Advertising And Consumer Tastes Economics Essay

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Maryam

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Contents of answers to the questions 2

Market Demand 3

Factors Causing Shift in Demand 4

Market Supply: 5

Factors causing shift in supply 5

Market Equilibrium: 7

Consumer Surplus: 8

Producer Surplus: 8

Price Ceiling: 9

Price Floor: 9

Budget line: 10

Effect of Increase and Decrease in Income 10

Effect of Increase and Decrease in Income Graphical representation 11

If price decrease: 12

If the price increases: 13

ISO-COST: 16

ISO-QUANT: 17

Perfect Competition 18

Monopoly: 18

Monopolistic competition 19

Oligopoly 19

Perfect price discrimination 19

Quantity discrimination 19

Multi market differentiation 19

1. What are the characteristics of perfect competition that are exhibited by the credit card industry? 20

2. Discuss the price and output condition of a perfect competition? 21

3. Do you think the same competitive state is applicable to the Indian scenario?

21

International Harvester and American Tobacco 23

Standard Oil 24

AT&T and Microsoft 24

Benefits: 24

Limitations: 24

Managerial Economics final assignment

Explain the following terms Market Demand, Market supply, what causes a shift in the demand and supply

Market Demand

The ability and willingness of the consumers to buy a product is known as the demand for that product, however the market demand is the aggregate potential and willingness of the consumers to buy a specific product in the specific market for a specific time.

Price

D

$15

$10

$5

Q3

Q2

Q1

Quantity

Factors Causing Shift in Demand

The potential factors that shift the demand curve and affect the demand of the product in the market are

Price of the goods:

The change in the price of the good will lead to shift in the demand curve accordingly, the increase in the price of the good will decrease the demand and decrease in the price will increase the demand of the good

Price of the substitute goods

The price of the substitutes or related goods will lead to the shift of demand of the other goods, e.g. the decrease in the price of Pepsi would lead to the decrease in the demand for Coca Cola but increase in demand of the Pepsi as they are the perfect substitutes of each other

Income of the consumers

The income of the consumer have the direct relation with the demand of the goods, the increase in the income of the consumer will ultimately lead to the increase in the demand of the goods, as the propensity to buy will raise, and the decrease in the income will lead to the decrease in the demand for the particular good.

Advertising and consumer tastes:

The advertising of the product would affect the demand for that product, for instance consumers bought 10,000 units of the apparel without advertising. But after the advertising the demand could increase to the 20,000 units. Thus the advertising has the potential effect on shifting of the demand.

Market Supply:

The supply is the production of a particular good at alternative prices of that good, alternative input prices and alternative values of the other variables affecting the supply. However market supply is the willingness and ability of the producer to supply the particular good in the particular market at particular time.

S

Price

$15

$10

$5

Quantity

Q1

Q3

Q2

Factors causing shift in supply

There are several identified factors that cause the shift in the supply among them the following are:

Price of the goods:

When the price of the particular good will rise the producers will tend to supply more as it will increase their profit with the more number of the goods sold.

Prices of input e.g. wages of labor, price of technology etc.:

The input prices would have the direct effect on the supply of the particular goods such as the higher wages for the labor would ultimately lower the supply in the market and will cause the shift in the supply curve. And so does the price of the technology have the impact as well.

Number of firms in the market

As more number of the firms will enter the market the supply would increase thus putting pressure towards lowering the price, and ultimately the firms will try to reduce and limit the supply in the market in order to control the prices.

Taxes and government intervention:

The government can intervene in two ways; either enhancing the tax level or giving the subsidy, the increased tax on the factors of production will limit the supply. However the subsidy will have the opposite effect, the subsidy from the government would help the firms to produce more and thus increase the supply.

Market equilibrium, Consumer surplus, Producer surplus

Market Equilibrium:

Market equilibrium is the situation when the demand of the product is equal to the supply of that product. And this market equilibrium in a competitive market is attained by the interaction of all the sellers and the buyers in market. The interaction of the supply and demand ultimately determines the competitive price such that there will be neither shortage nor any surplus in the market and thus at this point the price is the equilibrium price and quantity is the equilibrium quantity and the market is said to be in equilibrium.

