Chapter 13
MONOPOLISTIC COMPETITION AND OLIGOPOLY
QUESTIONS & ANSWERS
Q13.1
Describe the monopolistically competitive market structure and give some examples.
Q13.1
ANSWER
Monopolistic competition is a market structure quite similar to perfect competition in
that vigorous price competition among a large number of firms and individuals is
present. The major difference between these two market structures is that at least
some degree of product differentiation is present in monopolistically competitive
markets. As a result, firms have at least some discretion in setting prices. However,
the presence of many close substitutes limits the price-setting ability of individual
firms, and drives profits down to a normal rate of return in the long-run. As in the
case of perfect competition, above-normal profits are only possible in the short-run
before rivals are able to take effective counter measures.
Examples of monopolistically competitive market structures include a broad
range of industries producing clothing, consumer financial services, professional
services, restaurants, and so on.
Q13.2
Describe the oligopoly market structure and give some examples.
Q13.2
ANSWER
Oligopoly is a market structure where only a few large rivals are responsible for the
bulk, if not all, industry output. As in the case of monopoly, high to very high
barriers to entry are typical. Under oligopoly, the price/output decisions of firms are
interrelated in the sense that direct reactions from leading rivals can be expected. As
a result, the decision making of individual firms is based, in part, on the likely
response of competitors. This "competition among the few@ involves a wide variety
of price and nonprice methods of interfirm rivalry, as determined by the institutional
characteristics of a particular market setting. Although fewness in the number of
competitors gives rise to a potential for excess profits, above-normal rates of return
are far from guaranteed. Competition among the few can sometimes be vigorous.
Examples of the oligopoly market structure include such industries as: bottled
and canned soft drinks, brokerage services, investment banking, long distance
telephone service, pharmaceuticals, ready-to-eat cereals, tobacco, and so on.
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Q13.3
Explain the process by which economic profits are eliminated in a monopolistically
competitive market as compared to a perfectly competitive market.
Q13.3
ANSWER
In a monopolistically competitive industry, excess profits are eliminated in the longrun through imperfect emulation of successful product design, production systems,
and marketing efforts by both established and new competitors. Excess profits are
eliminated in a perfectly competitive industry through expansion by established firms
and entry of new firms, both of whom offer identical products that are perfect
substitutes.
Q13.4
Would you expect the demand curve for a firm in a monopolistically competitive
industry to be more or less elastic in the long run after competitor entry has
eliminated economic profits?
Q13.4
ANSWER
In most instances, demand will be more elastic in monopolistically competitive
industries after excess profits have been eliminated. The effect of increased
competition will typically be to make firm demand curves more elastic given the
greater availability of close substitutes. However, it is conceivable that increased
competition would simply involve a parallel leftward shift in the firm demand curve.
As discussed in the chapter, monopolistically competitive equilibrium will typically
involve a price-output combination between the high price-low output equilibrium
reached following a parallel leftward shift in demand, and the low price-high output
(perfectly competitive) equilibrium reached when the firm demand curve becomes
perfectly elastic.
Q13.5
AOne might expect firms in a monopolistically competitive market to experience
greater swings in the price of their products over the business cycle than those in an
oligopoly market. However, fluctuations in profits do not necessarily follow the
same pattern.@ Discuss this statement.
Q13.5
ANSWER
Oligopoly prices are expected to be more stable than those in a monopolistically
competitive industry. To see this, simply recall the discussion of the kinked
oligopoly demand curve and the fact that marginal cost changes within limits will not
affect prices, whereas similar cost changes would affect prices in a monopolistically
competitive industry. But would the more stable price pattern for firms in
monopolistically competitive industries produce a correspondingly more stable
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Chapter 13
pattern for profits? This is not entirely clear. This depends on a great many factors,
including the speed of entry and exit in response to profit changes, the level of fixed
versus variable costs, and so on. For example, if entry conditions in the
monopolistically competitive industry allowed instantaneous entry, profits for
individual firms might closely reflect required rates of return and be quite stable. In
general, the quicker (slower) the return to equilibrium, the less (more) variable will
be firm profits in monopolistically competitive industries. In oligopoly markets,
price tends to fluctuate less than costs, and profits can be quite variable (e.g., readyto-eat cereal and tobacco industries).
Q13.6
What is the essential difference between the Cournot and Stackelberg models?
Q13.6
ANSWER
In the Cournot model, oligopoly firms make output decisions simultaneously. In the
Stackelberg model, oligopoly firms make output decisions sequentially rather than
simultaneously. In the Stackelberg model, a dominant firm is the first to set output,
and the remaining competitors follow that lead and make their own output decisions
given the output decision of the dominant first mover.
Q13.7
Which oligopoly model(s) result in long-run oligopoly market equilibrium that is
identical to a competitive market price/output solution?
Q13.7
ANSWER
In markets where competitors produce identical products, the Bertrand model and
contestable markets theory result in a long-run oligopoly market equilibrium
price/output solution that is identical to that achieved in a competitive market.
According to Bertrand, when products and production costs are identical all
customers will purchase from the firm selling at the lowest possible price. For
example, consider a duopoly where each firm has the same marginal costs of
production. By slightly undercutting the price charged by a rival, the competing firm
would capture the entire market. In response, the competing firm can be expected to
slightly undercut the rival price, thus recapturing the entire market. Such a price war
would only end when the price charged by each competitor converged on their
identical marginal cost of production, PA = PB = MC, and economic profits of zero
would result. While critics regard as implausible Bertrand=s prediction of a
competitive-market equilibrium in oligopoly markets that offer homogenous
products, contestable markets theory provides some additional useful perspective.
Oligopoly firms will sometimes behave much like perfectly competitive firms if
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Monopolistic Competition and Oligopoly
potential entrants pose a credible threat and entry costs are largely fungible rather
than sunk.
Q13.8
Q13.8
Why is the four-firm concentration ratio only an imperfect measure of market power?
ANSWER
The four firm concentration ratio measures the share of domestic output produced by
the top four firms in an industry. As such, it is only an imperfect measure of
monopoly power. First, concentration ratios ignore the magnitude of foreign
competition. Such competition limits the market power of industry leaders in
automobile manufacturing, electronics, television equipment and many other
industries. And second, concentration ratios compiled using national data fail to
recognize regional market power due to the local character of markets such as those
for the newspapers, dairy products, waste disposal, and so on. Thus, although
foreign competition can sometimes cause concentration ratios to overstate true
market power by ignoring the regional characteristics of many markets,
concentration ratios can also understate monopoly power in some instances.
