Trading In a Monopolistic Competitive Markets - Case Study Example

Name: Tutor: Title: Course: Trading In a Monopolistic Competitive Markets Institution Date of Submission: Table of Contents Table of Contents 2 1.0 Introduction 4 2.0 Pepsi Company as a Monopolistic Business Practice 5 3.0 Characteristics of Monopolistic market Competition 5 3.1 A fairly larger competing firm in the market 5 3.2 Products Differentiation under Imperfect Competition 6 4.0 Freedom of entry/exit under imperfect competitive market 7 4.1 The Equilibrium in the short period and the long term 7 4.2 Effect of New Brands Entry on Pepsi-Cola’s (Brand X) Demand 9 5.0 Research Findings 10 5.1 Pepsi-Cola product Profit Contribution in the Short Run 10 5.2 Pepsi-Cola product Profit Contribution in the Long Run 10 5.3 Nature of product demand curve 12 5.4 Advertising and Branding 12 6.0 Conclusion 16 7.0 Bibiliography 17 Executive Summary The report reveals business activities and market competition as practiced by PepsiCo. Attention is directed on the US market were PepsiCo has for years developed a massive customer base. The firm is an established producer of snacks partnering with Frito-lay Company. Our focus is on the firms business competitiveness in the US market, in particular report focuses on firms business practices on the soft drink products. PepsiCo produce and supply Pepsi-cola beverages in the US market among other countries, this brand has gained an increasing rivalry from other brands in the market with Coca-cola being the potential rival particularly in the US market. The firm is placed in a market where three features can best explain for of market completion it is involved in. these include a) The market creates the possibility of firms to freely enter and leave the market b) Their several firms in this market c) Products in the market are differentiated by use of brands. Products in this market are typical substitutes of other firm’s products. A good example is revealed in products such as Coca-cola which is supplied by Coca-Cola Company while Pepsi Company supply a similar product identified as Pepsi-cola (Pindyck, 2001). In addition, the report reflects on issues of Pepsi-cola battle in the market against other brands both on the short term and on the long run suggesting possible effects on the product demand, supply, and pricing among other related measures. In the report we discuss micro-economic characteristics as identified in a monopolistic competitive market as PepsiCo products are placed in this form of market. 1.0 Introduction Pepsi Company is among most successful consumer products firms in the world. The firm is said to have 2000 revenue sources generating estimated sales revenue of over $ 20 billion annually. The firm consists of Frito-lay Company, on of the established producers and supplier of snack particularly chips (Cline, 2005). The firm has an estimated employee workforce of about 125,000. Pepsi Company is also reported to be the second largest soft drink business and Tropicana product, the largest dealer and producer of branded fruit drink. The firms brands are among the top known and respected a cross the globe and are available in a bout 190 countries worldwide. Pepsi bottling Group for instance is among the world’s largely known producer seller and supplier of Pepsi-cola beverages. It separated from its parent in 1999, in this year alone Pepsi Bottling group sales accounted for an estimated 55% of Pepsi-cola beverages sold in US with over 30% reflection of a worldwide revenue contribution to the mother company. The firm’s strongest presence is in US and Canada. However, it also holds special Pepsi franchises in Greece, Russia and Spain. The company for long time has been supplying its products directly to stores without using middlemen. The firm products faces increase competition from other substitute suppliers, with biggest rival on Pepsi-Cola brand being coca-cola. 2.0 Pepsi Company as a Monopolistic Business Practice Pepsi Company can be characterized under a monopolistic competition setting. This can be revealed in the company’s operational structure serving with many apparel stores and differentiated products. The firm is able to differentiate its product, unlike under perfect competition where products are never regard as identical. An ease entry to this market industry is considered another important requirement in this form of competitive market setting (Goodwin & Ackerman, 2009). 3.0 Characteristics of Monopolistic market Competition 3.1 A fairly larger competing firm in the market The number of firms in an imperfect competition is fairly large. The circumstances are that each firm produce and manufacture and sell products that are close substitutes of other competing firms in the market. It is this set of circumstances that product differentiation seen to be the main feature of monopolistic competition. PepsiCo main market rivals are Coca-cola and Cadbury Schweppes among other product soft drink rivals in the industry. 3.2 Products Differentiation under Imperfect Competition In cases of imperfect competition, firms sell differentiated products. Product differentiation can be real or invented. Real differentiation is done through differences in materials used, color, and design among other factors. An invented deference’s is created through advertisement, brand name and trade marks (Goodwin & Ackerman, 2009). In this form of market the firms producing substitute products in this form of imperfect competitive segment does not trigger increased prices on the products. For instance, strategies developed by PepsiCo soft drink marketing team does not have to be much higher than their market potential rivals, in our case we the team has to compare the company’s products to either Coca-cola’s substitute product price or that of Cadbury Schweppes. This is important as a higher prices will trigger reduced sales for the firm, on the other hand in case they consider lowering their products price, the total sale can increase significantly to a given extent. More