S

Price

D

S

$15

$10

Equilibrium

$5

D

Q3

Q2

Q1

Quantity

Consumer Surplus:

The consumer surplus is the value that consumer get from the product but they do not have to pay for it. Or we can say that consumer surplus is the measure of the consumer satisfaction, by calculating the difference between the willingness of the consumer to pay for a certain product despite of its relative market price. For instance the customer goes to market to buy a mobile at $150 but he found that there is sale on the prices and the mobile is of $100 so those $50 are the consumer surplus that he was willing to pay.

Price

Consumer Surplus

P0

Quantity

Q0

Producer Surplus:

Price

As the consumer wants the prices to be as low the producers want the prices to be as high, the supply curve tells the amount at which the producers will be willing to produce at a given price. For instance the producer wants to sell the 1000 units at $2 and the consumers are willing to buy that product in $3. The producer will sell the 1000 units at $3 and will receive $3000 in total. The producer was willing to accept the amount of $2000 but the surplus he gained is $3000-$2000 = $1000, this $1000 is the producer surplus.

Producer Surplus

$3

$2

1000

Quantity

Price ceiling and price floor explain with the help of real life examples how these price controls are enforced by the government.

Price Ceiling:

The price ceilings tend to be the maximum legal prices a producer could charge for its good in the market. The price system is used to determine that everyone has the access to the good; if the prices will rise indefinitely then we will be living in the world of scarcity. The governments enforce these price ceilings so that the consumer would not charge more. The example is the price of the gasoline, which when rests on the determination of the market forces tend to rise and then government has to impose the price ceilings in order to control the rising prices of the gasoline.

Price Floor:

The price floor is opposite to the price ceilings, they are the minimum legal prices that could be charged in the market for a particular good. When the equilibrium prices are tend to be too low for the producers to produce they form a lobby against the low prices; the government and legislative are then forced to put the price floors in order set the minimum legal prices for the goods. For instance in Quebec and Ontario the price floors are established on the alcohol to artificially keep the higher prices and lower the consumption of the alcohol and protect the Canadian brewers.

What information is embodied in a budget line? What shifts occur in the budget line when money income increases and decreases?

Budget line:

The bundles of the goods that a consumer can afford are the budget set, and the combinations of the goods that could actually exhaust the consumers income is defined by the budget line.

Y

5

Budget Line

4

3

10

4

2

0

X

Effect of Increase and Decrease in Income

If the prices of the goods remain constant, this would not affect the slope of the budget line, and the increase in the income would lead to the parallel shift of budget towards right indicating that propensity of the consumer to buy has been increased. However reduction in the income would lead the budget line to shift toward the left, thus demonstrating the decrease in the propensity of the consumer to spend more

Effect of Increase and Decrease in Income Graphical representation

Y

M1/Py

M0/Py

Decrease in Income

M2/Py

Increase in Income

M1/Px

M0/Px

M2/Px

X

What shifts occur in the budget line when the price of the product shown on the vertical axis (ii) increases (ii) decreases?

If the income of the consumer remained fixing, and there is change in the prices of the products there will be shift in the slope of the budget line.

If price decrease:

If the price of the good X decreases and the price of the good Y remains same, the budget line slope will become more flat as the demand of the Y good remains constant but the demand of X will increase.

Y

M/Py

New Budget Line

Previous Budget Line

X

M/P1x

M/P0x

If the price increases:

Keeping the above situation for the Y product same, if the price of the good X increases the budget line will have the clockwise shift in its slope, the demand and ability to buy the good X will decrease simultaneously

Y

New Budget Line

Previous Budget Line

M/Py

0

M/Px0

M/Px1

X

What information is contained in an indifference curve? Why are such curves (i) down sloping and convex to the origin? Why does total utility increase as the consumer moves to indifference curves farther from the origin?