Q13.9
The statement AYou get what you pay for@ reflects the common perception that high
prices indicate high product quality and low prices indicate low quality. Irrespective
of market structure considerations, is this statement always correct?
Q13.9
ANSWER
No, not necessarily. In both perfectly competitive and monopolistically competitive
markets P = AC in long run equilibrium. Given efficient methods of production, it is
reasonable to infer a close relation between prices and the costs of production, and
hence product quality, in such markets. However, in both monopoly and oligopoly
markets P > AC in long-run equilibrium. Therefore, there may only be a weak
relation between prices and the costs of production (product quality) in these markets.
Thus, the statement AYou get what you pay for@ may be quite descriptive of
vigorously competitive markets, but is less true in instances of imperfectly
competitive markets.
Q13.10
AEconomic profits result whenever only a few large competitors are active in a given
market.@ Discuss this statement.
Q13.10
ANSWER
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Chapter 13
This statement is not true, and reflects a simplistic view of the link between the
number of competitors and the vigor of competition. Holding buyer power constant,
competition can sometimes be fierce in markets that involve only a handful of
competitors. Similarly, markets involving several Acompetitors@ may have little or
no effective competition. For example, despite the fact that there are relatively few
providers of general aviation equipment, competition for new plane orders is often
fierce and suppliers seldom earn above-normal profits. On the other hand, textile and
agricultural markets involve thousands of competitors that are sometimes sheltered
from import competition by trade barriers and government price support programs.
To accurately assess the vigor of competition in any given market, one must carefully
analyze market structure (including the number and size distribution of competitors),
competitor behavior and industry performance.
SELF-TEST PROBLEMS & SOLUTIONS
ST13.1
Price Leadership. Over the last century, The Boeing Co. has grown from building
planes in an old, red boathouse to become the largest aerospace company in the
world. Boeing=s principal global competitor is Airbus, a French company jointly
owned by Eads (80%) and BAE Systems (20%). Airbus was established in 1970 as a
European consortium of French, German and later, Spanish and U.K companies. In
2001, thirty years after its creation, Airbus became a single integrated company.
Though dominated by Boeing and Airbus, smaller firms have recently entered the
commercial aircraft industry. Notable among these is Embraer, a Brazilian aircraft
manufacturer. Embraer has become one of the largest aircraft manufacturers in the
world by focusing on specific market segments with high growth potential. As a
niche manufacturer, Embraer makes aircraft that offer excellent reliability and cost
effectiveness.
To illustrate the price leadership concept, assume that total and marginal cost
functions for Airbus (A) and Embraer (E) aircraft are as follows:
TCA
= $10,000,000 + $35,000,000QA + $250,000QA2
MCA
= $35,000,000 + $500,000QA
TCE
= $200,000,000 + $20,000,000QE + $500,000QE2
MCE
= $20,000,000 + $1,000,000QE
Boeing=s total and marginal cost relations are as follows:
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Monopolistic Competition and Oligopoly
TCB
= $4,000,000,000 + $5,000,000QB + $62,500Q2
B
MCB
= ΜTCB/ΜQB = $5,000,000 + $125,000QB
The industry demand curve for this type of jet aircraft is
Q
= 910 - 0.000017P
Assume throughout this problem that the Airbus and Embraer aircraft are perfect
substitutes for Boeing=s Model 737-600, and that each total cost function includes a
risk-adjusted normal rate of return on investment.
A. Determine the supply curves for Airbus and Embraer aircraft, assuming that
the firms operate as price takers.
B.
What is the demand curve faced by Boeing?
C.
Calculate Boeing=s profit-maximizing price and output levels. (Hint:
Boeing=s total and marginal revenue relations are TRB = $50,000,000QB $50,000Q2
B, and MRB =ΜTRB/ΜQB = $50,000,000 - $100,000QB.)
D.
Calculate profit-maximizing output levels for the Airbus and Embraer aircraft.
E.
Is the market for aircraft from these three firms in short-run and in long-run
equilibrium?
ST13.1
SOLUTION
A.
Because price followers take prices as given, they operate where individual marginal
cost equals price. Therefore, the supply curves for Airbus and Embraer aircraft are:
Airbus
PA
= MCA = $35,000,000 + $500,000QA
500,000QA
= -35,000,000 + PA
QA
= -70 + 0.000002PA
Embraer
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Chapter 13
PE = MCE = $20,000,000 + $1,000,000QE
1,000,000QE = -20,000,000 + PE
QE = -20 + 0.000001PE
B.
As the industry price leader, Boeing=s demand equals industry demand minus
following firm supply. Remember that P = PB = PM = PE because Boeing is a price
leader for the industry:
QB = Q - QA - QE
= 910 - 0.000017P + 70 - $0.000002P
+ 20 - $0.000001P
= 1,000 - 0.00002PB
PB = $50,000,000 - $50,000QB
C.
To find Boeing=s profit maximizing price and output level, set MRB = MCB and
solve for Q:
MRB
$50,000,000 - $100,000QB
45,000,000
= MCB
= $5,000,000 + $125,000QB
= 225,000QB
QB
= 200 units
PB
= $50,000,000 - $50,000(200)
= $40,000,000
D.
Because Boeing is a price leader for the industry,
P = PB = PA = PE = $40,000,000
Optimal supply for Airbus and Embraer aircraft are:
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Monopolistic Competition and Oligopoly
QA = -70 + 0.000002PA
= -70 + 0.000002(40,000,000)
= 10
QE = -20 + 0.000001PE
= -20 + 0.000001(40,000,000)
= 20
E.
Yes. The industry is in short-run equilibrium if the total quantity demanded is equal
to total supply. The total industry demand at a price of $40 million is:
QD
= 910 - 0.000017P
= 910 - 0.000017(40,000,000)
= 230 units
The total industry supply is:
QS = QB + QA + QE
= 200 + 10 + 20
= 230 units
Thus, the industry is in short-run equilibrium. The industry is also in long-run
equilibrium provided that each manufacturer is making at least a risk-adjusted
normal rate of return on investment. To check profit levels for each manufacturer,
note that:
πA = TRA - TCA
= $40,000,000(10) -$10,000,000 -$35,000,000(10)
- $250,000(102)
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Chapter 13
= $15,000,000
πE = TRE - TCE
= $40,000,000(20) -$200,000,000 -$20,000,000(20)
- $500,000(202)
= $0
πB = TRB - TCB
= $40,000,000(200) -$4,000,000,000 - $5,000,000(200)
- $62,500(2002)
= $500,000,000
Boeing and Airbus are both earning economic profits, whereas Embraer, the
marginal entrant, is earning just a risk-adjusted normal rate of return. As such, the
industry is in long-rum equilibrium and there is no incentive to change.