often how much the product sales will increase under this circumstance majorly depend on product differentiation of the rival firms in the industry. If product of competing firms are close substitutes of the rival each rival firms in the market and known imaginary or real differentiation felt by buyers, then a slight price drop or climb in products of one firm will considerably decrease or increase to a given extent. How much the sale increase or drop by either lowering or increasing price? This will certainly depend upon product differentiation of the other market competitors. For instance, if Pepsi soft drink products prices are revised down by 2% on the current rate, it may possibly influence consuming pattern in the market with a possible increase in sales and a commanding market share. While a possible increment trigger the opposite reaction. This effect is driven to other market player such as Cadbury Schweppes will have to possibly adjust their product selling price in an effort to retain their market share (Goodwin & Ackerman, 2009). It is important that PepsiCo measure the cost potentials competitors to enter the soft drink industry. Considering technology required in production of soft drinks is widely available for potential competitors. However, it is difficult competing on a national scene requires the firm to produce and distribute a well known brand. Considering this demands, it is evident that PepsiCo is not the only firm that has to spare funds needed in product promotion, other firms such as Coca-cola and Cadbury Schweppes go through the same promotional campaign path. Product branding serves to 4.0 Freedom of entry/exit under imperfect competitive market There are no obstacles that may hinder new firms to enter the product group or in the long run leave the industry. 4.1 The Equilibrium in the short period and the long term Just like in a perfect competitive market, firms under imperfect competition develop monopoly power and hence they face a down ward demand curve. According to Holt (1996), argument he reveals that this kind of market setting the profit maximum rule is achieved where MR = MC, and therefore, MR< P, in the short run the firm may earn a positive economic profit as indicated in figure below. Figure 1 Figure 1, Source: Perloff, 2008 4.2 Effect of New Brands Entry on Pepsi-Cola’s (Brand X) Demand Figure 2, Source: Perloff, 2008 In a situation that there is a positive profit, there will higher chances that more firms will gain interest to make an entry into this market, which will ultimately influence prices to drop. Reduced price will alter both demand and marginal revenue (MR) curves of Pepsi company products down, an effect that will have Pepsi Company’s or other firms serving on the market profit shrink with to become lowest point (TR=TC alternatively P=ATC). As reflected in the figure 2 the tendency between the new inverse demand P and ACT curve (Laury, 1999). Due to the free entry and exit firms under imperfect competition will earn no profit in the long run. This is well lustrated in the figure 2, where MC = MR correspond to the point reflecting demand curve to be tangent to the ATC curve achieving no profit. 5.0 Research Findings 5.1 Pepsi-Cola product Profit Contribution in the Short Run The short run equilibrium of Pepsi-Cola under the imperfect competition will fully maximize on profits while they produce a quantity where firm’s marginal revenue (MR) is equal to its marginal cost (MC). This is calculated based on the average revenue (AV) curve. The deference between the firm’s product average revenue and average cost when multiplied by the quantity of product sold (Qsr) gives the product total profit. 5.2 Pepsi-Cola product Profit Contribution in the Long Run The initial positive profits encourage entry of other firms who introduce competing brands. For example we look at initial profits generated within the US market by PepsiCo and Coca-Cola Co on soft drink products among other firms substitute products triggered entry of other many product providers (Laury, 1999). Ultimately Pepsi Company among other existing firms in that market will lose a measurable share market and the demand curve will shift downwards (Figure 2). ATC and MC may at a point shift especially when more firms enter the US market. When there is know alteration witnessed in the cost curves. The effect will be felt at Dlr will drop down until it becomes tangent, this will be a long run observation, where AC correspond to the equation, with MR = MC. This result reflects no profit is generated in the long term process. The diagram below illustrates the market for Pepsi-Cola at the long run equilibrium. Figure 3, source: Pindyck, 2001 The consumer surplus from purchase of Pepsi- cola is in A + B. The efficient level of output is reflected where demand curve intersects with the marginal cost curve at QC. In our case the dead weight loss is represented by area C, the region above marginal cost and which is below demand in between QM to QC. 5.3 Nature of product demand curve The existence of close substitutes significantly influence monopoly power, the demand curve faced by a monopolistic competitive firm is often associated with a fairly elastic demand curve. The defined degree of elasticity majorly depends upon number of firms in the in the market. Our case PepsiCo market is faced with a fairly large and their products are not very similar, its demand curve remains quite elastic. However, in cases where close competition is evident among rival firms when it concerns sale of similar products results have proved that in this case demand curve will reflect a less elastic result (Laury, 1999). 