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Chapter 13 MONOPOLISTIC COMPETITION AND OLIGOPOLY

QUESTIONS & ANSWERS Q13.1 Q13.1 Describe the monopolistically competitive market structure and give some examples. ANSWER Monopolistic competition is a market structure quite similar to perfect competition in that vigorous price competition among a large number of firms and individuals is present. The major difference between these two market structures is that at least some degree of product differentiation is present in monopolistically competitive markets. As a result, firms have at least some discretion in setting prices. However, the presence of many close substitutes limits the price-setting ability of individual firms, and drives profits down to a normal rate of return in the long-run. As in the case of perfect competition, above-normal profits are only possible in the short-run before rivals are able to take effective counter measures. Examples of monopolistically competitive market structures include a broad range of industries producing clothing, consumer financial services, professional services, restaurants, and so on. Q13.2 Q13.2 Describe the oligopoly market structure and give some examples. ANSWER Oligopoly is a market structure where only a few large rivals are responsible for the bulk, if not all, industry output. As in the case of monopoly, high to very high barriers to entry are typical. Under oligopoly, the price/output decisions of firms are interrelated in the sense that direct reactions from leading rivals can be expected. As a result, the decision making of individual firms is based, in part, on the likely response of competitors. This "competition among the few@ involves a wide variety of price and nonprice methods of interfirm rivalry, as determined by the institutional characteristics of a particular market setting. Although fewness in the number of competitors gives rise to a potential for excess profits, above-normal rates of return are far from guaranteed. Competition among the few can sometimes be vigorous. Examples of the oligopoly market structure include such industries as: bottled and canned soft drinks, brokerage services, investment banking, long distance telephone service, pharmaceuticals, ready-to-eat cereals, tobacco, and so on.
Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance. - 378 -

Q13.3

Explain the process by which economic profits are eliminated in a monopolistically competitive market as compared to a perfectly competitive market. ANSWER In a monopolistically competitive industry, excess profits are eliminated in the longrun through imperfect emulation of successful product design, production systems, and marketing efforts by both established and new competitors. Excess profits are eliminated in a perfectly competitive industry through expansion by established firms and entry of new firms, both of whom offer identical products that are perfect substitutes.

Q13.3

Q13.4

Would you expect the demand curve for a firm in a monopolistically competitive industry to be more or less elastic in the long run after competitor entry has eliminated economic profits? ANSWER In most instances, demand will be more elastic in monopolistically competitive industries after excess profits have been eliminated. The effect of increased competition will typically be to make firm demand curves more elastic given the greater availability of close substitutes. However, it is conceivable that increased competition would simply involve a parallel leftward shift in the firm demand curve. As discussed in the chapter, monopolistically competitive equilibrium will typically involve a price-output combination between the high price-low output equilibrium reached following a parallel leftward shift in demand, and the low price-high output (perfectly competitive) equilibrium reached when the firm demand curve becomes perfectly elastic.

Q13.4

Q13.5

AOne might expect firms in a monopolistically competitive market to experience greater swings in the price of their products over the business cycle than those in an oligopoly market. However, fluctuations in profits do not necessarily follow the same pattern.@ Discuss this statement. ANSWER Oligopoly prices are expected to be more stable than those in a monopolistically competitive industry. To see this, simply recall the discussion of the kinked oligopoly demand curve and the fact that marginal cost changes within limits will not affect prices, whereas similar cost changes would affect prices in a monopolistically competitive industry. But would the more stable price pattern for firms in monopolistically competitive industries produce a correspondingly more stable
Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance. - 379 -