Monopolistically Competitive Equilibrium. Soft Lens, Inc., has enjoyed rapid
growth in sales and high operating profits on its innovative extended-wear soft
contact lenses. However, the company faces potentially fierce competition from a
host of new competitors as some important basic patents expire during the coming
year. Unless the company is able to thwart such competition, severe downward
pressure on prices and profit margins is anticipated.
ST13.2
A.
Use Soft Lens=s current price, output, and total cost data to complete the table:
Monthly
Total
Marginal
Total
Marginal
Average
Total
Price
Output
Revenue
Revenue
Cost
Cost
Cost
Profit
($)
(million)
($million)
($million)
($million)
($million)
($million)
($million)
$20
0
$0
19
1
12
18
2
27
17
3
42
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Monopolistic Competition and Oligopoly
Monthly
Total
Marginal
Total
Marginal
Average
Total
Price
Output
Revenue
Revenue
Cost
Cost
Cost
Profit
($)
16
(million)
4
($million)
($million)
($million)
58
($million)
($million)
($million)
15
5
75
14
6
84
13
7
92
12
8
96
11
9
99
10
10
105
(Note: Total costs include a risk-adjusted normal rate of return.)
ST13.2
B.
If cost conditions remain constant, what is the monopolistically competitive
high-price/low-output long-run equilibrium in this industry? What are industry
profits?
C.
Under these same cost conditions, what is the monopolistically competitive
low-price/high-output equilibrium in this industry? What are industry profits?
D.
Now assume that Soft Lens is able to enter into restrictive licensing agreements
with potential competitors and create an effective cartel in the industry. If
demand and cost conditions remain constant, what is the cartel price/output
and profit equilibrium?
SOLUTION
A.
Monthly
Total
Marginal
Total
Marginal
Average
Total
Price
Output
Revenue
Revenue
Cost
Cost
Cost
Profit
($)
(million)
($million)
($million)
($million)
($million)
($million)
($million)
$20
0
$0
---
$0
---
---
$0
19
1
19
$19
12
$12
$12.00
7
18
2
36
17
27
15
13.50
9
17
3
51
15
42
15
14.00
9
16
4
64
13
58
16
14.50
6
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Chapter 13
Monthly
Total
Marginal
Total
Marginal
Average
Total
Price
Output
Revenue
Revenue
Cost
Cost
Cost
Profit
($)
(million)
($million)
($million)
($million)
($million)
($million)
($million)
15
5
75
11
75
17
15.00
0
14
6
84
9
84
9
14.00
0
13
7
91
7
92
8
13.14
-1
12
8
96
5
96
4
12.00
0
11
9
99
3
99
3
11.00
0
10
10
100
1
105
6
10.50
-5
B.
The monopolistically competitive high-price/low-output equilibrium is P = AC = $14,
Q = 6(000,000), and π = TR - TC = $0. Only a risk-adjusted normal rate of return is
being earned in the industry, and excess profits equal zero. Because π = $0 and MR
= MC = $9, there is no incentive for either expansion or contraction. Such an
equilibrium is typical of monopolistically competitive industries where each
individual firm retains some pricing discretion in long-run equilibrium.
C.
The monopolistically competitive low-price/high-output equilibrium is P = AC = $11,
Q = 9(000,000), and π = TR - TC = $0. Again, only a risk-adjusted normal rate of
return is being earned in the industry, and excess profits equal zero. Because π = $0
and MR = MC = $3, there is no incentive for either expansion or contraction. This
price/output combination is identical to the perfectly competitive equilibrium. (Note
that average cost is rising and profits are falling for Q > 9.)
D.
A monopoly price/output and profit equilibrium results if Soft Lens is able to enter
into restrictive licensing agreements with potential competitors and create an
effective cartel in the industry. If demand and cost conditions remain constant, the
cartel price/output and profit equilibrium is at P = $17, Q = 3(000,000), and π =
$9(000,000). There is no incentive for the cartel to expand or contract production at
this level of output because MR = MC = $15.
PROBLEMS & SOLUTIONS
P13.1
Market Structure Concepts. Indicate whether each of the following statements is
true or false and explain why.
A.
Equilibrium in monopolistically competitive markets requires that firms be
operating at the minimum point on the long-run average cost curve.
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Monopolistic Competition and Oligopoly
B.
A high ratio of distribution cost to total cost tends to increase competition by
widening the geographic area over which any individual producer can compete.
C.
The price elasticity of demand tends to fall as new competitors introduce
substitute products.
D.
An efficiently functioning cartel achieves a monopoly price/output combination.
E.
An increase in product differentiation tends to increase the slope of firm
demand curves.
P13.1
SOLUTION
A.
False. Stable equilibrium in perfectly competitive markets requires that firms must
operate at the minimum point on the long-run average cost curve.
In
monopolistically competitive markets, however, equilibrium is achieved at a point of
tangency between firm demand and average cost curves. This tangency typically
occurs at an output level below the point of minimum long-run average costs.
B.
False. A low ratio of distribution cost to total cost tends to increase competition by
widening the geographic area over which any individual producer can compete.
C.
False. The price elasticity of demand tends to rise as new competitors introduce
substitute products.
D.
True.
A perfectly functioning cartel achieves the monopoly price-output
combination.
E.
True. An increase in product differentiation tends to increase the slope of individual
firm demand curves.
P13.2
Monopolistically Competitive Demand. Would the following factors increase or
decrease the ability of domestic auto manufacturers to raise prices and profit
margins? Why?
A.
Decreased import quotas
B.
Elimination of uniform emission standards
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Chapter 13
C.
Increased automobile price advertising
D.
Increased import tariffs (taxes)
E.
A rising value of the dollar, which has the effect of lowering import car prices
P13.2
SOLUTION
A.
Increase.
As import quotas are decreased, fewer substitutes for domestic
automobiles become available. This will decrease competition in the industry, and
ease pressure on profit margins.
B.
Increase.
An elimination of uniform emission standards reduces product
homogeneity. As product differentiation rises, some increase in the pricing
discretion of firms will result.
C.
Decrease. An increase in automobile price advertising increases price competition in
the industry and thereby decreases the ability of firms to raise prices and profit
margins.