The curve that defines the combinations of two goods, that provides the consumer with the same level of the satisfaction is indifference curve. The consumers have to choose among the different bundles of the goods, this indifference curves work on the basis of the diminishing marginal rate of the substitution in which for instance, the consumer in order to have one more unit of good Y has to leave two units of the good X this is the reason that the indifference curves are convex towards the origin. The indifference curves that are farther from the origin are have increased total utility and are preferred more as they represent larger bundles of the goods.

Y

C

A

B

X

Explain why the point of tangency of the budget line with an indifference curve is the consumer’s equilibrium position. Explain why any point where the budget line intersects an indifference curve is not equilibrium and the equilibrium is actually where MUx / MUy = Px/Py

The objective of the consumer is to maximize the level of the satisfaction within the budget, if the bundle A, B and C are lying on the budget line of the consumer he will choose the bundle C where the budget line is in tangent with the indifference curve as this will maximize the satisfaction level within the budget constraint but the other bundles the A and B will exhaust the income of the consumer completely. This is the reason that the consumer equilibrium is established where MUx / MUy = Px/Py where the relative prices of the two goods are equal to the marginal utility of both the products.

Y

B

Consumer Equilibrium

C

A

X

ISO-COST and ISO-QUANT

ISO-COST:

ISOCOST is the line that demonstrate the combinations of the input that costs the producer same amount of money in production of the good.

For instance the producer has the option of labor and capital to use as the input in the production within the budget of $120 and has three combinations X, Y, and Z

Combinations

Units of Capital

$15 per unit

Units of Labor

$ 10 per unit

Total expenditure

In $

X

8

0

120

Y

6

3

120

Z

0

12

120

Capital

8

6

Isocost Line

Labor

12

3

0

ISO-QUANT:

ISOQUANT is the curve that demonstrate the all possible combination of the inputs that yield the same level of the output, for instance the producer has two input options with the three combinations

Combination

Labor

Capital

Yield

X

3

20

60

Y

4

15

60

Z

20

3

60

Capital

Isoquant Curve

20

X

15

Y

3

Z

Labor

20

4

3

Producers Equilibrium

Producer’s equilibrium is the situation in which the level of the output of the commodity gives the maximum profit to the producer. Thus the situation where the TR-TC = Profit is greater or Marginal revenue = Marginal Cost is the producer’s equilibrium. When MC is equal to the MR the gain becomes equal to the cost thus the producer is said to be in equilibrium.

Perfect competition, monopoly, monopolistic competition, oligopoly, Perfect price discrimination, quantity discrimination and multi market differentiation. Explain all this with the help of an example.

Perfect Competition

The market condition in which there are large number of firms, having access to the similar technologies and produce the similar products and no firm has any potential competitive advantage over the other. The most common example related to the perfect competition is the agricultural products such as the vegetables and fruits.

Monopoly:

It is the market structure in which the single firm serves the entire market for a certain good that has no other close substitutes and has the monopoly power as the barrier to entry of the other firms. The utility companies are the perfect example of the monopoly like the electricity, water, natural gas suppliers in the market.

Monopolistic competition

The monopolistically competitive market lies in between the monopoly and perfect competition, it is the market structure in which there are many buyers and sellers with each firm producing the different product, and there is free entry and exit in the industry. In the monopolistic competition the products slightly differs from each other and are not the perfect substitutes to each other. The common example for this market structure is the fast food companies such as burger king, McDonald etc.

Oligopoly

Oligopoly is the market structure in which there are relatively only few large firms in the industry, ranges from 2 to 10 firms, the oligopoly having only two firms is called duopoly. The common example for oligopoly market structure is the telecommunication industry, mobile industry such as Nokia, Sony, Samsung, HTC etc.