Q13.5

Chapter 13 pattern for profits? This is not entirely clear. This depends on a great many factors, including the speed of entry and exit in response to profit changes, the level of fixed versus variable costs, and so on. For example, if entry conditions in the monopolistically competitive industry allowed instantaneous entry, profits for individual firms might closely reflect required rates of return and be quite stable. In general, the quicker (slower) the return to equilibrium, the less (more) variable will be firm profits in monopolistically competitive industries. In oligopoly markets, price tends to fluctuate less than costs, and profits can be quite variable (e.g., readyto-eat cereal and tobacco industries). Q13.6 Q13.6 What is the essential difference between the Cournot and Stackelberg models? ANSWER In the Cournot model, oligopoly firms make output decisions simultaneously. In the Stackelberg model, oligopoly firms make output decisions sequentially rather than simultaneously. In the Stackelberg model, a dominant firm is the first to set output, and the remaining competitors follow that lead and make their own output decisions given the output decision of the dominant first mover. Q13.7 Which oligopoly model(s) result in long-run oligopoly market equilibrium that is identical to a competitive market price/output solution? ANSWER In markets where competitors produce identical products, the Bertrand model and contestable markets theory result in a long-run oligopoly market equilibrium price/output solution that is identical to that achieved in a competitive market. According to Bertrand, when products and production costs are identical all customers will purchase from the firm selling at the lowest possible price. For example, consider a duopoly where each firm has the same marginal costs of production. By slightly undercutting the price charged by a rival, the competing firm would capture the entire market. In response, the competing firm can be expected to slightly undercut the rival price, thus recapturing the entire market. Such a price war would only end when the price charged by each competitor converged on their identical marginal cost of production, PA = PB = MC, and economic profits of zero would result. While critics regard as implausible Bertrand=s prediction of a competitive-market equilibrium in oligopoly markets that offer homogenous products, contestable markets theory provides some additional useful perspective. Oligopoly firms will sometimes behave much like perfectly competitive firms if
Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance. - 380 -

Q13.7

Thus. and so on. in such markets. waste disposal. electronics. In both perfectly competitive and monopolistically competitive markets P = AC in long run equilibrium. However. is this statement always correct? ANSWER No. Q13.@ Discuss this statement. Given efficient methods of production. Q13.8 Why is the four-firm concentration ratio only an imperfect measure of market power? ANSWER The four firm concentration ratio measures the share of domestic output produced by the top four firms in an industry. And second. MGMT Panel . Irrespective of market structure considerations.9 Q13.381 - . concentration ratios can also understate monopoly power in some instances. . Such competition limits the market power of industry leaders in automobile manufacturing. it is only an imperfect measure of monopoly power.9 The statement AYou get what you pay for@ reflects the common perception that high prices indicate high product quality and low prices indicate low quality. ANSWER Q13. concentration ratios compiled using national data fail to recognize regional market power due to the local character of markets such as those for the newspapers. dairy products.10 Presented by Suong Jian & Liu Yan. television equipment and many other industries. First. As such. Q13. Thus. the statement AYou get what you pay for@ may be quite descriptive of vigorously competitive markets. in both monopoly and oligopoly markets P > AC in long-run equilibrium. it is reasonable to infer a close relation between prices and the costs of production. concentration ratios ignore the magnitude of foreign competition. there may only be a weak relation between prices and the costs of production (product quality) in these markets. but is less true in instances of imperfectly competitive markets. and hence product quality. although foreign competition can sometimes cause concentration ratios to overstate true market power by ignoring the regional characteristics of many markets.10 AEconomic profits result whenever only a few large competitors are active in a given market. not necessarily. Therefore.Monopolistic Competition and Oligopoly potential entrants pose a credible threat and entry costs are largely fungible rather than sunk.8 Q13. Guangdong University of Finance.

On the other hand. Though dominated by Boeing and Airbus. MGMT Panel .000. Guangdong University of Finance.000. In 2001.000. Embraer makes aircraft that offer excellent reliability and cost effectiveness. For example. Airbus became a single integrated company.000QA = $200.000QE + $500. competitor behavior and industry performance. Boeing=s principal global competitor is Airbus. . To accurately assess the vigor of competition in any given market.000 + $35.000 + $1. and reflects a simplistic view of the link between the number of competitors and the vigor of competition. competition can sometimes be fierce in markets that involve only a handful of competitors. a Brazilian aircraft manufacturer. markets involving several Acompetitors@ may have little or no effective competition.000. despite the fact that there are relatively few providers of general aviation equipment. German and later.Chapter 13 This statement is not true.000. Notable among these is Embraer. Holding buyer power constant. red boathouse to become the largest aerospace company in the world.000QA + $250. Spanish and U. thirty years after its creation. To illustrate the price leadership concept.000 + $20. As a niche manufacturer. textile and agricultural markets involve thousands of competitors that are sometimes sheltered from import competition by trade barriers and government price support programs. one must carefully analyze market structure (including the number and size distribution of competitors). Airbus was established in 1970 as a European consortium of French.K companies. Similarly.382 - . competition for new plane orders is often fierce and suppliers seldom earn above-normal profits.000QA2 = $35. SELF-TEST PROBLEMS & SOLUTIONS ST13. Over the last century. smaller firms have recently entered the commercial aircraft industry. has grown from building planes in an old. Embraer has become one of the largest aircraft manufacturers in the world by focusing on specific market segments with high growth potential.1 Price Leadership.000 + $500.000QE2 = $20.000. a French company jointly owned by Eads (80%) and BAE Systems (20%). assume that total and marginal cost functions for Airbus (A) and Embraer (E) aircraft are as follows: TCA MCA TCE MCE = $10.000.000QE Boeing=s total and marginal cost relations are as follows: Presented by Suong Jian & Liu Yan. The Boeing Co.