D.
Increase. An increase in import tariffs (taxes) increases the price of import cars, thus
making imports less attractive to car buyers. This will reduce the price pressure on
domestic manufacturers, and make it easier for them to increase profit margins.
E.
Decrease. A rising value of the dollar that has the effect of lowering import car
prices puts downward pressure on the profit margins of domestic manufacturers.
P13.3
Competitive Markets v. Cartels. The City of Columbus, Ohio, is considering two
proposals to privatize municipal garbage collection. First, a handful of leading
waste disposal firms have offered to purchase the city's plant and equipment at an
attractive price in return for exclusive franchises on residential service in various
parts of the city. A second proposal would allow several individual workers and
small companies to enter the business without any exclusive franchise agreements or
competitive restrictions. Under this plan, individual companies would bid for the
right to provide service in a given residential area. The city would then allocate
business to the lowest bidder.
The city has conducted a survey of Columbus residents to estimate the amount
that they would be willing to pay for various frequencies of service. The city has also
estimated the total cost of service per resident. Service costs are expected to be the
same whether or not an exclusive franchise is granted.
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Monopolistic Competition and Oligopoly
Complete the following table.
A.
P13.3
Trash Pickups
per Month
Price per
Pickup
Total
Revenue
Marginal
Revenue
Total
Cost
0
$5.00
$0.00
1
4.80
3.75
2
4.60
7.45
3
4.40
11.10
4
4.20
14.70
5
4.00
18.00
6
3.80
20.90
7
3.60
23.80
8
3.40
27.20
9
3.20
30.70
10
3.00
35.00
Marginal
Cost
B.
Determine price and service level if competitive bidding results in a perfectly
competitive price/output combination.
C.
Determine price and the level of service if local regulation results in a cartel.
SOLUTION
A.
Trash Pickups
per Month
Price per
Pickup
Total
Revenue
Marginal
Revenue
Total
Cost
Marginal
Cost
0
$5.00
$0.00
--
$0.00
--
1
4.80
4.80
$4.80
3.75
$3.75
2
4.60
9.20
4.40
7.45
3.70
3
4.40
13.20
4.00
11.10
3.65
4
4.20
16.80
3.60
14.70
3.60
5
4.00
20.00
3.20
18.00
3.30
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Chapter 13
Trash Pickups
per Month
6
Price per
Pickup
3.80
Total
Revenue
22.80
Marginal
Revenue
2.80
Total
Cost
20.90
Marginal
Cost
2.90
7
3.60
25.20
2.40
23.80
2.90
8
3.40
27.20
2.00
27.20
3.40
9
3.20
28.80
1.60
30.70
3.50
10
3.00
30.00
1.20
35.00
4.30
B.
In a perfectly competitive industry, P = MR, so the optimal activity level occurs
where P = MC. Here, P = MC = $3.40 at Q = 8 pickups per month.
C.
A monopoly cartel maximizes profits by setting MR = MC. Here, MR = MC = $3.60
at Q = 4 pickups per month and P = $4.20 per pickup.
P13.4
Monopolistic Competition. Gray Computer, Inc., located in Colorado Springs,
Colorado, is a privately held producer of high-speed electronic computers with
immense storage capacity and computing capability. Although Gray=s market is
restricted to industrial users and a few large government agencies (e.g., Department
of Health, NASA, National Weather Service, etc.), the company has profitably
exploited its market niche.
Glen Gray, founder and research director, has recently announced his
retirement, the timing of which will unfortunately coincide with the expiration of
several patents covering key aspects of the Gray computer. Your company, a
potential entrant into the market for supercomputers, has asked you to evaluate the
short- and long-run potential of this market. Based on data gathered from your
company=s engineering department, user surveys, trade associations, and other
sources, the following market demand and cost information has been developed:
P
= $54 - $1.5Q,
MR
= ΜTR/ΜQ = $54 - $3Q,
TC
= $200 + $6Q + $0.5Q2,
MC
= ΜTC/ΜQ = $6 + $1Q,
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Monopolistic Competition and Oligopoly
where P is price, Q is units measured by the number of supercomputers, MR is
marginal revenue, TC is total costs including a normal rate of return, MC is
marginal cost, and all figures are in millions of dollars.
A.
Assume that these demand and cost data are descriptive of Gray=s historical
experience. Calculate output, price, and economic profits earned by Gray
Computer as a monopolist. What is the point price elasticity of demand at this
output level?
B.
Calculate the range within which a long-run equilibrium price/output
combination would be found for individual firms if entry eliminated Gray=s
economic profits. (Note: Assume that the cost function is unchanged and that
the high-price/low-output solution results from a parallel shift in the demand
curve while the low-price/high-output solution results from a competitive
equilibrium.)
C.
Assume that the point price elasticity of demand calculated in Part A is a good
estimate of the relevant arc price elasticity. What is the potential overall
market size for supercomputers?
D.
If no other near-term entrants are anticipated, should your company enter the
market for supercomputers? Why or why not?
P13.4
SOLUTION
A.
Set MR = MC to determine the profit-maximizing activity level.
MR
$54 - $3Q
= MC
= $6 + $1Q
4Q
= 48
Q
= 12
and
P = $54 - $1.5Q
= $54 - $1.5(12)
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Chapter 13
= $36 million
π = -$2(122) + $48(12) - $200
= $88 million
From the demand curve note that:
Q = 36 - 0.67P,
which, at the profit-maximizing activity level, implies a point price elasticity of
εP = ΜQ/ΜP Η P/Q
= -0.67 Η 36/12
= -2
(Note: Profits are declining for Q > 12.)
B.
The high-price/low-output equilibrium point is identified by the point of tangency
between the firm=s demand and average cost curves which occurs after a parallel
leftward shift in demand due to competitor entry. Therefore, in equilibrium the new
firm demand and average cost curves have the same slope.
To determine the slope of the average cost curve note that:
$200 + $6 Q + $0.5Q 2
AC = TC/Q =
Q
= $200Q-1 + $6 + $0.5Q
Slope of average
cost curve
Slope of new
demand curve
= ΜAC/ΜQ = -200Q-2 + 0.5
= -1.5 (Same as for original demand curve)
And in equilibrium,
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Monopolistic Competition and Oligopoly
Slope of average
cost curve
=
Slope of new
demand curve
-200Q-2 + 0.5 = -1.5
Q-2
= 2/200
Q2
= 100
Q = 10
and
P
= AC = $200(10-1) + $6 + $0.5(10)
= $31 million
π
= P Η Q - TC
= $31(10) - $200 - $6(10) - $0.5(102)
= $0
The low-price/high-output equilibrium point occurs where P = AC and average
costs are minimized (this is also the perfectly competitive equilibrium). Set MC =
AC to determine the point of minimum average costs, and solve for Q:
MC = AC
$6 + $1Q = $200Q-1 + $6 + $0.5Q
200Q-1 = 0.5Q
200Q-2 = 0.5
Q2 = 200/0.5
= 400
Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance.