Perfect price discrimination

The perfect price discrimination, or the first degree price discrimination is the one in which the producer charge each consumer the maximum price that he/she is willing to pay for each unit of the good purchased. The producers through the perfect price discrimination extract the entire surplus from consumer and get the higher profits. The most common example related to this is the bidding process in which the consumer is willing to pay the highest price to get the product and the producer or the supplier keep increasing the prices.

Quantity discrimination

The quantity discrimination is related to the second degree price discrimination in which the producers set the different prices for different quantities such as, the consumption of electricity; there are higher rates on consuming the electricity in first hour then subsequent after the one hour.

Multi market differentiation

This is the third degree of the price discrimination, in this the producer tend to charge the different prices for the same product in the different market segments. Such as the student’s discount on the tickets to the museum or the senior citizen discount on the hotel rooms etc.

Case Studies

Read the given case studies carefully and answer the given questions from the given text in your own words?

Case Study: A perfect competition

in 1997, over $700 billion purchases were charged on credit cards and this total is increasing at a rate of over 10 per cent a year. At first glance, the credit card market would seem to be a rather concentrated industry. Visa, MasterCard and American Express are the most familiar names, and over 60 per cent of all charges are made using one of these three cards. But on closer examination, the industry seems to exhibit most characteristics of perfect competition. Consider first the size and distribution of buyers and sellers. Although Visa, MasterCard and American Express are the choices of the majority of consumers, these cards do not originate from just three firms. In fact, there are over six thousand enterprises (primarily banks and credit unions) in the US that offers charge cards to over 90 million credit card holders. One person's Visa card may have been issued by his company's credit union in Los Angeles, while a next door neighbor may have acquired hers from a Miami Bank when she was living in Florida. Credit cards are a relatively homogenous product. Most Visa cards are similar in appearance, and they can all be used for the same purposes. When the charge is made, the merchant is unlikely to notice that it was that actually issued the card. Entry into and exit from the credit card market is easy as evidenced by the 6000 institutions that currently offer cards. Although a new firm might find it difficult to enter the market, a financially sound bank, even one of modest size, could obtain the right to offer a MasterCard or a Visa card from the present companies with little difficulty. If the bank wanted to leave the field, there would be a ready market to sell its accounts to other credit card suppliers. Thus, it would seem that the credit card industry meets most of the characteristics for a perfectly competitive market.

Questions

1. What are the characteristics of perfect competition that are exhibited by the credit card industry?

There were almost 6000 institutions in the market that issued the credit cards, thus the large number of the firms in the market is the characteristic of the perfect competition

They all were producing the same purpose product that is "credit cards" or" visa and master cards" thus the same products by all the firms is the other characteristic of the perfect competition

There are no barriers to the entry or to the exit in the market by any institution

2. Discuss the price and output condition of a perfect competition?

There was no price discrimination as there was no competitive advantage of any institution on the other and all the institutions were providing the same product.

3. Do you think the same competitive state is applicable to the Indian scenario?

In credit card market the same condition prevails in every country and in Indian scenario as well because the purpose of the product is same and there is large number of institutions providing the same product.

Monopoly

Case Study 1: International Harvester and American Tobacco

For example, International Harvester produced cheap agricultural equipment for a largely agrarian nation, and was thus considered untouchable lest the voters rebel. American Tobacco, on the other hand, was suspected of charging more than a fair price for cigarettes - then touted as the cure for everything from asthma to menstrual cramps - and consequently called down the legislator's wrath in 1907 and was broken up in 1911. 

Case Study 2: Standard Oil

The oil industry was prone to a natural monopoly because of the rarity of the deposits. Rockefeller and his partners took advantage of both the rarity of oil and the revenue produced from it to set up a monopoly without the help of the banks. The business practices and questionable tactics that Rockefeller used to create Standard Oil would make the Enron crowd blush, but the finished product was not near as damaging to the economy or the environment as the industry was before Rockefeller monopolized it. (For more on this sector, read Oil and Gas Industry Primer and Unearth Profits in Oil Exploration and Production.) 