ST13.383 - .000.000. MGMT Panel . and that each total cost function includes a risk-adjusted normal rate of return on investment.000 . .000.500Q2 B = ΜTCB/ΜQB = $5. Therefore.000QB. they operate where individual marginal cost equals price.1 A.000QB + $62.000.000QA QA = MCA = $35.000.Monopolistic Competition and Oligopoly TCB MCB = $4.000 + PA = -70 + 0.000.000 + $5.000 + $500.000QA = -35. E. Is the market for aircraft from these three firms in short-run and in long-run equilibrium? D.) B Calculate profit-maximizing output levels for the Airbus and Embraer aircraft.000002PA Embraer Presented by Suong Jian & Liu Yan. Guangdong University of Finance.000017P Assume throughout this problem that the Airbus and Embraer aircraft are perfect substitutes for Boeing=s Model 737-600. B. (Hint: Boeing=s total and marginal revenue relations are TRB = $50. assuming that the firms operate as price takers. C. A. What is the demand curve faced by Boeing? Calculate Boeing=s profit-maximizing price and output levels. SOLUTION Because price followers take prices as given.000.000.000QB The industry demand curve for this type of jet aircraft is Q = 910 .$100.0.000Q2 .000 + $125. and MRB =ΜTRB/ΜQB = $50.000QB $50. Determine the supply curves for Airbus and Embraer aircraft. the supply curves for Airbus and Embraer aircraft are: Airbus PA 500.

Remember that P = PB = PM = PE because Boeing is a price leader for the industry: QB = Q .000.384 - .000.000 .000QB = 225.000QB = 200 units = $50.00002PB PB = $50.$0.000.000QB 45.000 + PE QE = -20 + 0.$50. .000.000 + $1.000 Optimal supply for Airbus and Embraer aircraft are: Presented by Suong Jian & Liu Yan.0.QA .000.000 .000001PE B.000 D.0.000 . To find Boeing=s profit maximizing price and output level.000017P + 70 . set MRB = MCB and solve for Q: MRB $50. Guangdong University of Finance.000(200) = $40.000.$50.000002P + 20 .000. MGMT Panel .000QE = -20.000.000QB C. Boeing=s demand equals industry demand minus following firm supply.Chapter 13 PE = MCE = $20.000 + $125.000 QB PB = MCB = $5.000.000.000. P = PB = PA = PE = $40.000QE 1. As the industry price leader.000 . Because Boeing is a price leader for the industry.QE = 910 .$0.$100.000001P = 1.

0.000001(40.000001PE = -20 + 0. MGMT Panel .000002PA = -70 + 0. . The industry is in short-run equilibrium if the total quantity demanded is equal to total supply.000.000.000) = 230 units The total industry supply is: QS = QB + QA + QE = 200 + 10 + 20 = 230 units Thus.000. the industry is in short-run equilibrium. Yes.000) = 10 QE = -20 + 0. The industry is also in long-run equilibrium provided that each manufacturer is making at least a risk-adjusted normal rate of return on investment. note that: πA = TRA .000.000(10) .TCA = $40.Monopolistic Competition and Oligopoly QA = -70 + 0.0.000.000002(40.000(102) Presented by Suong Jian & Liu Yan.385 - .000 -$35. To check profit levels for each manufacturer.000) = 20 E. Guangdong University of Finance. The total industry demand at a price of $40 million is: QD = 910 .000017P = 910 .000(10) -$10.000.$250.000017(40.

