1
Running Head: Operations
Operations Decision
Introduction
Decisions made by managers are crucial to the success or failure of a business. Roles
played by business managers are becoming increasingly more challenging as complexity in the
business world grows. Business decisions are increasingly dependent on constraints imposed
from outside the economy in which a particular business is based both in terms of production of
goods as well as the markets for the goods produced. The impact of rapid technological change
on innovation in products and processes, as well as in marketing and sales techniques, figures
prominently among the factors contributing to the increasing complexity of the business
environment. Moreover because of increased globalization of the marketplace, there is more
volatility in both input and product prices.
From the data provided, we can see that the demand function for low-calorie microwavable food
is
QD = 20,000 - 10P + 1500A + 5PX + 10 I
According to Nicholson, (2012) the most important result that follows from the
regression is that advertisement plays an important role in determining the demand. Therefore,
the market for low-calorie microwavable food is not perfectly competitive. This is because there
is no role of advertisement in a perfectly competitive market. The market is also not a
monopoly. This is because even monopoly doesn’t require advertisement expenditure. Moreover,
the demand function estimated states that the demand depends on the price of its competitor.
Therefore the market for low calorie microwavable food is surely not a monopoly. This implies
that, the market for low calorie microwavable food must belong to either an oligopoly market or
Running Head: Operations
2
a monopolistically competitive market. We know that advertisement plays an important role in a
monopolistically competitive market. Besides this, another salient feature of a monopolistically
competitive market is product differentiation. Every firm under a monopolistically competitive
market performs product differentiation.
In our example, there are several firms producing low calorie microwavable foods. But
each of the firms practices product differentiation. They slightly differentiate their product from
their competitors to highlight their own product and thereby increase the market share. Therefore
this firm is an example of a monopolistically competitive market.
Pricing Strategies: In a monopolistic competitive market, there are a large number of
sellers. Hence a price change will induce the consumers to shift to other firm. This makes the
demand curve relatively elastic. But since the products sold under monopolistic competitive
market are differentiated, the demand curve is not perfectly elastic like that of a perfectly
competitive market (Enke, 2010).
Now, Profit (π) = Total Revenue (TR) – Total Cost (TC)
3
Running Head: Operations
= P×Q – TC
According to the FOC of profit maximization, we get
=
-
[Here P is not fixed]
= MR – MC = 0
Therefore MR = MC
Similar to that of a perfect competition, a monopolistic firm can earn normal profit, super
normal profit or even can incur losses in the short run. If a monopolistic competitive firm enjoys
a supernormal profit in the short run, then the other firms outside the industry will be attracted
and enter the industry. As more and more firms enter the industry, the number of products
available to a consumer will increase. The demand curve for each firm will shift to the left.
Again, if the firms were incurring losses in the short run, few firms will go out of the industry
which will lower the consumers’ choice and shift the demand curve faced by each firm to the
right. This process of entry and exit will continue till firms are earning zero profit. Thus, in the
long run it earns only normal profit.
Short Run Equilibrium
4
Running Head: Operations
Long Run Equilibrium
Since the firm belongs to a monopolistically competitive market, it would practice active
product differentiation and indulge in advertisement of its products to highlight the same to the
consumers. If more customers get attracted by the product, then the market share of the firm will
increase. This will increase the revenues and profits of the firm. We know that for a monopolistic
competitive firm, the price charged is greater than the marginal cost. Therefore the firm has
certain degree of market power. Market power is define in terms of Lerner’s index, where
Lerner’s index is denoted as:
Lerner’s index (L) =
=-
[Where, e = own price elasticity]
Running Head: Operations
5
Therefore, Lerner’s index is inversely related to the price elasticity of demand. We all
know that the greater the degree of product differentiation, the greater the market power.
Therefore, it is advisable for the organization to perform active product differentiation to
maximize its profits.
According to Whelan (1996), demand is the rate at which consumers want to buy a
product. Economic theory holds that demand consists of two factors: taste and ability to buy.
