Elasticity of Demand

Standard

Element A

Elasticity of demand is a gauge of how sensitive buyers will be to a price change of a product. This is measured using a formula. This formula is the percentage change in quantity demanded divided by the percentage change in price. Using percentages to compute the equation is called the midpoint formula and it allows one set of results to be applicable to both positive and negative changes when figuring elasticity of demand. The result is converted to an absolute value, which is the coefficient of demand. This coefficient determines if demand is elastic, inelastic or unit elastic.

The demarcation of elasticity in the demand coefficient is one. If the number is one then demand is unit elastic. This means that any change in price is offset to an equal degree by an opposite change in demand. Thus, total revenue would stay the same despite the changes. Specific instances of unitary elasticity are hard to find in the real world but a close example could be cars that retain a core of brand loyalty among consumers allowing the brand to retain sufficient numbers after a price increase to maintain revenue.

A demand coefficient less than one indicates that demand is inelastic.  This means that price changes would not have a great effect on demand. If prices go up, total revenue will go up as well. If prices go down, so will revenue. An example of this is liquor sales. Consumers develop loyalty to specific brands and varieties so they will follow them through price fluctuations.

Products with a demand coefficient greater than one are elastic. Generic products that are easily substitutable typify elastic demand. Price and revenue move in opposite directions. If prices go up, revenue goes down because consumers can easily find a comparable product elsewhere. An example of this is restaurants. If one restaurant starts charging more than other comparable establishments, consumers will go elsewhere to eat out. The reverse is also true, if prices go down, then total revenue will go up (McConnell, Brue, & Flynn, 2012).

Element B

Cross elasticity of demand seeks to compare products to one another to determine if the two products are substitutable or complementary. Substitutable products can easily replace one another and are indicative of elasticity. Complementary products naturally go together, that is to say, if one product is purchased, then the other will most likely be purchased as well.

The equation used to determine cross elasticity is as follows: the percentage change in quantity demanded of product X is divided by the percentage change in the price of product Y to arrive at the coefficient of cross elasticity. This number is either a positive or a negative number. This is critical as zero is the threshold of cross elasticity. A result of zero means the two items in questions are unrelated and do not influence each other.

If the number is negative, or less than zero, then the two items are complementary, meaning that the two are usually purchased together. Therefore, price fluctuations of one are reflected in sales of the other. An example of this would be charcoal and lighter fluid.

When the equation results in a positive number, or greater than zero, then the two products are substitute goods. This means that the two products are closely related so a change in the price of one will influence sales of the other. Specific brands of breakfast cereal are good examples of this. If the price of say, Wheaties, increases, consumers will opt for a similar cereal like Corn Flakes, because it is now cheaper (McConnell, Brue, & Flynn, 2012).

Element C

Another factor that influences demand is the income elasticity of demand. This concept explains how consumers buying decisions are influenced by changes in their income. This is revealed through another coefficient arrived at by dividing the percentage change in the amount demanded of a good by the percentage change in the income of the consumer. Again, the threshold for this equation is zero.

If the result is negative, the good is defined as inferior and demand will go down as incomes rise. An example of this is mass transit tickets.

Conversely, if the result is positive the good is called normal or superior, and demand will increase as incomes increase. Most goods fall into this category but a good example would be smartphones and the accompanying service plans (McConnell, Brue, & Flynn, 2012).

Element D

As a rule, price elasticity of demand is easy to see by how many substitute products exist in a given market. An example of this is fruit juice. A visit to any grocery store will show dozens of different varieties and brands of fruit juice. This makes demand for one particular brand of juice elastic because consumers will be very sensitive to price changes and will readily substitute one brand for another.

Elements E & E1

Price elasticity of demand is also influenced by how large a price is compared to an individual income. Price increases will more greatly affect a buying decision for a high-ticket item than a low one. Consider price increases of five percent for bread and mortgage payments. The increase in the price of bread will probably not change the amount of bread purchased by a household at all. On the other hand, and increase in home prices by five  percent will be much more likely to keep a family renting until the market comes back down, thus not making a purchase at all given the price increase. On the demand side, bread would not be affected while the housing market would stagnate.

Element F

The consumer’s time horizon is another factor to consider in elasticity. Assume that local cable prices have risen 15 percent. In the short-run, if the consumer wants to continue watching TV, then the additional price must be paid. In the long-run, however, consumers may experiment with other forms of programming access, such as the internet, satellite or specific media providers, and ultimately abandon cable altogether. This shows that in this instance, consumer demand is much more elastic in the long-run.