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Chapter 13
Q =
400
= 20
and
P = AC
= $200(20-1) + $6 + $0.5(20)
= $26 million
π
= P Η Q - TC
= $26(20) - $200 - $6(20) - $0.5(202)
= $0
C.
If the high-price/low-output equilibrium is achieved in the long run, total industry
output rises to 16.2 supercomputers because:
Q 2 - Q1 P 2 + P1
EP =
x
P 2 - P1 Q 2 + Q1
-2
=
Q 2 - 12 31 + 36
x
31 - 36 Q 2 + 12
-2
=
67(Q 2 - 12)
-5(Q 2 + 12)
10(Q2 + 12)
= 67(Q2 - 12)
10Q2 + 120
= 67Q2 - 804
57Q2
= 924
Q2
= 16.2
Conversely, if the low-price/high-output equilibrium is achieved, total industry
output rises to 23.4 supercomputers because:
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Monopolistic Competition and Oligopoly
EP
=
Q 2 - Q1 P 2 + P1
x
P 2 - P1 Q 2 + Q1
-2
=
Q 2 - 12 26 + 36
x
26 - 36 Q 2 + 12
-2
=
62(Q 2 - 12)
-10(Q 2 + 12)
20(Q2 + 12)
= 62(Q2 - 12)
20Q2 + 240
= 62Q2 - 744
42Q2
= 984
Q2
= 23.4
D.
No. Entry into this industry is unwise. Gray currently sells 12 supercomputers per
year, a substantial share of the projected long-run potential of between 16.2 and 23.4
for total industry output. Moreover, the industry does not have the potential to
support more than one firm of Q = 20 size class, the minimum optimal firm size.
Therefore, by virtue of its role as an industry leader of dominant proportions, Gray
would have the capability to continuously undercut new rivals and make profitable
entry very difficult, if not impossible. (Note: Fractional output can be completed
during subsequent periods).
P13.5
Cartel Equilibrium. The Hand Tool Manufacturing Industry Trade Association
recently published the following estimates of demand and supply relations for
hammers:
A.
QD
= 60,000 - 10,000P
(Demand),
QS
= 20,000P
(Supply).
Calculate the perfectly competitive industry equilibrium price/output
combination.
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Chapter 13
B.
Now assume that the industry output is organized into a cartel. Calculate the
industry price/output combination that will maximize profits for cartel
members. (Hint: As a cartel, industry MR = $6 - $0.0002Q.)
C.
Compare your answers to parts A and B. Calculate the price/output effects of
the cartel.
P13.5
SOLUTION
A.
The industry equilibrium price is determined by setting:
QD = QS
60,000 - 10,000P = 20,000P
P = $2
At P = $2, the equilibrium output is 40,000 because:
QD
60,000 - 10,000(2)
40,000
B.
= ? QS
= ? 20,000(2)
= _ 40,000
The profit-maximizing activity level is found where MR = MC. Here it is important
to recognize that the industry supply curve represents the horizontal sum of the
marginal cost curves for individual producers. Therefore, when the industry is
organized into a cartel and acts like a monopolist, the industry supply curve
represents the relevant marginal cost curve:
QS
MC = P
= 20,000P
(Supply)
= $0.00005Q
From the demand curve:
QD
P
= 60,000 - 10,000P
(Demand)
= $6 - $0.0001Q
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Monopolistic Competition and Oligopoly
TR
= PΗQ
= ($6 - $0.0001Q)Q
= $6Q - $0.0001Q2
MR
= ΜTR/ΜQ = $6 - $0.0002Q
And the profit-maximizing activity level is found by setting MR = MC and solving
for Q:
MR = MC
$6 - $0.0002Q = $0.00005Q
0.00025Q = 6
Q = 24,000
P = $6 - $0.0001(24,000)
= $3.60
C.
P13.6
With a cartel, the level of industry output falls from 40,000 to 24,000 units and price
rises from $2 to $3.60, when compared with the perfectly competitive industry.
Generally speaking, monopolists offer consumers too little output at too high a price.
Cournot Equilibrium. VisiCalc, the first computer spreadsheet program, was
released to the public in 1979. A year later, introduction of the DIF format made
spreadsheets much more popular because they could now be imported into word
processing and other software programs. By 1983, Mitch Kapor used his previous
programming experience with VisiCalc to found Lotus Corp. and introduce the
wildly popular Lotus 1-2-3 spreadsheet program. Despite enormous initial success,
Lotus 1-2-3 stumbled when Microsoft Corp. introduced Excel with a much more
user-friendly graphical interface in 1987. Today, Excel dominates the market for
spreadsheet applications software, and Lotus represents a small part of IBM=s suite
of instant messaging tools.
To illustrate the competitive process in markets dominated by few firms,
assume that a two-firm duopoly dominates the market for spreadsheet application
software, and that the firms face a linear market demand curve
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Chapter 13
P = $1,250 - Q
where P is price and Q is total output in the market (in thousands) . Thus Q = QA +
QB. For simplicity, also assume that both firms produce an identical product, have
no fixed costs and marginal cost MCA = MCB = $50. In this circumstance, total
revenue for Firm A is
TRA = $1,250QA - QA2 - QAQB
Marginal revenue for Firm A is
MRA = ΜTRA/ΜQA = $1,250 - $2QA - QB
Similar total revenue and marginal revenue curves hold for Firm B.
A.
Derive the output reaction curves for Firms A and B.
B.
Calculate the Courtnot market equilibrium price-output solutions.
P13.6
SOLUTION
A.
Because MCA = 0, Firm A=s profit-maximizing output level is found by setting MRA
= MCA = 0:
MRA = MCA
$1,250 - $2QA - QB
= 50
$2QA = $1,200 - QB
QA = 600 - 0.5QB
Notice that the profit-maximizing level of output for Firm A depends upon the level
of output produced by itself and Firm B. Similarly, the profit-maximizing level of
output for Firm B depends upon the level of output produced by itself and Firm A.
