Please respond to the following 2 questions based on the given scenarios

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Narrations

Slide 1

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An older cottage style family run business (Katrina’s Candies)

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In Renee’s office, Herb and Renee continue evaluating markets structures; and together decide that Katrina's  Candies is operating in an oligopolistic manner.

Renee: Good Afternoon, Herb! 

Herb:  Hello, Renee.

Renee: According to our timetable, we are on schedule to discuss Katrina’s Candies selling environment.

Herb: Selling environment? I’m not familiar with this term.

Renee: Oh, sorry, you may have heard it being called “market structures.”

Herb: Yes, I have definitely heard of that term. Why do you refer to this term as “selling environment”?

Renee: We use the term “selling environment” to remind us about  competition in Katrina’s Candies market.

Herb:  That makes sense. So what type of competition does this company confront?

Renee: Just regular competition from companies that sell similar products. I want you to keep in mind that there is more than one type of “selling environment.” 

Herb: More than one type! I thought competition is competition!

Renee: No, it isn’t. No matter the type of competition or selling environment, firms determine the maximum profit by equating marginal revenue and marginal cost.  The similarity does stop there.  I can explain the different types of competition, if you like. 

Herb:  That would be fantastic!  I can’t believe I didn’t know there is more than one selling environment.

Renee: Let’s meet in the conference room and we’ll begin.

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Herb and Renee in the conference room to discuss different types of competition

Renee: To tell the difference between types of market structures, “selling environments,” you should use three characteristics to identify the market and they include:

The number of firms in the market;

The type of product sold in the market; and

The ease of entering and exiting the market. 

Herb: Number of firms? Isn’t there competition no matter how many firms are in a market?

Renee: Yes, that is correct. To clarify your question, let me show you this informative video that may answer several of your questions. We can then talk afterwards and see if we need to revisit any concepts.

Herb:  Thanks, Renee!

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Interaction Slide

Ipad will be showcasing the video:

·         Microeconomics- Market Structures

o   http://www.youtube.com/watch?v=CH04Xxtm1ow

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Herb and Renee in the conference room to discuss different types of competition and the video Herb just watched

Renee: There you have it, Herb.  Based upon the three characteristics, there are four market structures which include: pure competition, monopolistic competition, oligopoly and monopolies. 

Herb:  Thanks, Renee!  But I still have one other question.

Renee: What is it, Herb?

Herb:  Is it proper to use the term competition to describe four markets that are different?

Renee: Actually, there is an additional way to distinguish markets. Broadly, there are purely competitive market structures and imperfectly competitive market structures. 

Herb:  I understand now! Imperfectly competitive market structures are markets where firms have the power to influence or determine price. 

Renee: That’s correct!  Firms that have the ability to influence price have market power; unlike firms operating in purely competitive markets. The question for us is, which of the market structures best describes Katrina’s Candies market?

Herb:  I was reflecting on that very question while listening to the explanation about market structures.

Renee: So, what do you think?

Herb:  Well, Katrina’s Candies is not the only seller of chocolates; there are other firms.

Renee: How many other firms?

Herb:  Looking at some census data  conducted two years ago, there were about forty firms.

Renee:  Really, forty firms?  That’s a lot! Does that sound like pure competition to you?

Herb: No, I don’t think so because each of the firms sells different types of chocolates.

Renee: Differentiated products do exclude the purely competitive market structure.  Any other reason the market is not purely competitive?

Herb:  I would say that, although there are forty firms, based upon the explanation of the number of firms criteria, I don’t think forty firms is considered “many” firms.

Renee: That is quite true, Herb. Many firms means the market has so many firms it isn’t possible to accurately count the number.  Since the former census resulted in forty known firms, the market is not purely competitive.

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Herb and Renee in the conference room to discuss monopolistic competition

Herb:  So, we’ve just excluded pure competition that now leaves monopolistic competition. This brings me to another question, how large is Katrina’s Candies relative to the other forty firms in the chocolate market?

Renee: Based on rank according to sells, it was listed as number four out of the forty. 

Herb: How close was Katrina’s to the number one firm?

Renee: That’s the interesting thing.  Although it was number four out of forty firms, the top three firms had a forty percent share of the market overall. When we looked closer, we discovered that within the category of specialty chocolates, firms like “Godiva’s” had nearly eighty percent of the total sells.

Herb:  The share you calculated is called concentration ratio and represents the numeric representation of a firm’s power in the market.  The more powerful a group or a single firm, the larger is the value of the concentration ratio.  In other words, this value shows the extent of market control that the firm has in the industry.