the industry is in long-rum equilibrium and there is no incentive to change. output.$500. has enjoyed rapid growth in sales and high operating profits on its innovative extended-wear soft contact lenses.000(200) -$4.000 -$20.000 Boeing and Airbus are both earning economic profits.000(200) . MGMT Panel . However.000 .Chapter 13 = $15. Unless the company is able to thwart such competition.000. As such.$5.000.TCB = $40. Soft Lens.000(20) .000 πE = TRE .000. . whereas Embraer. ST13. severe downward pressure on prices and profit margins is anticipated.500(2002) = $500. is earning just a risk-adjusted normal rate of return.386 - .000. Inc.000.000.TCE = $40. Guangdong University of Finance.000(20) -$200. and total cost data to complete the table: Monthly Price ($) $20 19 18 17 Output (million) 0 1 2 3 Total Revenue ($million) Marginal Revenue ($million) Total Cost ($million) $0 12 27 42 Marginal Cost ($million) Average Cost ($million) Total Profit ($million) Presented by Suong Jian & Liu Yan.000(202) = $0 πB = TRB .000.$62. A. the company faces potentially fierce competition from a host of new competitors as some important basic patents expire during the coming year.. Use Soft Lens=s current price. the marginal entrant.000.2 Monopolistically Competitive Equilibrium.000.

If cost conditions remain constant.) B.387 - . what is the monopolistically competitive low-price/high-output equilibrium in this industry? What are industry profits? Now assume that Soft Lens is able to enter into restrictive licensing agreements with potential competitors and create an effective cartel in the industry.00 13. . Guangdong University of Finance.Monopolistic Competition and Oligopoly Monthly Price ($) 16 15 14 13 12 11 10 Output (million) 4 5 6 7 8 9 10 Total Revenue ($million) Marginal Revenue ($million) Total Cost ($million) 58 75 84 92 96 99 105 Marginal Cost ($million) Average Cost ($million) Total Profit ($million) (Note: Total costs include a risk-adjusted normal rate of return. SOLUTION Monthly Price ($) $20 19 18 17 16 Output (million) 0 1 2 3 4 Total Revenue ($million) $0 19 36 51 64 Marginal Revenue ($million) --$19 17 15 13 Total Cost ($million) $0 12 27 42 58 Marginal Cost ($million) --$12 15 15 16 Average Cost ($million) --$12. what is the cartel price/output and profit equilibrium? C. ST13.50 Total Profit ($million) $0 7 9 9 6 Presented by Suong Jian & Liu Yan.2 A. MGMT Panel . what is the monopolistically competitive high-price/low-output long-run equilibrium in this industry? What are industry profits? Under these same cost conditions. If demand and cost conditions remain constant.00 14.50 14. D.

MGMT Panel . Because π = $0 and MR = MC = $3.TC = $0.50 Total Profit ($million) 0 0 -1 0 0 -5 B.000). Q = 3(000. and π = $9(000. Because π = $0 and MR = MC = $9.00 13. Indicate whether each of the following statements is true or false and explain why. If demand and cost conditions remain constant.1 Market Structure Concepts. .000).000).TC = $0.388 - .) A monopoly price/output and profit equilibrium results if Soft Lens is able to enter into restrictive licensing agreements with potential competitors and create an effective cartel in the industry. The monopolistically competitive low-price/high-output equilibrium is P = AC = $11. Only a risk-adjusted normal rate of return is being earned in the industry.14 12. Equilibrium in monopolistically competitive markets requires that firms be operating at the minimum point on the long-run average cost curve. Q = 6(000. (Note that average cost is rising and profits are falling for Q > 9. the cartel price/output and profit equilibrium is at P = $17. and π = TR .Chapter 13 Monthly Price ($) 15 14 13 12 11 10 Output (million) 5 6 7 8 9 10 Total Revenue ($million) 75 84 91 96 99 100 Marginal Revenue ($million) 11 9 7 5 3 1 Total Cost ($million) 75 84 92 96 99 105 Marginal Cost ($million) 17 9 8 4 3 6 Average Cost ($million) 15. there is no incentive for either expansion or contraction. Presented by Suong Jian & Liu Yan. D. Such an equilibrium is typical of monopolistically competitive industries where each individual firm retains some pricing discretion in long-run equilibrium. Q = 9(000.00 10. A. Again. The monopolistically competitive high-price/low-output equilibrium is P = AC = $14. and excess profits equal zero.000). there is no incentive for either expansion or contraction. and π = TR . and excess profits equal zero. This price/output combination is identical to the perfectly competitive equilibrium. only a risk-adjusted normal rate of return is being earned in the industry. PROBLEMS & SOLUTIONS P13. C. Guangdong University of Finance. There is no incentive for the cartel to expand or contract production at this level of output because MR = MC = $15.00 11.00 14.