These relationships are each competitor=s output-reaction curve
Firm A output-reaction curve:
QA = 600 - 0.5QB
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Monopolistic Competition and Oligopoly
Firm B output-reaction curve:
B.
QB = 600 - 0.5QA
The Cournot market equilibrium level of output is found by simultaneously solving
the output-reaction curves for both competitors. To find the amount of output
produced by Firm A, simply insert the amount of output produced by competitor
Firm B into Firm A=s output-reaction curve and solve for QA. To find the amount of
output produced by Firm B, simply insert the amount of output produced by
competitor Firm A into Firm B=s output-reaction curve and solve for QB. For
example, from the Firm A output-reaction curve
QA = 600 - 0.5QB
QA = 600 - 0.5(600 - 0.5QA)
QA = 600 - 300 + 0.25QA
0.75QA = 300
QA = 400 (000) units
Similarly, from the Firm B output-reaction curve, the profit-maximizing level of
output for Firm B is QB = 400. With just two competitors, the market equilibrium
level of output is
Cournot equilibrium output
= QA + QB
= 400 + 400
= 800 (000) units
The Cournot market equilibrium price is
Cournot equilibrium price = $1,250 - Q
= $1,250 - $1(800)
= $450
P13.7
Stackelberg Model. The Stackelberg model allows for strategic behavior by leading
firms, and can be used to illustrate how leading firms maintain dominence of
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Chapter 13
important industries. To illustrate the concept of Stackelberg first-mover advantages,
again imagine that a two-firm duopoly dominates the market for spreadsheet
application software for personal computers. Also assume that the firms face a
linear market demand curve
P = $1,250 - Q
where P is price and Q is total output in the market (in thousands) . Thus Q = QA +
QB. For simplicity, also assume that both firms produce an identical product, have
no fixed costs and marginal cost MCA = MCB = $50. In this circumstance, total
revenue for Firm A is
TRA = $1,250QA - QA2 - QAQB
Marginal revenue for Firm A is
MRA = ΜTRA/ΜQA = $1,250 - $2QA - QB
Similar total revenue and marginal revenue curves hold for Firm B.
A.
Calculate the Stackelberg market equilibrium price-output solutions.
B.
How do the Stackelberg equilibrium price-output solutions differ from those
suggested by the Cournot model? Why?
P13.7
SOLUTION
A.
To illustrate Stackelberg first-mover advantages, reconsider the Cournot model but
now assume that Firm A, as a leading firm, correctly anticipates the output reaction
of Firm B, the following firm. With prior knowledge of Firm B=s output-reaction
curve, QB = 600 - 0.5QA, Firm A=s total revenue curve becomes
TRA = $1,250QA - QA2 - QAQB
= $1,250QA - QA2 - QA(600 - 0.5QA)
= $650QA - 0.5QA2
With prior knowledge of Firm B=s output-reaction curve, marginal revenue for Firm
A is
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Monopolistic Competition and Oligopoly
MRA = ΜTRA/ΜQA = $650 - $1QA
Because MCA = $50, Firm A=s profit-maximizing output level with prior knowledge
of Firm B=s output-reaction curve is found by setting MRA = MCA = $50:
MRA = MCA
$650 - $1QA = $50
QA = 600
After Firm A has determined its level of output, the amount produced by Firm B is
calculated from Firm B=s output-reaction curve
QB = 600 - 0.5QA
= 600 - 0.5(600)
= 300
With just two competitors, the Stackelberg market equilibrium level of output is
Stackelberg equilibrium output
= QA + QB
= 600 + 300
= 900 (000) units
The Stackelberg market equilibrium price is
Stackelberg equilibrium price = $1,250 - Q
= $1,250 - $1(900)
B.
= $350
Notice that market output is greater in Stackelberg equilibrium than in Cournot
equilibrium because the first mover, Firm A, produces more output while the
follower, Firm B, produces less output. Stackelberg equilibrium also results in a
lower market price than that observed in Cournot equilibrium. In this example, Firm
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Chapter 13
A enjoys a significant first-mover advantage. Firm A will produce twice as much
output and earn twice as much profit as Firm B so long as Firm B accepts the output
decisions of Firm A as given and does not initiate a price war. If Firm A and Firm B
cannot agree on which firm is the leader and which firm is the follower, a price war
can break out with the potential to severely undermine the profitability of both
leading and following firms. If neither duopoly firm is willing to allow its
competitor to exercise a market leadership position, vigorous price competition and a
competitive market price/output solution can result. Obviously, participants in
oligopoly markets have strong incentives to resolve the uncertainty surrounding the
likely competitor response to leading-firm output decisions.
P13.8
Bertrand Equilibrium. Coke and Pepsi dominate the U. S soft-drink market.
Together, they account for about 75% of industry sales. Dr. Pepper/Seven Up, Cott
Beverage, and Royal Crown Cola account for most of the rest. The Bertrand model
can be used to show the effects of price competition in this highly differentiated
market. Suppose the quantity of Coke demanded depends upon the price of Coke (PC)
and the price of Pepsi (PP)
QC = 15 - 2.5PC + 1.25PP
where output (Q) is measured in millions of 24-packs per month, and price is the
wholesale price of a 24-pack. For simplicity, assume average costs are constant and
AC = MC = X dollars per unit. In that case, the total profit and change in profit with
respect to own price functions for Coke are
πC
= TRC - TCC = PCQC - xQC = (PC - X) QC
ΜπC/ΜPC = 15 - 5PC + 1.25PP + 2.5X
A.
Set ΜπC/ΜPC = 0 to derive Coke=s optimal price-response curve. Interpret
your answer.
B.
Calculate Coke=s optimal price-output combination if Pepsi charges $5 and
marginal costs are $2 per 24-pack.
P13.8
SOLUTION
A.
To derive Coke=s optimal price-response curve, set
ΜπC/ΜPC = 0
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Monopolistic Competition and Oligopoly
15 - 5PC + 1.25PP +2.5X = 0
5PC
PC
= 15 + 1.25PP + 2.5X
= $3 + $0.25PP + $0.5X
Coke=s optimal price-response curve shows that Coke should increase its own price
by 254 with each $1 increase in the price of Pepsi, and increase its own price by 504
with every $1 increase in the marginal cost of production.
B.
