Competing as Starbucks

Starbucks may be confused by some as part of a perfect competition because coffee is the primary good being sold. As an establishment, Starbucks is providing service, a variety of products and most importantly, the experience which differentiates them from similar businesses. Although it does meet the perfect competition requirements of easy market entry and open access to market information, this coffee mogul is more characteristic of a monopolist competition. We know they have some control over pricing since they are typically charging double that of the competitor and obvious to almost anyone, Starbucks is preferred by many consumers.

A lack of originality which the company once possessed, has forced closed the doors of 600 stores in the U.S., accounting for 19% of American locations. The condition of the business has faltered due to a number of stipulations. The most common reasoning for its failures is that Starbucks executed an extreme development during a time of economic recession. Included in the closures, were 70% of which were opened after 2006. Howard Shultz among others, seems to think the experience and service provided to Starbucks customers became too common. The efficiency that resulted from improved technology came at the cost of a unique and personal transaction between the barista and consumer, who were suddenly paying 4 dollars for a coffee they could make at home. Although it may seem that reducing prices would have been beneficial, this would only result in less revenue but costs would remain the same. This is shown in the two graphs below when price changes from P1 to P2.

Starbucks decision to close such a large number of store came with its fair share of pitfalls. They spent approximately 328 million in the short-run to cover for severance packages, lease terminations and future obligations. I believe this drastic decision will lead to profits in the long-run since the company will no longer be carrying the dead weight of so many unsuccessful locations. With the objective of getting back to the company's roots, Starbucks success should be reinforced with their recent actions.



Resources:

 

Sayre, J.E. & Morris, A.J.  (2009).  Principles of Microeconomics (6th ed.).  Toronto, ON: McGraw-Hill Ryerson

http://econ651spring2009.wikispaces.com/Monopolistic+competition+(Include+coverage+from+chapters+2-6+of+Science+of+Success)

http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html

 

http://www.cbc.ca/money/story/2008/07/01/starbucks-closures.html

 

http://seattletimes.nwsource.com/html/businesstechnology/2008028854_starbucks02.html

Comparing Market Structures

Type of market:	Perfect Competition	Monopolistic Competition	Oligopoly	Monopoly
number of firms	numerous	many	few	one
freedom of entry	easy	easy	difficult	difficult or inaccessible
implications for demand curve	horizontal, price takers	slopes down, elastic	slopes down more, less elastic	slopes down even further, inelastic
average size of firms	small	small	large	large
nature of product	identical	similar but differentiated	identical or differentiated	exclusive
possible consumer demand	perfectly elastic, depends on price	relatively elastic, depends on product differentiation	relatively inelastic or elastic, depends on product differentiation	inelastic
profit making possibility	normal profits	economic profits in the short-run and normal profits in the long-run	economic profit	economic profit, depending on government intervention
government intervention	no	no	sometimes, through quotas and licenses	sometimes, through taxes, price control and nationalization
a new example	dairy farm	American Apparel	Telus	NBA
concentration ratio	very low	low	fairly high	very high

Perfect Competition



The horizontal demand curve represents a perfectly elastic demand. Therefore, we know that price = average revenue = marginal revenue. Since sellers are price takers, they only have control over levels of output. The profit maximising level of output is reached when marginal revenue equals marginal cost. In this graph the average cost is equal to average revenue, meaning the seller is making normal profits. In the short-run, economic profits can be achieved if average cost is less then average revenue.

The downward sloping demand curve demonstrates a fairly elastic demand, although this varies among firms depending on product differentiation. The most favourable quantity to be produced  is found where marginal revenue is equal to marginal cost. The price is determined by the demand curve and is the highest amount that can be charged while selling the desired quantity. In the short-run, as shown, the difference between the firms average revenue and average cost multiplied by the quantity sold is equal to the economic profit. In the long-run the demand curve will shift to the left and goods will no longer be sold above average costs, resulting  in normal profits.

Oligopoly

Oligopolies exemplify a kinked demand curve because at higher prices demand is elastic and at lower prices it is inelastica. The current market price is determined when marginal revenue is equal to marginal cost, which also generates maximum profits. Here the marginal revenue curve will become vertical reflecting the resistance towards a change in price.

Monopoly

The optimum profit is obtained when marginal revenue is equal to marginal cost, determining the desired output quantity and price which lies between the two break even points. These are present where the average cost curve crosses the demand curve. The marginal revenue curve is always below average revenue and as long as it's positive the total revenue must be increasing. Producing output at any price between the average cost and demand curves will conclude with economic profits and if the two are equal normal profits will result.