Element G

These two graphs show the demand curve and total revenue of a product. To determine elasticity, the total revenue (TR) test is applied to the demand curve. This test is price multiplied by quantity equals TR. Along the demand curve the TR test shows increasing returns from falling prices up to the quantity of four units. Elasticity is shown by increasing TR with falling prices and more units selling. Unit elasticity is the point where returns from price reduction and sales increase equal each other. Inelasticity shows TR falling from further price reduction and increased sales.  In the demand curve graph, demand is elastic from $80 to $50, unit elastic from $50 to $40, and inelastic from $40 to $0.

In the TR graph, the elastic range is seen as TR increasing to its highest point at four units. From there TR levels off between four and five units, showing the unit elastic range. From there, TR drops off with every additional unit showing that demand is inelastic after five units.

 

References

McConnell, C. R., & Brue, S. L., Flynn, S. (2012).  Economics (19th ed., pp. 48-90). McGraw-Hill.

 

Economic Marginal Analysis

Standard

  1. A.    Profit Maximization

In order for Company A to be successful, it must produce the optimal amount of widgets to achieve maximum profits at all levels. There are two ways to determine this (McConnell, Brue, & Flynn, 2012).

Total Revenue to Total Cost (TR/TC)

This method is concerned with overall levels of price and production. TR is determined by how many widgets are produced multiplied by how much each widget is sold for (price x quantity). TC is determined most simply by combining the average fixed costs and the average variable costs for producing any specific amount of widgets (AFV + AVC). Profits are then determined by subtracting total costs from total revenues at various production levels. Profits are maximized by discovering the point where the gap between the two is largest on the revenue side.

Marginal Revenue to Marginal Cost (MR/MC)

This method of determining profit maximization focuses on the changes made by adding or subtracting individual units. MR and MC is the difference each additional unit makes to total revenue or cost. In other words, MC (or MR) is the change in total cost (or revenue) divided by the quantity. Profit maximization occurs where MR equals MC.

  1. B.     Marginal Revenue Calculations

Based on the changes in total revenue, MR is greatest at the quantity of one and diminishes steadily as quantity increases. This can be seen in the chart how MR decreases by $10 for every unit after the first. That is to say, MR decreases steadily as production and sales increase. This shows that Company A exists in a Monopolistically Competitive environment and must offer discounts at each level of production to maintain demand. MR is derived from the difference in revenue from each additional unit. In other words, MR is calculated as the change in TR from adding one more widget to production and selling it. The formula for this is MR=change in TR/change in quantity.

  1. C.    Marginal Cost Calculations

Referring again to the chart above, it is seen that MC is constant from one unit to two and then increases steadily throughout the production range. This shows the fixed cost of $10 and a variable cost of $10 through the second unit whereupon the MC increases steadily with each successive unit. MC is calculated by determining the difference in TC from adding each additional widget. The formula for this is MC=change in TR/change in quantity.

  1. D.    Point of Profit Maximization

From the given data, it is seen that from the perspective of TR/TC, maximum profits of
$540 are achieved at eight units. The MR/MC chart included here corroborates this conclusion as it is seen that MR equals MC at eight units.

  1. E.     Adjusting Output 1

If it is discovered during marginal analysis that MR exceeds MC, then production should be increased to the point where MR is equal to MC, or as close to that as possible on the positive side.

  1. F.     Adjusting Output 2

On the other hand, if it turns out that MC exceeds MR, then this means the company is losing money and losses need to be minimized by restricting output to the point where MR equals MC, or as close as possible on the positive side.

References

McConnell, C. R., & Brue, S. L., Flynn, S. (2012).  Economics (19th ed., pp. 141-238). McGraw-Hill.

Cultural Sensitivity Analysis

Standard

Element A

Premium smartphone apps are approaching market saturation in the United States. In order to foster continued growth, this company must expand to accommodate a global market. Smartphone sales have been skyrocketing in Thailand and that will be the location of the first target international market (Huang, 2013).

Before any sort of plan is created, some cross-cultural differences must be addressed.

