Introduction
The objective of any firm is to maximise profits and increase shareholders’ wealth. This objective can only be attained if the market structure is favourable for the operations of the firm. The market for low-calorie microwavable food has changed from perfect to imperfect competition. This paper discusses the effectiveness of the new market structure to the operations of the company. It also assesses the profitability of the firm based on the cost functions and the demand function from assignment. In addition, the paper explores was in which the company can improve its profitability as well as the circumstances under which it should discontinue its operations.
- Assessing the effectiveness of the market
The market for low-calorie microwavable food was originally monopolistically competitive as indicated by the high value of price elasticity of demand. The price elasticity of demand for the low-calorie frozen, microwavable food was 1.19 indicating that a 1% change in price would cause a 1.19% change in quantity demanded. Firms in the industry include Nestle SA, Kellogg Company, Birds Eye Foods, among other firms.
The change from perfect competition to imperfect competition gives freedom to the existing firms to control the pricing of their products. This is because imperfect competitive markets are characterised by price inelastic demand hence a firm can increase its price without experiencing a substantial loss in sales (Tucker, 2011). In addition, an imperfect market will favour product differentiation, among other non-price competitive measures.
- Possible causes of change in market structure
- Product differentiation: Many firms in the market may have engaged in extensive product differentiation. The effect of product differentiation is that it reduces price-based competition as consumers begin to base their buying decisions on factors other than price. This in turn causes a reduction in price elasticity of demand thereby giving existing firms more power in determining the prices of goods.
- Exit of firms: The initial competitive market implies that firms were free to enter or exit the market. Firms that could not maintain the fierce competition in the market may have exited the market. Therefore, existing firms experienced an increase in their market shares and market concentration (McEachern, 2012). It may also have been caused by horizontal integration strategies employed by existing firms. Mergers and acquisitions may have reduced the number of firms in the market. They result in the formation of large corporations that control larger market shares. In addition, large companies resulting from mergers and acquisition may have made it difficult for smaller companies to sustain competition in the market. The reduction in the number of firms, therefore, reduced competition in the market ad gave existing firms more powers to set prices and hence caused the change from perfect to imperfect competition.
These changes have a primary effect on the operations of the company. Firstly, the business can improve its profitability to changing prices. The market structure makes it possible for the firm to increase revenue by raising prices. High-quality is not impossible under perfect competition as perfect competitive firms do not have the latitude to set prices. Furthermore, the change will force the firm to revise its competitive strategy from pricing to non-price competitive strategies (McEachern, 2012). It must be innovative to ensure continuous product development, product differentiation, among other measures. Under imperfect competition, the company cannot solely rely on its pricing as a strategy for maintaining and increasing its market share.
- Cost functions
The cost function of the firm indicates that it incurs a fixed cost of $160,000,000 and a variable cost given as: 100Q + 0.0063212Q2. Based on the equilibrium quantity of 28,000 units (from assignment 1), the firm’s costs will be as follows:
Total Cost, TC = 160,000,000 + (100 × 28,000) + (0.0063212 × 28,0002)
= 160,000,000 + 2,800,000 + 4,955,821
= 167,755,821
Variable cost = (100 × 28,000) + (0.0063212 × 28,0002)
= 2,800,000 + 4,955,821
= 7,755,821
Variable cost per unit = 7,755,82128,000 = 276.99
Average total cost = 167,755,82128,000 = 5,991.28
The cost functions are applied in both short-term and long-term decisions, especially pricing and production decisions. In the short-run, the firm’s fixed cost will be 160,000,000 irrespective of any decisions taken. It is, therefore, an irrelevant cost in pricing and production decisions. The firm should, therefore, ignore its fixed cost in making short-term decisions (Krugman & Wells, 2009). For instance, when determining the appropriate price for the low-calorie microwavable food, it should ignore the 160,000,000 and set a price that covers only the average variable cost (276.99).
In the long-run, all costs become relevant in the firm’s pricing and output decisions. This is because even fixed costs become variable in the long-run. Therefore, the long-run price charged for each unit of the low-calorie frozen microwavable food should cover the average total cost and guarantee the desired the profit margin. The firm should, therefore, consider all the costs, whether fixed or variable, in long-term decisions.
- Circumstances under which the company should discontinue operations
The company should discontinue its operations if it continuously makes losses. In this case, the firm is not able to charge a price that covers its production costs. It may be a result of stiff competition in the market making it difficult for the company to charge higher prices. In the short-run, it should shut down if it has a negative contribution. If it has a positive contribution (if total revenue is more than total variable costs), the company should not suspend its operations as it will make losses due to fixed costs (Krugman & Wells, 2009). In the long-run, however, the total income should cover both fixed and variable costs; otherwise, the company should terminate its activities.