If Pepsi charges $5 and marginal costs are $2 per 24-pack, Coke=s optimal priceresponse curve shows that Coke should charge $5.25 per 24-pack:
PC
= $3 + $0.25PP + $0.5X
= $3 + $0.25($5) + $0.5($2)
= $5.25
P13.9
Kinked Demand Curves. Safety Service Products (SSP) faces the following
segmented demand and marginal revenue curves for its new infant safety seat:
1. Over the range from 0 to 10,000 units of output,
P1
MR1
= $60 - Q,
= ΜTR1/ΜQ = $60 - $2Q.
2. When output exceeds 10,000 units,
P2
MR2
= $80 - $3Q,
= ΜTR2/ΜQ = $80 - $6Q.
The company=s total and marginal cost functions are as follows:
TC
= $100 + $20Q + $0.5Q2,
MC
= ΜTC/ΜQ = $20 + $1Q,
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Chapter 13
where P is price (in dollars); Q is output (in thousands); MR is marginal revenue;
TC is total cost; and MC is marginal cost, all in thousands of dollars.
A.
Graph the demand, marginal revenue, and marginal cost curves.
B.
How would you describe the market structure of the industry in which SSP
operates? Explain why the demand curve takes the shape indicated previously.
C.
Calculate price, output, and profits at the profit-maximizing activity level.
D.
How much could marginal costs rise before the optimal price would increase?
How much could they fall before the optimal price would decrease?
P13.9
SOLUTION
A.
Note that:
MR1
= ΜTR1/ΜQ = $60 - $2Q
MR2
= ΜTR2/ΜQ = $80 - $6Q
MC
= ΜTC/ΜQ = $20 + Q
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Monopolistic Competition and Oligopoly
B.
The firm is in an oligopolistic industry. It faces a kinked demand curve, indicating
that competitors will react to price reductions by cutting their own prices and causing
the segment of the demand curve below the kink to be relatively inelastic. Price
increases are not followed, causing the portion of the demand curve above the kink to
be relatively elastic.
C.
An examination of the graph indicates that the marginal cost curve passes through
the gap in the marginal revenue curve. Graphically, this indicates optimal P = $50
and Q = 10(000). Analytically,
MR1 = $60 - $2Q
Q
# 10,000
MR2 = $80 - $6Q
Q
> 10,000
MC = $20 + $Q
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Chapter 13
MR1 > MC over the range Q # 10(000), and MR2 < MC for the range Q > 10(000).
Therefore, SSP will produce 10(000) units of output and market them at a price P1 =
$60 - Q = $60 - $(10) = $50. Alternatively, P2 = $80 - $3Q = $80 - $3(10) = $50.
At P = $50 and Q = 10:
π
= TR - TC
= $50(10) - $100 - $20(10) - $0.5(102)
= $150(000) or $150,000
D.
At Q = 10(000),
MR1
= $60 - $2Q
MR2
= $80 - $6Q
= $60 - $2(10)
= $80 - $6(10)
= $40
= $20
This implies that if marginal costs at Q = 10(000) exceed $40, the optimal price
would increase. Conversely, if marginal costs at Q = 10(000) fall below $20, the
optimal price would decrease. So long as marginal cost at Q = 10(000) is in the
range of $20 to $40, SSP will have no incentive to change in price.
P13.10
Price Signaling. Louisville Communications, Inc., offers 24-hour telephone
answering service for individuals and small businesses in southeastern states.
Louisville is a dominant, price-leading firm in many of its markets. Recently,
Memphis Answering Service, Inc., and Nashville Recording, Ltd., have begun to offer
services with the same essential characteristics as Louisville=s service. Total and
marginal cost functions for Memphis (M) and Nashville (N) services are as follows:
TCM
= $75,000 - $7QM + $0.0025QM,
2
MCM
= ΜTCM/ΜQM = -$7 + $0.005QM,
TCN
= $50,000 + $3QN + $0.0025Q2
N,
MCN
= ΜTCN/ΜQN = $3 + $0.005QN.
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Monopolistic Competition and Oligopoly
Louisville=s total and marginal cost relations are as follows:
TCL
= $300,000 + $5QL + $0.0002Q2
L,
MCL
= ΜTCL/ΜQL = $5 + $0.0004QL.
The industry demand curve for telephone answering service is
Q
= 500,800 - 19,600P.
Assume throughout this problem that the Memphis and Nashville services are perfect
substitutes for Louisville=s service.
A.
Determine the supply curves for the Memphis and Nashville services, assuming
that the firms operate as price takers.
B.
What is the demand curve faced by Louisville?
C.
Calculate Louisville=s profit-maximizing price and output levels. (Hint:
Louisville=s total and marginal revenue relations are TRL = $25QL $0.00005Q2
L, and MRL =ΜTRL/ΜQL = $25 - $0.0001QL.)
D.
Calculate profit-maximizing output levels for the Memphis and Nashville
services.
E.
Is the market for service from these three firms in short-run equilibrium?
P13.10
SOLUTION
A.
Because price followers take prices as given, they operate where individual marginal
cost equals price. Therefore, the supply curves for Memphis and Nashville services
are:
Memphis
PM = MCM = -$7 + $0.005QM
0.005QM = 7 + PM
QM = 1,400 + 200PM
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Chapter 13
Nashville
PN = MCN = $3 + $0.005QN
0.005QN = -3 + PN
QN = -600 + 200PN
B.
As the industry price leader, Louisville=s demand equals industry demand minus
following firm supply. Remember that P = PL = PM = PN because Louisville is a
price leader for the industry:
QL = Q - QM - QN
= 500,800 - 19,600P - 1,400 - 200P
+ 600 - 200P
= 500,000 - 20,000PL
PL = $25 - $0.00005QL
C.
To find Louisville=s profit-maximizing price and output level, set MRL = MCL and
solve for Q:
MRL
$25 - $0.0001QL
= MCL
= $5 + $0.0004QL
20
= 0.0005QL
QL
= 40,000 units
PL
= $25 - $0.00005QL
= $25 - $0.00005(40,000)
= $23
D.
Because Louisville is a price leader for the industry,
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Monopolistic Competition and Oligopoly
P = PL = PM = PN = $23
Optimal supply for Memphis and Nashville services are:
QM = 1,400 + 200PM
= 1,400 + 200($23)
= 6,000
QN = -600 + 200PN
= -600 + 200($23)
= 4,000
E.
Yes. The industry is in short-run equilibrium if the total quantity demanded is equal
to total supply. The total industry demand at a price of $23 is:
QD
= 500,800 - 19,600P
= 500,800 - 19,600($23)
= 50,000 units
The total industry supply is:
QS = QL + QM + QN
= 40,000 + 6,000 + 4,000
= 50,000 units
Thus, the industry is in short-run equilibrium.