  • This company has made a deep commitment to the environment and green computing as a cornerstone of its culture. Thai culture takes a much more laissez-faire approach to environmental controls, viewing themselves as merely a part of nature and ultimately not responsible for any environmental problems (Knutson, 1994). To ensure compliance with this company’s mission statement, any operations set up in Thailand will have to address this difference in paradigms.
  • There are glaring interpersonal differences between Thai and American culture that will need solutions. Thais value social harmony and hierarchal interactions above all other things (Knutson, 1994).  They feel that directness can be offensive and all conflict is negative. This will present obstacles as Americans value directness and equality in communications, especially as applied to a business environment. In addition to their basic duties, interpreters will need to serve as social arbiters to avoid cultural misunderstandings. American employees operating in Thailand will also need extensive cultural sensitivity training.
  • Thai culture is collectivist versus American culture being primarily individualistic. It is important to remember that no one person is responsible for a problem to a Thai mindset (Knutson, 1994). This may present as a problem with motivation and goal orientation that will need to surmounted. Avoiding situations that will cause any one individual social discomfort will help here. In addition, allowing additional time for meetings and other group tasks will help with avoiding deadlines and other schedule conflicts that may come about.

Element B

While a marketing plan is developed, it is important to address some ground floor aspects of marketing logistics (McConnell, Brue, & Flynn, 2012).

Product:  Smartphone apps are a highly successful market in the United States where millions of smartphones are sold every year. Sales of smartphones have been growing rapidly in Thailand, growing by 24 percent in the first quarter of 2013 alone (Huang, 2013). As they are complementary goods, the demand for smartphone apps will grow there as well.  However, only a small portion of the population of Thailand speaks English. To make smartphone apps marketable there they will need to be in Thai. To create the initial marketing mix, existing apps will be researched for their universal appeal and translated to Thai. Once a marketing foothold is established, local talent will be recruited to create future sales with more geographically-based offerings.

Pricing: Comparisons will be drawn up to isolate price relationships between markets. Specifically, the price paid for an average smartphone here will be compared to the price paid for an average app to arrive at a percentage price based on the total cost of the phone. This formula will then be applied to the Thai market based on average smartphone prices there and adjusted as necessary to assign initial pricing to the premium marketing mix. Subsequent offerings will be priced accordingly as well.

Promotion: Since they have been the key to success in American markets, ad banners in both the smartphone and regular internet markets will be utilized as the primary marketing vehicle. Given the cultural differences noted in the first section between the American and Thai cultures, Thai focus groups will be enlisted to ensure the advertising material is culturally acceptable. Sales campaigns specific to both platforms as well as a Thai-language sales site need to be constructed on the Internet. Contracts for running the banners will have to be pursued with existing internet and cellular service providers. In addition, free “lite” versions of some apps will be promoted to establish brand awareness.

Place: Most aspects of this expansion can be handled on the Internet, including product delivery, the same as it is done for current markets. Business licensing, market research and local research and development teams will all need to operate in-country. As noted in the next section, there are some regulatory differences between the two markets that will have to addressed. The most critical of these will be compliance with the Thai Electronic Transactions Act. Where in America the internet marketplace is more or less unregulated, in Thailand numerous laws have been enacted to protect the consumer in the virtual environment. Lastly, critical to this growth will be establishing permanent contracts with internet and cell service providers in Thailand to ensure reliable virtual real estate from which to distribute products.

Element C

Expanding business to Thailand will have two legal or ethical ramifications that will need to be addressed specific to smartphone apps (Thailand Law).

Thailand has set up extensive consumer protections in the digital environment in their Electronic Transactions Act. A special internet business license must be obtained before any commercial website can be published. Unlike here, a website has to be certified by the government before any marketing or sales can take place. A thorough review of the law by counsel will be necessary to ensure full compliance.

Another aspect of the E-commerce laws in Thailand is a total ban on pornography in the digital environment. This is salient for the smartphone market as many of the apps available contain what could be construed as pornographic imagery. Care will have to be taken that no apps be marketed there that could contain any pornographic images.

References

Huang, E. (2013). Smartphones on the cusp of overtaking feature phones in Thailand. Retrieved from http://memeburn.com/2013/06/smartphones-on-the-cusp-of-overtaking-feature-phones-in-thailand/

Knutson, T. J. (1994). Comparison of Thai and US American cultural values:‘mai pen rai’versus ‘just do it’. ABAC Journal, 14(3), 1-38.

McConnell, C. R., & Brue, S. L., Flynn, S. (2012).  Economics (19th ed., pp. 141-238). McGraw-Hill.