Monopolistic Competition and Oligopoly B. E. An increase in product differentiation tends to increase the slope of individual firm demand curves. Guangdong University of Finance. D.389 - . False. MGMT Panel . D. This tangency typically occurs at an output level below the point of minimum long-run average costs. The price elasticity of demand tends to fall as new competitors introduce substitute products. P13. Decreased import quotas Elimination of uniform emission standards B. A high ratio of distribution cost to total cost tends to increase competition by widening the geographic area over which any individual producer can compete. True.2 Presented by Suong Jian & Liu Yan. In monopolistically competitive markets. C. Monopolistically Competitive Demand. E. B. SOLUTION False.1 A. An efficiently functioning cartel achieves a monopoly price/output combination. P13. The price elasticity of demand tends to rise as new competitors introduce substitute products. False. equilibrium is achieved at a point of tangency between firm demand and average cost curves. A low ratio of distribution cost to total cost tends to increase competition by widening the geographic area over which any individual producer can compete. . however. Stable equilibrium in perfectly competitive markets requires that firms must operate at the minimum point on the long-run average cost curve. A perfectly functioning cartel achieves the monopoly price-output combination. Would the following factors increase or decrease the ability of domestic auto manufacturers to raise prices and profit margins? Why? A. C. An increase in product differentiation tends to increase the slope of firm demand curves. True.

P13. Presented by Suong Jian & Liu Yan. Competitive Markets v. thus making imports less attractive to car buyers. First. A second proposal would allow several individual workers and small companies to enter the business without any exclusive franchise agreements or competitive restrictions. Under this plan. An increase in automobile price advertising increases price competition in the industry and thereby decreases the ability of firms to raise prices and profit margins.390 - B. and ease pressure on profit margins. E. and make it easier for them to increase profit margins. E. The city has conducted a survey of Columbus residents to estimate the amount that they would be willing to pay for various frequencies of service. D.3 . As product differentiation rises. which has the effect of lowering import car prices SOLUTION Increase. Service costs are expected to be the same whether or not an exclusive franchise is granted. a handful of leading waste disposal firms have offered to purchase the city's plant and equipment at an attractive price in return for exclusive franchises on residential service in various parts of the city.2 A. C. An elimination of uniform emission standards reduces product homogeneity. MGMT Panel . Guangdong University of Finance.Chapter 13 C. some increase in the pricing discretion of firms will result. The city would then allocate business to the lowest bidder. Increase. The City of Columbus. fewer substitutes for domestic automobiles become available. Increased automobile price advertising Increased import tariffs (taxes) A rising value of the dollar. An increase in import tariffs (taxes) increases the price of import cars. D. Increase. individual companies would bid for the right to provide service in a given residential area. A rising value of the dollar that has the effect of lowering import car prices puts downward pressure on the profit margins of domestic manufacturers. This will reduce the price pressure on domestic manufacturers. Cartels. This will decrease competition in the industry. . is considering two proposals to privatize municipal garbage collection. As import quotas are decreased. Decrease. Decrease. The city has also estimated the total cost of service per resident. Ohio. P13.

MGMT Panel .75 7.70 18.00 3.20 30.00 4.20 3. .75 3.60 3. SOLUTION Trash Pickups per Month 0 1 2 3 4 5 Price per Pickup $5.00 4.80 4.60 4.75 7.60 4. Guangdong University of Finance. Determine price and the level of service if local regulation results in a cartel.70 18. Complete the following table. P13.391 - .00 Marginal Cost -$3.70 3.45 11.20 Total Cost $0.65 3.10 14.60 3. C.10 14.40 4.00 20.80 4.00 Marginal Cost Trash Pickups per Month 0 1 2 3 4 5 6 7 8 9 10 B.80 27.30 Presented by Suong Jian & Liu Yan.90 23.00 Total Revenue Marginal Revenue Total Cost $0. Determine price and service level if competitive bidding results in a perfectly competitive price/output combination.00 4.80 20.20 4.00 3.20 16.00 Total Revenue $0.60 3.45 11.00 3.20 4.20 13.40 4.3 A.Monopolistic Competition and Oligopoly A.00 Marginal Revenue -$4.40 4.40 3.70 35.80 9.80 4.00 3. Price per Pickup $5.80 3.