CASE STUDY FOR CHAPTER 13
Market Structure Analysis at Columbia Drugstores, Inc.
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Chapter 13
Demonstrating the tools and techniques of market structure analysis is made difficult by the fact
that firm competitive strategy is largely based upon proprietary data. Firms jealously guard
price, market share and profit information for individual markets. Nobody should expect Target,
for example, to disclose profit and loss statements for various regional markets or on a store-bystore basis. Competitors like Wal-Mart would love to have such information available; it would
provide a ready guide for their own profitable market entry and store expansion decisions.
To see the process that might be undertaken to develop a better understanding of product
demand conditions, consider the hypothetical example of Columbia Drugstores, Inc., based in
Seattle, Washington. Assume Columbia operates a chain of 30 drugstores in the Pacific
Northwest. During recent years, the company has become increasingly concerned with the
long-run implications of competition from a new type of competitor, the so-called superstore.
To measure the effects of superstore competition on current profitability, Columbia asked
management consultant Anna Kournikova to conduct a statistical analysis of the company=s
profitability in its various markets. To net out size-related influences, profitability was measured
by Columbia=s gross profit margin, or earnings before interest and taxes divided by sales.
Columbia provided proprietary company profit, advertising, and sales data covering the last
year for all 30 outlets, along with public trade association and Census Bureau data concerning
the number and relative size distribution of competitors in each market, among other market
characteristics.
As a first step in the study, Kournikova decided to conduct a regression-based analysis of
the various factors thought to affect Columbia=s profitability. The first is the relative size of
leading competitors in the relevant market, measured at the Standard Metropolitan Statistical
Area (SMSA) level. Columbia=s market share, MS, in each area is expected to have a positive
effect on profitability given the pricing, marketing, and average-cost advantages that accompany
large relative size. The market concentration ratio, CR, measured as the combined market share
of the four largest competitors in any given market, is expected to have a negative effect on
Columbia=s profitability given the stiff competition from large, well-financed rivals. Of course,
the expected negative effect of high concentration on Columbia profitability contrasts with the
positive influence of high concentration on industry profits that is sometimes observed.
Both capital intensity, K/S, measured by the ratio of the book value of assets to sales, and
advertising intensity, A/S, measured by the advertising-to-sales ratio, are expected to exert
positive influences on profitability. Given that profitability is measured by Columbia=s gross
profit margin, the coefficient on capital intensity measured Columbia=s return on tangible
investment. Similarly, the coefficient on the advertising variable measures the profit effects of
advertising. Growth, GR, measured by the geometric mean rate of change in total disposable
income in each market, is expected to have a positive influence on Columbia=s profitability,
because some disequilibrium in industry demand and supply conditions is often observed in
rapidly growing areas. Columbia=s proprietary information is shown in Table 13.3
Table 13.3 here
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Monopolistic Competition and Oligopoly
Finally, to gauge the profit implications of superstore competition, Kournikova used a
Adummy@ (or binary) variable where S = 1 in each market in which Columbia faced superstore
competition and S = 0 otherwise. The coefficient on this variable measures the average profit
rate effect of superstore competition. Given the vigorous nature of superstore price competition,
Kournikova expects the superstore coefficient to be both negative and statistically significant,
indicating a profit-limiting influence. The Columbia profit-margin data and related information
used in Kournikova=s statistical analysis are given in the preceding table. Regression model
estimates for the determinants of Columbia=s profitability are shown in Table 13.4:
Table 13.4 here
A.
Describe the overall explanatory power of this regression model, as well as the
relative importance of each continuous variable.
B.
Based on the importance of the binary or dummy variable that indicates superstore
competition, do superstores pose a serious threat to Columbia=s profitability?
C.
What factors might Columbia consider in developing an effective competitive
strategy to combat the superstore influence?
CASE STUDY SOLUTION
A.
The coefficient of determination R2 = 77.7% means that 77.7% of the total variation
in Columbia=s profit-margins can be explained by the regression model. This is a
relatively high level of statistically significant explanation (F = 13.38) for a crosssection study such as this, suggesting that the model provides useful insight
concerning the determinants of profitability. The standard error of the estimate
(S.E.E. = 2.1931%) means that there is roughly a 95% chance that the actual profit
margins for a given store will lie within the range of the estimated or fitted value ∀ 2
Η S.E.E., or ∀ 2 Η 2.1931%.
The intercept coefficient of 6.155 has no economic meaning because it lies far
outside the relevant range of observed data. The 0.189 coefficient for the
market-share variable means that, on average, a 1% (unit) rise in Columbia=s market
share leads to a 0.189% (unit) rise in Columbia=s profit margin. Similarly, as
expected, Columbia=s profit margin is positively related to capital intensity,
advertising intensity, and the rate of growth in the market area. Conversely, high
concentration has the expected limiting influence. Because of the effects of
leading-firm rivalry, a 1% rise in industry concentration will lead to a 0.156%
decrease in Columbia=s profit margin. This means that relatively large firms
compete effectively with Columbia.
Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance.
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Chapter 13
B.
Yes, the regression model indicates that superstore competition in one of
Columbia=s market areas reduces Columbia=s profit margin on average by 2.102%.
Given that Columbia=s rate of return on sales routinely falls in the 10% to 15%
range, the profit-limiting effect of superstore competition is substantial. Looking
more closely at the data, it appears that Columbia faces superstore competition in
only one of the seven lucrative markets in which the company earns a 20% to 25%
rate of return on sales. Both observations suggest that current and potential
superstore competition constitutes a considerable threat to the company and one that
must be addressed in an effective competitive strategy.
C.
Development of an effective competitive strategy to combat the influence of
superstores involves the careful consideration of a wide range of factors related to
Columbia=s business. It might prove fruitful to begin this analysis by more carefully
considering market characteristics for Store No. 6, the one Columbia outlet able to
earn a substantial 20% profit margin despite superstore competition. For example,
this analysis might suggest that Columbia, like Store No. 6, should specialize in
service (e.g., prescription drug delivery) or in a slightly different mix of merchandise.
On the other hand, perhaps Columbia should follow the example set by Wal-Mart in
its early development and focus its plans for expansion on small to medium-size
markets. In the meantime, Columbia=s still-profitable stores in major metropolitan
areas could help fund future growth.
Although obviously only a first step, a regression-based study of market
structure such as that described here can provide a very useful beginning to the
development of an effective competitive strategy.
Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance.
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