. [online] Available at: http://europa.eu/scadplus/glossary/convergence_criteria_en.htm. [Accessed 27 November 2010]. Eurostat, 2010. Statistics Database. [online] Available at: http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/.[Accessed 27 November 2010]. Europa, 2010. Antitrust: Commission fines DRAM producers € 331 million for price cartel; reaches first settlement in a cartel case. [Online] Available at: http://europa.eu/scadplus/glossary/convergence_criteria_en.htm. [Accessed 27 November 2010]. Mintel, 2009. What Women Want: Mintel identifies which beauty products women won’t trade down on. [Press release], April 2009, Available at: http://www.mintel.com/press-centre/press-releases/343/what-women-want-mintel-identifies-which-beauty-products-women-wont-trade-down-on [Accessed 25 November 2010] Office of National Statistics, 2010. Key Statistics. [online] Available at: http://www.statistics.gov.uk/default.asp. [Accessed 27 November 2010]. Read More