Resources:

 

Sayre, J.E. & Morris, A.J.  (2009).  Principles of Microeconomics (6th ed.).  Toronto, ON: McGraw-Hill Ryerson

wealthisnottheproblem.blogspot.com

cyro.cs-territories.com

edecon.wordpress.com

thismatter.com



Defining Oligopoly and Game Theory

- The characteristics listed below demonstrate the resemblance and contrast between each type of market.

perfect competition:

• numerous buyers and sellers
• many perfect substitutes are available so no preference is shown
• easy entry and exit for buyers and sellers
• sellers have no control over price
• market knowledge is available to everyone
• perfectly elastic demand

monopolistic competition:

• large number of small firms
• easy entry
• sellers have some control over price
• similar substitutes are available but product is differentiated
• highly elastic demand

oligopoly:

• controlled by a few dominate firms
• entry is difficult since economies of scale is usually present
• non price competition is practised especially when product differentiation exists
• sellers have significant control over price
• mutual interdependence subsists between sellers
• elasticity of demand will vary

- As a consumer, my preferred market type is a perfect competition since the price is not determined by the seller. If I were to own a business I would prefer to be part of a monopolistic competition, offering brand name, differentiated products. Although firms operating in an oligopoly have the most control over price and profit, they are constrained by the actions of other relative businesses.

- As a consumer of each market type I feel in control of all purchasing choices, except those which come from an oligopoly. As shown by the oil example in our text, if supply is limited by the cooperation of firms it will drive the prices up. This is not fair for the buyers.

- Game theory is the mathematical theory of conflict and cooperation. It is a study of how a person will strategically position themselves to recieve maximum gains while taking others actions into consideration.

- In 1944, Game Theory was established after the publication of, "Theory of Games and Economic Behavior, by John Von Neumann and Oskar Morgenstern. The idea originated from watching the social interaction and matematical outcomes of parlour games.

- In the current economy, Game Theory exists within the majority of oligopoly market structures, even when collusive and cartel actions are present. When mutual interdependence prevails, a business will always be looking out for it's best interests. This includes anticipating moves and reactions of other firms. It seems there should be cooperation between firms to recieve maximum profits but it is safer for a firm to cheat. If one firm cheats and the other doesn't, the loyal firm is rewarded by a large loss of profit but if both fims cheat the loss is much smaller for both.

- A payoff matrix is a tool used to display all possible outcomes of the decisions made by two mutually interdependant parties. The four combinations include:

• both player a and player b cheating
• both player a and player b not cheating
• player a cheating and player b not cheating
• player b cheating and player a not cheating

- Collusion is cooperation between rival firms, usually in the form of agreement over price setting and division of the market. Between countries collusion is acceptable but is illegal among firms. A cartel is a formal organization that acts in collusion in order to increase individual members' profits by reducing competition.



Resources:

Sayre, J.E. & Morris, A.J.  (2009).  Principles of Microeconomics (6th ed.).  Toronto, ON: McGraw-Hill Ryerson.

http://plato.stanford.edu/entries/game-theory/

http://dictionary.reference.com/browse/game+theory

Defining Monopolistic Competition

A monopolistic competition is a market containing a large number of sellers, offering similar products which accounts for approximately half of the economy's total production. Since entry into the market is easily available the demand curve is continuously shifting back, making it extremely competitive and challenging to earn a profit. The seller has limited control over the price of goods sold but can gain more by differentiating their product. This can be attained through physical differences, perceived differences and support services. Sellers in this market have equal opportunities since thorough knowledge of prices, products, and technologies is available to everyone.

Size:	Small Company	Medium Company	Large Company
Features:	Diner Deluxe	The Running Room	The Bay
Differentiated products	Yes. Signature, original dishes are prepared.	Yes. Customised programs are created for clients.	Yes. Brands are sold here that can not be found elsewhere.
Control over price	Limited. Competes with 3 similar establishments within the same block	Limited. Many gyms are offering similar programs.	Limited. Must be closely matched to current brand costs unless they sell something exclusively.
Mass advertising	No. Has become popular by word of mouth and has been featured on the food network.	Yes.	Yes.
Brand name goods	No	Yes	Yes
Level of competition	Very high	Very high	Moderately high
Elasticity of demand	Very elastic	Very elastic	Moderately elastic
Concentration ratios	Very low	Very low	Moderately low

Resources:

Sayre, J.E. & Morris, A.J.  (2009).  Principles of Microeconomics (6th ed.).  Toronto, ON: McGraw-Hill Ryerson.

Long Run Costs and Economies of Scale

I have always had an interest in launching a dog walking business. Services offered would include a 1/2 hour or one hour, walk or run in addition to dog sitting, visits, overnight stays, bathing and grooming, and play dates. Equipped with sufficient training and experience, I would provide quality time with dogs that many owners are not able to afford due to busy work schedules. A daily diary would be written after each interaction describing activites pets engaged in, behavior, what they ate. etc. Promoting a stronger connection between the dog and myself or employee, I would offer a discounted rate for clients who signed up for a minimum number of walks per week.

The initial market for my business would be small, targeting people within my own neighborhood. Living half a block form a popular dog park gives me the advantage of word of mouth advertising and  low start-up costs. After building a credible reputation I would begin using other forms of advertising such as; kijiji, craigslist, brochures in vet offices and grooming boutiques and rotation of a professional business card. In reaching out to a larger market, my business would have the potential to continue growing. This in turn would require larger costs and more employess but would be outweighed by greater profits.