When faced with these situations, the firm can remedy the situation by charging higher prices. In this market structure, it is possible for the firm to increase its prices since demand is not elastic (Landsburg, 2010). However, this strategy will not be effective in increasing revenues. Even under imperfect competition, significant variations in prices will make consumers more responsive. The firm should, therefore, enhance the efficiency of its operations to reduce its production costs.
- Pricing policy
The most appropriate policy is to charge the profit maximizing price. This is achieved if it operates at a level of output that equates its marginal cost and marginal revenue.
Marginal cost, MC = 100 + 0.0126424Q
Demand equation: Q = 38,650 – 42P
P = 38,650-Q42
Total Revenue = Q × 38,650-Q42 = 38,650Q-Q242
Marginal Revenue, MR = 38,65042 - 2Q42
38,65042 - 2Q42 = 100 + 0.0126424Q
38,650 – 2Q = 4200 + 0.5309808
2.5309808Q = 34,450
Q = 13,611 units
Profit maximizing price = 38,650-Q42 = 38,650-13,61142
= 596.2
The appropriate strategy for the company is to produce 13,611 units and charge the corresponding price of 596.2 cents. The profit maximizing price and the corresponding quantity are different from the equilibrium price and quantity. The equilibrium price was 254 cents while the quantity was 28,000 units. The profit maximizing price is, therefore, higher than the equilibrium price. This indicates that in an imperfect competition, the company can set a higher price. The company would charge the equilibrium price if it were operating in a perfect competitive market (Hall & Lieberman, 2013). However, the quantity the firm will produce and sell is less than the equilibrium quantity it would sell under perfect competition market.
- Financial performance
Profit at profit-maximizing output
Total revenue = 13,611 units × 596.20
= 8,114,878.20
Total Cost, TC = 160,000,000 + (100 × 13,611) + (0.0063212 × 13,6112)
= 160,000,000 + 1,361,100 + 1,171,061.20
= 162,532,161.20
Total Variable Cost = (100 × 13,611) + (0.0063212 × 13,6112)
= 1,361,100 + 1,171,061.20
= 2,532,161.20
Total contribution = Total revenue – Total variable cost
= 8,114,878.20 - 2,532,161.20
= 5,582,717
Profit = Contribution – Fixed cost
= 5,582,717 – 160,000,000
= -154,417,283
Profit at equilibrium values
Total revenue = 254 × 28,000 = 7,112,000
Total cost = 160,000,000 + (100 × 28,000) + (0.0063212 × 28,0002)
= 160,000,000 + 2,800,000 + 4,955,821
= 167,755,821
Profit = 7,112,000 - 167,755,821
= -160,643,821
As shown above, the company makes a positive contribution of 5,582,717. However, its operations are not profitable as it makes a loss of -154,417,283. This is caused by the high fixed costs it incurs. Therefore, in the short-term, the company is profitable and should continue operating since its contribution is positive. In the long-term, the company is not profitable as its total revenue is not sufficient to cover its total production cost. If the marketing environment does not change, the firm will be forced to terminate its operations. The company makes more losses if it operates at equilibrium values, charging 254 cents and producing 28,000 units.
A study of the critical success factors such as cost of raw materials, competition, among other factors, indicate that the selling environment is likely to become more competitive. Statistics indicates that the price of agricultural inputs is on the rise. In addition, many companies are entering the market since there are no barriers. This will make the market more competitive thereby worsening the firm’s profitability. Furthermore, the industry may face additional health and safety regulations. Obesity among Americans has become a concern hence the operations of firms in the frozen food industry may be regulated to guarantee safety.
- Measures to enhance profitability
- Investing in research and development: The firm can improve its profitability by improving the quality of its products. This can only be achieved through continuous product development. It requires the firm to invest heavily in research and development. High quality products will enable them firm to increase its market share. They can also attract higher prices thereby improving
- Horizontal integration: The Company can improve its profitability by merging with or acquiring competing firms in the industry, especially the small firms. It will gain from economies of scale and will increase its market power. It will be able to increase its production capacity and reduce cost per unit.
- Improving efficiency: The firm should consider restructuring its internal operations to reduce its production cost. It should change its production technology and methods, and train employees. This will help it reduce its current high fixed cost and enhance profitability.
- It can also diversify its products as well markets. This will spread risks and allow it exploit new opportunities in emerging as well established markets.
References
Hall, R., & Lieberman, M. (2013). Microeconomics: Principles & applications (6th ed.). Mason, OH: South-Western Cengage Learning.
Krugman, P., & Wells, R. (2009). Microeconomics (2nd ed.). New York, NY: Worth.
Landsburg, S. (2010). Price theory and applications (8th ed., International ed.). Mason, Ohio: South-Western.
McEachern, W. (2012). Economics: A contemporary introduction (10th ed.). New York: Cengage Learning.
Tucker, I. (2011). Microeconomics for today's world (7th ed., International ed.). Mason, Ohio: South-Western.