Back when there were a lot of oil companies competing to make the most of their find, companies would often pump waste products into rivers or straight out on the ground rather than going to the cost of researching proper disposal. They also cut costs by using shoddy pipelines that were prone to leakage. By the time Standard Oil had cornered 90% of oil production and distribution in the United States, it had learned how to make money off of even its industrial waste - Vaseline being but one of the new products launched. 

The benefits of having a monopoly like Standard Oil in the country was only realized after it had built a nationwide infrastructure that no longer depended on trains and their notoriously fluctuating costs, a leap that would help reduce costs and the overall price of petroleum products after the company was dismantled. The size of Standard Oil allowed it to undertake projects that disparate companies could never agree on and, in that sense; it was as beneficial as state-regulated utilities for developing the U.S. into an industrial nation. 

Despite the eventual break of up of Standard Oil, the government realized that a monopoly could build up a reliable infrastructure and deliver low-cost service to a broader base of consumers than competing firms - a lesson that influenced its decision to allow the AT&T monopoly to continue until 1982. The profits of Standard Oil and the generous dividends also encouraged investors, and thereby the market, to invest in monopolistic firms, providing them with the funds to grow larger. 

Case Study 3 AT&T and Microsoft

AT&T was a government-supported monopoly - a public utility - that would have to be considered a coercive monopoly. Like Standard Oil, the AT&T monopoly made the industry more efficient and wasn't guilty of fixing prices, but rather the potential to fix prices. The break up of AT&T by Reagan in the 1980s gave birth to the "Babylon bells". Since that time, many of the baby bells have begun to merge and increase in size in order to provide better service to a wider area. Very likely, the break up of AT&T caused a sharp reduction in service quality for many customers and, in some cases, higher prices, but the settling period has elapsed and the baby bells are growing to find a natural balance in the market without calling down Sherman's hammer again. 

Microsoft, on the other hand, was never actually broken up even though it lost its case. The case against it was centered on whether Microsoft was abusing what was essentially a non-coercive monopoly. Microsoft has been challenged by many companies, including Google, over its operating systems' continuing hostility to competitors' software. 

Just as U.S. Steel couldn't dominate the market indefinitely because of innovative domestic and international competition, the same is true for Microsoft. A non-coercive monopoly only exists as long as brand loyalty and consumer apathy keep people from searching for a better alternative. Even now, the Microsoft monopoly is looking chipped at the edges as rival operating systems are gaining ground and rival software, particularly open source software, is threatening the bundle business model upon which Microsoft was built. Because of this, the antitrust case seems premature and/or redundant. 

Solution:

International Harvester and American Tobacco

International harvester had the monopoly over the market, producing the cheap equipment to the agrarian nation, they put the barrier to the entry of the other companies and thus the other companies have to be price takers in this situation.

The American Tobacco was seem to have the negative monopoly they were charging the high prices to the consumers, exploiting the consumers and causing the damage to the health of the consumers.

Standard Oil

There was no risk of the over production, and the firm has the control over the market which thus helped in lowering the prices for the services to the consumer, with the efficient use of the resources and benefits to the others. However there would be the limitation and risk of exploitation of the labor.

AT&T and Microsoft

In the case of AT&T the consumers were getting the better services as there was no competitive firms in the market and there was the perfect and efficient use of the resources despite the fixed prices, but breaking up the monopoly lowered the level of the quality of service to the consumers with the increase in the competition in the market. However the Microsoft case is related to the brand loyalty, the Microsoft had been a monopoly in the market for the long run, but consumers are loyal to the brand.

Benefits:

There was no risk of over production, and there was efficient use of the resources

The customers were loyal to the brand

The quality of the services and product was good since there was monopoly of the company

There was the control over the market

Consumers could get the lower prices on the services and products

Other firms have to be price takers in order to enter in to the market

Limitations:

There was extreme exploitation of the consumers

The consumers have restricted choice

There was threat of rebel from the other parties and legislative wraths

There was increased possibility of the exploitation of the labor