5.4 Advertising and Branding This is one important characteristic of any monopolistic completion set up. Here each firm tries to create deference in its product from other firm’s. More often this idea is promoted through advertising, attractive packaging and misinformation. This is done with an objective of commanding an increased market share in a manner that it may end up occupying the place of a monopolist. In this position firm is set to raise product prices with know indications of reduced customers share in the market (Pindyck, 2001). Figure 4 In micro-economics there three key attributes of imperfect competition as: a) Existence of many sellers b) Each company produces a slightly different product c) Firms can enter or make an exit in the market freely In our diagram above, It is revealed that the long-run equilibrium in imperfectly competitive market. The equilibrium differs from that of a perfectly competitive market, since price exceeds marginal cost (MC) and the firm out come indicates that it does not produce at the least possible point of the estimated average total cost (AC). Under this circumstance advertising may creates reduced markets competitiveness as it serves to influence consumer’s tastes rather than serving the purpose indented that is giving information on the product (Holt, 1996). Product advertising develops consumer perception that there is a greater dissimilarity between two or more products than it really exists. Thus demand curve for product gains a more inelastic as firms charge higher mark-up over the incurred marginal cost. According to Hemphill (1994), reveals that some other form of advertisements may create increased competition among the products, since products promotion is one primary objective of delivering useful information to consumers, this may create a situation where consumers to take advantage of price variation. Often consumer, perceive expensive product promotion to signify quality. In addition, advertising allows entry as it serves to inform customers on possible entry of new product. This is a typical situation face by Pepsi Company products, the firm products are faced with a frequent entry and exit competition from other firms within the market it serves. 5.5 Non-price Competition Situation Firms trading under imperfect competition market’s situation make every effort to succeed over the customer share in the market. Other than in a perfect competition markets where price increment is eminent, price cutting is characterized by this kind of market competition with firms embracing after sales service and gift scheme or discount on products that part of the elements that are not declared in the price list (Pindyck, 2001). With this kind of diversity, the firm’s products is no longer taken for granted, this is because product sale will majorly depend upon sale efforts. Since each firm in an imperfect competitive market produces a product that is slightly different from other products, this kind of market setting creates the possibility having introduction of many product. Whether the number is optimal or not it depends on two externalities (Ball, 1998). a) The business product variety externality is often looked at as an encouraging externality to consumers while introducing new product. b) Business stealing externality is an unhelpful externality, since other firms lose customers and profits by addition of a new product. Since the competitor does not use these externalities into account in deciding whether or not to go into the market, it is never clear to whether the real number of products will be most favorable, or even below optimal (Hemphill, 1994). As reflected in the report monopolistically competitive firms differentiate their products in order to increase some control over the price. In this situation, products on offer are never ideal substitutes, a case that makes them demand less than perfectly elastic. The ultimate implication on this is that some consumer won switch when price is increased within a certain limit, while other customer will immediately switch to other products. For instance, a typical is witnessed between Pepsi-Cola and Coca-cola among other brands in the US market, increase or drop in product brand of either firm will shift their customer share either downwards or to a higher share in the respective firms (Hemphill, 1994). 6.0 Conclusion The monopolistic market model as revealed earlier in our report, presents several critical features. More often the product manufactured carry features that are almost identical. Usually in this form of market competition products are differentiated through branding in our case we have PepsiCo which offers Pepsi-Cola as one of the product in this imperfect completion market, while Coca-Cola Co supplying Coca-Cola products in the same market, this are just two examples among many others within the very same market, competing for same customers. In this form of market pricing is never an issue, infect, our report reveals that firms have no control over prices but rather the market do decided (Hemphill, 1994). This is derived from supply and demand of these substitute products. Price in this case is driven to be come identical across all competitors in the market. For instance, if Pepsi and Coca firms are confronted by a new product supplier in their market, they initiate a very powerful campaign. This will see respective firms product price drops closer marginal cost, as their production segment will make fewer units compared to pervious periods prior to competitor’s arrival. 7.0 Bibiliography Ball, S. B 1998, Research, Teaching, and Practice in Experimental Economics. Review Article, Southern Economic Journal , Vol. 64:(3), pp.772-779. Cline, A. D 2005, A Consumer Behavior Approach to Modeling Monopolistic Competition. ournal of Economic Psychology , 26 (6): 797–826. Goodwin, N. N., & Ackerman, F 2009, Microeconomics in Context 2d. Sharpe, London. Hemphill, T. A 1994, Beyond Competition: The Economics of Mergers and Monopoly Power, Southern Economic Journal . Holt, C. A 1996, Trading in a pit market. Journal of Economic Perspectives, 10(1): 193-203. Laury, S. K 1999, Multi-market equilibrium, trade, and the law of one price. Southern Economic Journal , 65(3): 611-622. Perloff, J 2008, Microeconomics Theory & Applications with Calculus. London: Pearson. Pindyck, R 2001, Microeconomics 5th ed, Prentice-Hall, London. Read More