Purpose : synthesize concepts from managerial economics and managerial finance t
ID: 1113011 • Letter: P
Question
Purpose: synthesize concepts from managerial economics and managerial finance to analyze profitability differences across industries and companies.
Introduction: There are four different market structures in the real world – perfect competition, monopolistic competition, oligopoly, and monopoly. They are differentiated by the number of producers, the degree of control that producers have on setting the price, the degree of interdependence between firms in pricing and other decisions, and the ease of entry of new firms (businesses) into the industry. Together, these factors – especially the last one - have consequences for profitability.
You may be familiar with the four forms of market structure from your managerial economics course and/or from awareness of the world around you (for instance, you all know that there is very likely one provider of electricity or water supply in your town but several restaurants serving different types of cuisine). You can also probably guess that profit margins for your electricity provider is higher than that of the restaurants in your town. That’s why the Citizens’ Utility Board (CUB) advocates on behalf of consumers when it fights utility rate hikes, but no such advocacy is required to fight the restaurant industry.
Examples of perfect competition are hard to come by in the real world (markets for agricultural products come close, but these are typically sold in stores that themselves are not operating in a perfectly competitive environment). For the purpose of this project, therefore, we will leave out perfect competition.
For the other three market structures, the different measures that can be used to determine the degree of concentration and competition in the industry are: (i) the number of firms in the industry, (ii) the 4- firm concentration ratio (and / or 8-firm and 20-firm concentration ratios), and (iii) the Herfindahl- Hirschman index. The larger the number of firms in the industry and the smaller the (4-firm) concentration ratio, higher is the degree of competition in the industry. These measures are provided by the Census Bureau at https://factfinder.census.gov/faces/nav/jsf/pages/searchresults.xhtml?refresh=t
Higher the degree of competition, lower is the expected profit margin.
In managerial finance, you learned how to measure profitability using different profit margins.
Required: For this project, you will analyze whether profit margins are indeed significantly different between the different market structures as theory suggests. You will present the findings of your analysis as a report.
Step 2: pick three different industries, one which most resembles monopolistic competition, one which most resembles oligopoly, and one which most resembles monopoly or duopoly (two firms in the industry. Then do some research and identify the two firms in each industry that have the largest market shares.
As mentioned earlier, the U.S. Census Bureau provides information about the number of firms, concentration ratios, and the Herfindahl-Hirschman index for different industry classification groups. I downloaded the Excel file and have attached it for your use. In the file, I have highlighted some industry groups for your reference. Note, for instance, the difference in the four-firm concentration ratios between:
• Breweries (NAICS1 code 31212) and Electronic computer manufacturing (NAICS code 334111): 89.5 per cent and 86.9 per cent respectively;
• Pharmaceutical and medicine manufacturing (NAICS code 3254) and Adhesive manufacturing (NAICS code 32552): 29.5 per cent and 23.2 per cent respectively;
• Apparel manufacturing (NAICS code 315) and Plastics product manufacturing (NAICS code 3261): 7.9 per cent and 5.4 per cent respectively.
You can note down the number of firms in each of the above industry groups by doing an Advanced Search on the American Factfinder web page at https://factfinder.census.gov/faces/nav/jsf/pages/searchresults.xhtml?refresh=t.
Step 3: either calculate the profitability ratios for the six firms yourself, or get the information from a trusted source like Morningstar. Analyze the data for profit differences across the three market structures. The specific research question you are addressing is whether profit margins are (a) indeed significantly different between the three market structures and (b) whether the difference is in line with what market structure theory suggests.
Step 4: Write up a report summarizing your research and analysis. Give your report a title, put names of all team members, and include a list of references you used.
Explanation / Answer
There are many distinctive market structures that can describe an economy. Be that as it may, in the event that you are simply beginning with this theme, you might need to take a gander at the four fundamental sorts of market structures first. To be specific impeccable rivalry, monopolistic rivalry, oligopoly, and restraining infrastructure. Each of them has their own arrangement of qualities and presumptions, which thus influence the basic leadership of firms and the benefits they can make. It is essential to take note of that not these market structures really exist in all actuality, some of them are quite recently hypothetical builds. In any case, they are of basic significance, since they can outline applicable parts of rivalry firms' basic leadership. Henceforth, they will help you to comprehend the hidden monetary standards.