Renee: Why is the concentration ratio important, given the three market characteristics we discussed? 

Herb:  In some cases the number of firms in a market misrepresents the actual behavior in the market. In this case, more than forty percent of the firms share the four largest firms control meaning the market is not monopolistically competitive despite the fact that there are enough firms in numbers to use that classification. I feel this is a good example of how concentration ratios allow for a more precise classification of markets.

Renee:  There’s only one type of market structure left, which is oligopoly. Does oligopoly describe Katrina’s Candies market?

Herb:  Based upon the information you told me about the four-firm concentration ratio; yes, it  is operating in an oligopolistic market structure. 

Renee: Now, I would like you to tell me how this information about the market is useful to Katrina’s Candies.  

Herb:  Essentially, understanding market structure empowers Katrina’s Candies because the information enlightens us about possible market reactions when it implements either an output or price decision. 

Renee: Thanks for going over that with me. That is all I want to go over today. I want to make sure you understand the different concepts we discussed. Therefore, I would like for you to participate in a review activity I put together based on the key items we discussed.

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Interaction Slide

Incorporate iPad to show supplemental information about today’s topics

·         Kinked Demand Oligopoly:  The lack of price competition.

o   http://www.youtube.com/watch?v=HT9t-zjYi_A

·         Price Leadership

o   http://www.youtube.com/watch?v=GeD2fwjJ8_U

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Check Your Understanding

Multiple Choice Question

·         In both monopolistic competition and oligopoly market structures:

a.  There are many sellers.

·         Incorrect Feedback: As a matter of fact neither monopolistic, competition, nor oligopoly has many sellers.   Oligopoly has only a few firms; while MC has more firms than in  Oligopoly yet not as many as in pure competition.

b.  There is easy entry and exit.

·         Incorrect Feedback: In monopolistic competition (MC), entry in and exit from the market is relatively easy; however, it’s difficult to penetrate the market for “leading brands.”  For oligopolistic markets, there are significant barriers that make entry into a market difficult.

c.  Consumers perceive differences among the products of various competitors.

·         Correct Feedback: Both monopolistically competitive and oligopolistic firms sell differentiated products.  For example, packaging may differ along with other characteristics of the product like color.

d.  Economic profits may be earned in the long run.

·         Incorrect Feedback: It is possible that neither monopolistically, competitive, or oligopolistic firms will earn profit in the long-run. There is no guarantee.

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Summary

Concluding scene taking place in conference room

Renee: Herb, I hope the review activities were helpful!

Herb: They were great, Renee! Thank you for sharing the youtubes and activities with me; they were great review tools. Can we do a review of what we accomplished today so I can be prepared for my next meeting with Ken?

Renee: Good thinking! We first learned about the three characteristics that are used to define market structures. Then, we saw that when we apply these characteristics, four market structures can be identified.

Herb: We noted that the "Oligopoly" market is characteristic of Katrina's Candies!

Renee: Thanks for emphasizing that point, Herb!.

As we saw oligopolistic firms face intense competition from other firms, yet there is a high level of interdependence among each group of firms. You should also keep in mind that the decisions of one firm impact the profits of other firms. 

Herb: I would say today was a success! I feel really good about meeting with Ken and answering any questions he may have about the concepts we discussed today.

Renee: That is fantastic and I believe that is all for our meeting today. Until we meet again, don’t forget to complete your weekly threaded discussions based on the key concepts we covered this week.

Herb: Thanks, Renee and have a great day!

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Narrations

Slide 1

Scene 1

An older cottage style family run business (Katrina’s Candies)

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In Gigi’s office where Herb explains to Gigi why a large company like Katrina’s Candies cannot ignore industry
rivals and why predicting rival responses is an important determinant of decisions Katrina's  Candies makes. 

Gigi: Good Afternoon, Herb! 

Herb: Hello, Gigi.

Gigi: I called you into my office today to talk about rival behaviors in our chocolate market. I had a couple of questions pertaining to this subject. My first question is, based on your time with Renee, what kind of market structure does Katrina’s Candies operate in?

Herb:  Renee and I determined that its Chocolates operate within an Oligopolistic market structure, and we noted that there are only three firms in our market that are larger than Katrina’s Candies.

Gigi: This market classification means that the market has consolidated over the past fifteen years.  When I started working here, there were a lot of other candy manufacturers and the market seemed to feature more monopolistic competition.