Thailand Law. (n.d.),  E- Commerce Law In Thailand . Retrieved from http://www.thailandlaw.org/e-commerce-law-in-thailand.html

Market Regulation

Standard

Regulation

Element A

In American history, there have been four major laws passed by Congress to regulate and control monopolistic behavior in business (McConnell, Brue, and Flynn, 2012).

The first was the Sherman Act in 1890. This law came about because of increasing collusion among rapidly growing firms after the Civil War while many markets were growing to national proportions. This seminal antitrust law made it illegal to collude for the purpose of fixing prices or dividing markets as well as outlawing the creation of monopolies.

In time, the Sherman Act proved too ambiguous in many areas and allowed multiple interpretations, so Congress enacted the Clayton Act in 1914 to clarify the core principles of the Sherman Act. The Clayton Act sharpened many definitions of antitrust policy. Among its key provisions were outlawing price discrimination, tying contracts, acquiring stock of competing corporations, and making it illegal for individuals to serve more than one corporation at a time when the result would be decreased competition.

That same year, Congress created the Federal Trade Commission Act. This act put in place the Federal Trade Commission, which created an entity for enforcing antitrust laws in conjunction with the Justice Department.

These laws were sufficient for 36 more years when the final major antitrust Act was adopted. The Celler-Kefauver Act was passed into law in 1950. This legislation eliminated a loophole in the Clayton Act that allowed firms to bypass the rule against stock ownership in competing companies. Corporations had instead been simply acquiring the physical assets of a competing firm. The new act put an end to this loophole.

Element B

The primary purpose of industrial, or economic, regulation is to ensure that markets function as close to allocative efficiency as possible, which means the economy is producing at the same level as its needs. The need for industrial regulation started in the wake of the Civil War as industries started growing into national markets, diminishing competition within. As this went on, the firms involved began taking on the characteristics of monopolies, creating deadweight loss and disrupting allocative efficiency.

In the case of oligopoly, where only a few companies dominate an entire market, the main purpose of industrial regulation is to prevent collusive price structuring among the firms involved and ensure that the handful of firms that constitute the oligopoly remain competitive.

Pure monopolies, by definition, destroy competition within a market. Without regulation, most industries would come to be dominated by monopolies. Regulation exists for the purpose of ensuring a competitive environment for all but natural monopolies and maintaining oversight on those to ensure fair pricing.

Element C

Three primary entities regulate industries that are natural monopolies. Two exist at the federal level and one at the state (McConnell, Brue, and Flynn, 2012).

  • Federal Energy Regulatory Commission, started in 1930, covers electricity, gas, oil and gas pipelines and water-power sites.
  • Federal Communications Commission, started in 1934, covers telephone, television, cable, radio, CB, and Ham operators.
  • State public utility commissions, actually comprises at least 50 separate entities, covers electricity, gas and telephones within statewide jurisdictions.

All of these entities operate under the “public interest theory of regulation” (McConnell, Brue, and Flynn, 2012). In effect, what all these agencies do is protect the public from monopolistic price structures in natural monopolies. Typically, this is done by mandating and enforcing price controls that are set where price is equal to average total cost, commonly called the “fair return” price.

Element D

While industrial regulation is concerned with price and efficiency, social regulation physically protects the public and the environment from industrial abuse. It provides rules and enforcement for protection of workers, product safety, environmental regulation and equal opportunity. Social regulation applies to all industries equally and exists to ensure businesses conduct themselves in an ethical manner and are held accountable when they do not.

Element E

Five main entities address social regulation; each of them has a national jurisdiction (McConnell, Brue, and Flynn, 2012):

  • Food and Drug Administration, formed in 1906, as its name implies, oversees production of food, drugs, and cosmetics to ensure safety and quality.
  • Equal Employment Opportunity Commission, formed in 1964, covers issues such as discrimination in employment, advancement and termination of employees.
  • Occupational Safety and Health Administration, formed in 1971, covers every industry in America to ensure a standard level of health and safety in the workplace.
  • Environmental Protection Agency, formed in 1972, studies and implements rules regarding industrial pollution in the ground, water and air.
  • Consumer Product Safety Commission, also formed in 1972, regulates safety standards for all other consumer products not covered by the Food and Drug Administration.

References

McConnell, C. R., & Brue, S. L., Flynn, S. (2012).  Economics (19th ed., pp. 375-389). McGraw-Hill.