Perfect Competition
Consummate rivalry portrays a market structure, where countless firms contend with each other. In this situation, a solitary firm does not have any noteworthy market control. Therefore, the industry in general delivers the socially ideal level of yield, since none of the organizations can impact showcase costs.
Perfect rivalry expands on various suspicions: (1) all organizations augment benefits (2) there is free section and exit to the market, (3) all organizations offer totally indistinguishable (i.e. homogenous) products, (4) there are no shopper inclinations. By taking a gander at those suspicions it turns out to be very self-evident, that we will scarcely ever discover idealize rivalry actually. This is a critical angle, since it is the main market structure that can (hypothetically) result in a socially ideal level of yield. Likely the best case of a market with practically culminate rivalry we can discover as a general rule is the share trading system. In the event that you are searching for more data on culminate rivalry, you can likewise check our post on idealize rivalry versus blemished rivalry.
Monopolistic Competition
Monopolistic rivalry likewise alludes to a market structure, where a substantial number of little firms go up against each other. Be that as it may, not at all like in consummate rivalry, the organizations in monopolistic rivalry offer comparative, however somewhat separated items. This gives them a specific level of market control which enables them to charge higher costs inside a specific range.
Monopolistic rivalry expands on the accompanying presumptions: (1) all organizations boost benefits (2) there is free section and exit to the market, (3) firms offer separated items (4) purchasers may incline toward one item finished the other. Presently, those suppositions are somewhat nearer to reality than the ones we took a gander at in idealize rivalry. Be that as it may, this market structure will never again result in a socially ideal level of yield, in light of the fact that the organizations have more power and can impact showcase costs to a specific degree. A case of monopolistic rivalry is the market for grains. There is a colossal number of various brands (e.g. Cap'n Crunch, Lucky Charms, Froot Loops, Apple Jacks). The majority of them most likely taste marginally unique, however by the day's end, they are all breakfast oats.
Oligopoly
An oligopoly portrays a market structure which is overwhelmed by just a modest number firms. This outcomes in a condition of restricted rivalry. The organizations can either contend with each other or work together. By doing as such they can utilize their aggregate market energy to drive up costs and procure more benefit.
The oligopolistic showcase structure expands on the accompanying suppositions: (1) all organizations boost benefits, (2) oligopolies can set costs, (3) there are boundaries to passage and exit in the market, (4) items might be homogenous or separated, and (5) there is just a couple of firms that rule the market. Tragically, it isn't obviously characterized what a «few» firms implies precisely. As a general guideline, we say that an oligopoly ordinarily comprises of around 3-5 overwhelming firms. To give a case of an oligopoly, how about we take a gander at the market for gaming supports. This market is ruled by three intense organizations: Microsoft, Sony, and Nintendo. This leaves every one of them with a lot of market control.
Monopoly
An imposing business model alludes to a market structure where a solitary firm controls the whole market. In this situation, the firm has the most elevated amount of market control, as purchasers don't have any options. Therefore, monopolists regularly lessen yield to build costs and acquire more benefit.
The accompanying suppositions are made when we discuss restraining infrastructures: (1) the monopolist boosts benefit, (2) it can set the value, (3) there are high hindrances to section and leave, (4) there is just a single firm that commands the whole market. From the point of view of society, most imposing business models are typically not alluring, on the grounds that they result in bring down yields and higher costs contrasted with focused markets. In this manner, they are frequently managed by the legislature. A case of a genuine restraining infrastructure could be Monsanto. Around 80% of all corn reaped in the US is trademarked by this organization. That gives Monsanto a to a great degree abnormal state of market control. You can discover extra data about syndications our post on restraining infrastructure control.
There are four fundamental sorts of market structures: idealize rivalry, blemished rivalry, oligopoly, and restraining infrastructure. Culminate rivalry depicts a market structure, where an expansive number of little firms contend with each other with homogenous items. In the interim, monopolistic rivalry alludes to a market structure, where countless firms contend with each other with separated items. An Oligopoly portrays a market structure where few firms go up against each other. What's more, to wrap things up a restraining infrastructure alludes to a market structure where a solitary firm controls the whole market.
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