Herb:  Perhaps the trend towards healthier life-styles was too much for those firms that left the market; especially burdensome is the higher cost associated with innovating products just to be able to stay in the market. Therefore, it’s good Katrina’s Candies was able to survive the adjustment that took place in the market.

Gigi: I couldn’t agree more, Herb.  All of its employees have helped maintain our competitive posture so far—from management to employees working on the manufacturing side of the operation.  We’ll just have to repeat the effort we organized..  We ignored all of the other chocolate manufacturers        and focused our efforts on making good chocolate.  We should implement a similar strategy now.

Herb:  The narrowly focused strategy Katrina’s Candies used previously to survive in the market might have worked with a larger number of manufacturers than what is present in today’s market.[DB1]   However, today, given the information that the market has a few dominant firms, the strategy of ignoring other firms will not work.  Katrina’s Candies has to be aware of these markets and consider the reactions of other firms.

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In Gigi’s office where Herb explains to Gigi why a large company like Katrina’s Candies cannot ignore industry rivals and why predicting rival responses is an important determinant of decisions it makes. 

Gigi: I’ll defer to your opinion on this one, Herb.  We brought you on the team because you have the most current information about best practices, so with that being said, how should Katrina’s  Candies proceed?

Herb:  The simple answer to your question is that we now need to focus attention on its competitors. We can develop a matrix of how competitors might respond if Katrina’s Candies expands into the international market. 

Gigi: How can we create a matrix of other firms’ reactions? We can’t survey our competitors to ask what they will do if we expand; I think that would violate U.S. anti-trust laws prohibiting collusion amongst firms.      

Herb:  That’s correct! We cannot directly engage competitors by telephoning firms and asking questions. However, we can build a matrix of hypothesized reactions based upon theories that attempt to explain the behavior of oligopolistic firms.  There are several theories we can review and use such as:
 

The Kinked Demand Curve theory;

The Price Leadership Theory;  and

Game Theory.

The common assumption among these theories is that firms operating in oligopolistic markets are “interdependent” meaning that the level of profit each firm earns depends upon the behavior of other firms within the market. 

Gigi: Can you elaborate on this connection between interdependence and Katrina’s Candies profit?

Herb: Yes.  It works like this.  Remember how overall profit is defined as the difference between total revenue and total cost?

Gigi: Yes, I remember.

Herb:  Also recall that Total Revenue is derived by multiplying Price times the Quantity sold.  In the market Katrina’s Candies is in, the price we set depends upon the price our competitors set; and vice versa.      That’s the reason the three oligopoly theories assume interdependence. 

Gigi: Okay, I believe I understand the interdependence assumption now.

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In Gigi’s office where Herb explains to Gigi why a large company like Katrina’s Candies cannot ignore industry
rivals and why predicting rival responses is an important determinant of decisions it makes. 

Herb:  Let’s now review Kinked Demand Theory.  Assume there are two firms considering two decisions about price.  Decision one is to raise prices and decision two is to lower prices.  According to kinked demand curve theory, if one firm chooses to lower prices, the other firm will also lower their prices.  However, if one firm raises prices, the other firm may not raise prices. 

Gigi:    Why would a firm ignore a price increase?  Wouldn’t an increase in price increase the firm’s total revenue?

Herb:  An increase in the price of an oligopolist’s product would increase total revenue only if the other firm reacted by also increasing the price of its product.  However, if firm A were to increase price and firm B did not react by increasing price, consumers would switch from consuming firm A’s product to consuming firm B’s product because both sell the same type of product. 

Gigi: Is this all there is to kinked demand curve theory?

Herb:              Almost.  Although the theory states that firms would follow price cuts, oligopolists avoid using price to compete.  Instead, oligopolists engage in lots of non-price competition; for example, spending on             advertising as a way to compete.

Gigi: Is there a reason firms behave differently than theorists predict?

Herb:  Yes, by using price to compete this can sometimes cause a price war for the best prices. To avoid that outcome, it’s best for firms to compete in ways that don’t affect price.  Let’s look at an example of the Kinked Demand Curve Theory.

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Interaction Slide

Ipad will be showcasing the video:

·         Kinked Demand Oligopoly:  The lack of price competition.

o   http://www.youtube.com/watch?v=HT9t-zjYi_A 

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In Gigi’s office with Herb briefly commenting on Kinked demand curve theory and preparing to view other presentations

Gigi: That was a very interesting explanation of Kinked demand theory.  The example brought everything into perspective.

Herb:  Fantastic! The next concept I want to cover is Price Leadership theory.  I found two short videos that will give you a basic overview of the basic assumptions of this theory.