Taste, which is the desire for a good, determines the willingness to buy the good at a specific
price. Ability to buy means that to buy a good at specific price, an individual must possess
sufficient wealth or income. Whenever there is a change in one of the factors of either supply or
demand, market equilibrium will be affected. Now, suppose that initially the firms in this
industry were earning supernormal profits. This made the industry very lucrative. But gradually,
suppose that low calorie microwavable food becomes very popular among people. Today life is
becoming very fast. People find it difficult to manage time for both office work and household
activities. They are preferring packaged and fast food more. But at the same time, people have
6
Running Head: Operations
become more health conscious. This has changed the preference pattern of the people. They are
switching towards low calorie microwavable food. This kind of food is easy to eat and also
contains low levels of calorie.
This increase in demand for low calorie microwavable food has attracted several other
firms to enter the industry. Now this sudden increase in demand induces the firms to produce the
different varieties of the product. Thus it has been observed that all the firms are producing
several varieties of the product. This reduces the scope of product differentiation among the
firms. As a result, the products sold by all the firms become more or less homogeneous in nature.
This reduces the market power of the firms. They can no more influence the market price as
before. They act as mere price takers. This gradually changes the market structure from a
monopolistically competitive market to a more or less perfectly competitive market structure.
The market prices and quantities in a perfectly competitive market are determined by the
intersection of demand and supply. A firm under perfect competition cannot affect the market
price. They take market price as given and sell any amount of quantity as per its capacity at that
price. If a firm increases its price, consumers will then buy the product from another firm
(McGuigan, 2014).
We know that the main objective of any firm is profit maximization.
Now, Profit (π) = Total Revenue (TR) – Total Cost (TC)
= P×Q – TC
According to the FOC of profit maximization, we get
=P= P – MC = 0
Therefore P = MC
[since P is fixed]
Running Head: Operations
7
Therefore a perfect competitive firm always sets its price equal to its MC.
Suppose that initially a perfectly competitive firm is enjoying a supernormal profit in the
short run. This situation is shown in the figure below.
This will attract other firms from outside into the industry. As a result industry output
will increase. This will lower the market price. Price will continue to fall until the whole
economic profit is exhausted and each firm ends up earning normal profits only. Price will fall
from P to P1, i.e. up to the minimum point of the Average cost (AC) curve. This situation is
shown in the following diagram.
8
Running Head: Operations
In the short run, the firm can only change its variable input to change its output and
profitability. In the long run, the company can indulge in R&D to reduce the cost of production.
If it can innovate any cost effective method of production, then the firm can enjoy a cost
advantage over the other firms (Varian, 2011).
But if the price falls below the marginal cost, then the firm will incur losses and it will
discontinue its production. In the long run, the lowest point of the average cost curve denotes the
break even point. If the price falls below that the firm will shut down.
Conclusion
In conclusion, the total of all consumer demands yields the market demand for a
particular commodity; the market demand curve shows quantities of the commodity demanded at
different prices, given all other factors. As price increases, quantity demanded falls. Individual
consumer demands thus provide the basis for the market demand for a product. The market
demand plays a crucial role in shaping decisions made by firms. Most important of all, it helps in
determining the market price of the product under consideration which, in turn, forms the basis
for profits for the firm producing that product.
9
Running Head: Operations
References
Enke, S. (2010). Profit Maximization under Monopolistic Competition. The American Economic
Review, Vol. 31, No. 2, 317-326. Retrieved February 10, 2014 from Academic Search
Premier database.
McGuigan, J. R., Moyer, R. C., & Harris, F. H. deB. (2014). Managerial economics:
applications, strategies and tactics (13th ed.). Stamford, CT: Cengage Learning.
Nicholson, W. (2012). Microeconomic Theory: Basic Principles and Extensions (11th ed.). USA:
Cengage Learning.
Varian, H. R. (2011). Intermediate Microeconomics: A Modern Approach (8th ed.). NY: Norton
Retrieved February 10, 2014 from Academic Search
Premier database.
Whelan, J. (1996). Economic Supply and Demand. Retrieved February 10, 2014 from Academic
Search Premier database