Cost incurred from the foundation of this business through to continual operation fall under the following categories:
long-run costs- dog food and treats, baggies for clean up, travel, taxes
short-run costs- dog toys, leashes, brochures, business cards, website launch
fixed costs- telephone bill, employee salaries, insurance

Furbabies Calgary is a local business that embodies many characteristics I would aspire to mirror in my own venture. It is owned by a women named Janice, who has a great passion for animals. She decided to "follow her dreams" and now has a growing, successful business that offers a variation of services.

The advantages of offering pet care services are:
- creating your own hours
- low costs
- physical activities
- enjoyment of spending time with animals

The disadvantages include:
- dealing with difficult behaviors
- putting yourself at risk for injury or harm
- upkeep of cleanliness at place of business
- bad weather

In my opinion, the benefits far outweigh the setbacks!



Resources:

Sayre, J.E. & Morris, A.J.  (2009).  Principles of Microeconomics (6th ed.).  Toronto, ON: McGraw-Hill Ryerson.

http://www.furbabiescalgary.com/

The Law of Diminishing Returns

The article, "The Diminishing Returns to Tobacco Legislation" by Pierre Lemieux, presents a controversial point of view on government efforts to reduce tobacco consumption. He believes the methods being used are only producing diminishing returns.

Lemieux respectively argues that smokers who were affected by the warnings on cigarette packages have already quit, and those who have maintained the deadly habit value smoking more. He also believes an individual can be exposed to too much information on a particular topic and become desensitised to it, no longer creating a reaction. Speaking from personal experience, although smokers may overestimate the risks of smoking, I believe many hold the mentality, "it won't happen to me".

Although warnings on cigarette packages may not have a large effect on current smokers, prevention of new smokers, especially teens, is an alternate desirable outcome. Deterring new smokers from starting may not provide instant returns in decreasing health care costs but it will result in lower costs and less tobacco consumption in the future. In a survey done by the Canadian Council for Tobacco Control, increasing costs is among the top four reasons people quit smoking. This may be why Lemieux has been lead to believe large tax increases would produce the same results as in 1995. The problem with this concept is closely matched with that of cigarette package warnings. Those who can truly no longer afford smoking have already quit and the remaining tobacco users value their habit more. These smokers will turn to whatever means necessary to acquire the nicotine to feed their addictions.

Nicotine is among the most addictive substances used by humans and often requires repeated intervention and multiple attempts to quit. For this reason the demand for tobacco is very inelastic, meaning the quantity demanded is only slightly responsive to a price change. One way the government earns revenue in order to offset health care costs is through sin taxes. High taxes can be applied to cigarettes causing a small drop in demand and a large increase in price, resulting in  larger tax revenues. Contradictory to the benefits of the higher price of tobacco, there are also implications that deter the government from placing high sin taxes on such a highly inelastic good. Because nicotine is so addictive users will turn to criminal activity to acquire this substance, as shown in 1993 when 30 percent of cigarette consumption was smuggled.

The point of diminishing returns for the government in their efforts to reduce tobacco consumption and health care costs is reached when the rate of smokers who are quitting hits a peak and begins to slow down. It is hard to determine when exactly this happened, being that our quit smoking campaign in Canada is over a decade old. Seventeen percent of Canadians are still smoking, a number which is slightly higher then all the years leading up to this one since 2005. This leads me to believe diminishing returns began not long after government efforts to reduce consumption began.

In most provinces in Canada, smoking cessation medications are classified as "lifestyle drugs" and are excluded from most of the country's public health care plans. Money should be reallocated to include these helpful quit smoking methods so they are available for every smoker who wants them. I have also noticed the new warning labels on packages have become much more graphic. My roommate, a ten year smoker, has gone as far as to ask the store clerk for a new package, saying she tries not to look as she pulls out a cigarette. Recent news has also announced a budget cut to government smoking intervention programs. Although anti-smoking advocates are upset with the change it may be just what is needed since the money being spent is no longer compensating health care costs. Hopefully, with the current change in efforts and involvement of new strategies we will begin to see results. After all, the diminishing returns are not only present for the government but also for us, the taxpayers.

References:

Lemieux, P.  (2001, March 19).  The Diminishing Returns to Tobacco Legislation.  The Laissez Faire City Times.  Retrieved May.31, 2012, from http://www.pierrelemieux.org/artdiminish.html
Image Retrieved May.31, 2012, from http://http://www.thestar.com/

Sayre, J.E., & Morris, A.J.  (2009).  Principles of Microeconomics (9th ed.).  Toronto: ON: McGraw-Hill Ryerson.

http://www.cctc.ca/

http://www.cbc.ca/news/health/story/2012/04/17/pol-0tobacco-cuts.html

http://www.statcan.gc.ca/tables-tableaux/sum-som/l01/cst01/health73a-eng.htm

http://www.lung.ca/_resources/Making_quit_happen_report.pdf