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Interaction Slide

Ipad will be showcasing these videos:

·         Price Leadership 1

o   http://www.youtube.com/watch?v=AtH4_lU_T8k

·         Price Leadership 2

o   http://www.youtube.com/watch?v=GeD2fwjJ8_U

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In Gigi’s office where Herb talks about Price Leadership Theory and Game Theory with Gigi 

Gigi: Thank you for showing me those videos Herb; they were a great overview! I now understand the difference between a firm’s behavior in a kinked demand curve environment and in a price leadership environment.  Initially, I thought the uncertainty in the kinked demand curve outcome was restrictive.  After learning the basics of price leadership theory, the kinked demand scenario seems more attractive. 

Herb:  I agree.  The price leadership scenario does not theorize a good outcome for Katrina’s Candies Chocolates, even though they are the fourth largest firm in the chocolate industry.

Gigi: So, what can we here at Katrina’s Candies do in this type of market?

Herb:  Katrina’s Candies must be very strategic with its decisions!  All decisions must be based upon the assumption that its nearest competitors will respond to the decisions they make.

Gigi: So, that’s your recommendation? Let the competitors react to our decisions?

Herb: Yes, I feel we should go along with that assumption and also look into a foundation involving “Game Theory.” Game Theory is a theory that provides a model for predicting the behavior of rivals.  It looks at strategic decision making!

Gigi: How do we apply this model to make a prediction?

Herb:  Here, take a look at this video. The video will give you an idea of how we need to be rational throughout various scenarios.

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Interaction Slide

Ipad will be showcasing the video:

·         Game theory in real life

o   http://www.youtube.com/watch?v=2o3H0AtEylg

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In Gigi’s office where Herb talks about Game Theory with Gigi 

Gigi: (laughter) That skit is hilarious!! 

Herb:  Yes, it is!  Every time I view it, it makes me laugh!

Gigi: I can see why!  However, it’s a great way to summarize the game theory method.  Did you hear how many times they used the word “probably”?

Herb:  Yes.  Can you imagine how we’re going to sound speculating about the reactions of Katrina’s Candies rivals!

Gigi: (Laughter) I hadn’t thought about that! However, we need to stop here for today because I have an appointment with a client in a few minutes.

Herb:  Before you go I think it would be best if we did a review since we covered so many new topics today. Therefore, I would like for you to participate in a review activity I put together based on the key items we discussed.

Gigi: Good thinking Herb. I will go through your review activity and then we will have a final review to finish up our time together today.

Slide 11

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Interaction Slide

Ipad will be showcasing the video:

·         Micro 4.8 Oligopolies and Game Theory

o   http://www.youtube.com/watch?v=AOEbJF0k8vM

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Check Your Understanding

Answer the following questions based on the payoff matrix for a one quarter time-period, for Katrina’s Candies and Gooey’s. The numbers in the matrix indicate the profit in billions of dollars for an international or national strategy.  The profit outcome cells are A, B, C, and D.

(insert matrix picture for question)

Question:

·         Which strategies are the dominate ones for Katrina’s Candies and Gooey’s?

Choices:

·         International

·         National

·         Demand theory

·         Game theory

Correct Answer:

·         The dominant strategy for Katrina’s Candies and Gooey’s is to always choose the international strategy.

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Summary

Concluding scene taking place in conference room

Herb: Gigi, I hope the review activities were helpful!

Gigi: They were great, Herb! Thank you for sharing these review materials with me; they were a great review tool. Can we now complete a review of what we accomplished today so I can be prepared for my next meeting with Ken?

Herb: Sure thing! We first established that Katrina’s Candies is operating in an oligopolistic market, meaning that at least three chocolate manufacturing firms dominate the market. I also mentioned that currently Katrina’s Candies is number four in this market.

Gigi: I also remember you talking about the primary characteristic of firms in oligopolistic markets is mutual interdependence.

Herb: That is correct, and I’m glad you remembered that! I also explained three theories that offered explanations for the behavior of oligopolistic firms.

Gigi: I believe those three theories were the Kinked Demand Curve theory, Price Leadership Theory, and Game Theory. You also provided me with videos that really helped solidify these three theories.

Herb: I’m glad that those videos were helpful for you! I believe you will be very well prepared for your next meeting with Ken to discuss the future of Katrina’s Candies. 

Gigi: That is fantastic and I believe that is all for our meeting today. Until we meet again, don’t forget to complete your weekly threaded discussions based on the key concepts we covered this week.

Herb: Thanks Gigi and have a great day!