80 25. Guangdong University of Finance.60 3.40 3.80 2.20 30. C.50 4. Colorado. A monopoly cartel maximizes profits by setting MR = MC.40 2. = ΜTR/ΜQ = $54 .$1. = ΜTC/ΜQ = $6 + $1Q. the company has profitably exploited its market niche.g.80 30. P = MR.40 3.90 3. etc. = $200 + $6Q + $0. trade associations. Inc.90 23.60 1.80 27.00 Marginal Cost 2. MGMT Panel .00 Total Revenue 22. Although Gray=s market is restricted to industrial users and a few large government agencies (e. Here. Based on data gathered from your company=s engineering department.$3Q. located in Colorado Springs. P13.20 Total Cost 20.20 per pickup.70 35. user surveys. and other sources. has asked you to evaluate the short. is a privately held producer of high-speed electronic computers with immense storage capacity and computing capability.90 2. Gray Computer. the following market demand and cost information has been developed: P MR TC MC = $54 . NASA. founder and research director.20 28.4 Presented by Suong Jian & Liu Yan. MR = MC = $3.Chapter 13 Trash Pickups per Month 6 7 8 9 10 Price per Pickup 3.30 B. Monopolistic Competition. Department of Health.00 1.20 27.5Q2. Your company.392 - . the timing of which will unfortunately coincide with the expiration of several patents covering key aspects of the Gray computer. has recently announced his retirement. a potential entrant into the market for supercomputers. Here.20 3.00 Marginal Revenue 2.).and long-run potential of this market.60 at Q = 4 pickups per month and P = $4. . P = MC = $3. so the optimal activity level occurs where P = MC..5Q. Glen Gray.40 at Q = 8 pickups per month. National Weather Service.80 3.. In a perfectly competitive industry.

Monopolistic Competition and Oligopoly where P is price. and all figures are in millions of dollars. MC is marginal cost.5Q = $54 . P13. D. should your company enter the market for supercomputers? Why or why not? B. C.$1. (Note: Assume that the cost function is unchanged and that the high-price/low-output solution results from a parallel shift in the demand curve while the low-price/high-output solution results from a competitive equilibrium. SOLUTION Set MR = MC to determine the profit-maximizing activity level.$3Q 4Q Q and P = $54 . MR $54 . and economic profits earned by Gray Computer as a monopolist. MGMT Panel .$1. . TC is total costs including a normal rate of return. Q is units measured by the number of supercomputers.) Assume that the point price elasticity of demand calculated in Part A is a good estimate of the relevant arc price elasticity. MR is marginal revenue. price. Calculate output. What is the potential overall market size for supercomputers? If no other near-term entrants are anticipated.393 - = MC = $6 + $1Q = 48 = 12 . Guangdong University of Finance. What is the point price elasticity of demand at this output level? Calculate the range within which a long-run equilibrium price/output combination would be found for individual firms if entry eliminated Gray=s economic profits.5(12) Presented by Suong Jian & Liu Yan.4 A. Assume that these demand and cost data are descriptive of Gray=s historical experience. A.

5 = -1. which. Presented by Suong Jian & Liu Yan.67P. at the profit-maximizing activity level. Therefore.5Q Slope of average cost curve Slope of new demand curve = ΜAC/ΜQ = -200Q-2 + 0. The high-price/low-output equilibrium point is identified by the point of tangency between the firm=s demand and average cost curves which occurs after a parallel leftward shift in demand due to competitor entry. implies a point price elasticity of εP = ΜQ/ΜP Η P/Q = -0.) B.67 Η 36/12 = -2 (Note: Profits are declining for Q > 12. . MGMT Panel .394 - . in equilibrium the new firm demand and average cost curves have the same slope.$200 = $88 million From the demand curve note that: Q = 36 .5 (Same as for original demand curve) And in equilibrium. To determine the slope of the average cost curve note that: $200 + $6 Q + $0.5Q 2 AC = TC/Q = Q = $200Q-1 + $6 + $0. Guangdong University of Finance.0.Chapter 13 = $36 million π = -$2(122) + $48(12) .

Guangdong University of Finance.5 = 400 Presented by Suong Jian & Liu Yan. and solve for Q: MC = AC $6 + $1Q = $200Q-1 + $6 + $0.$6(10) .5(102) = $0 The low-price/high-output equilibrium point occurs where P = AC and average costs are minimized (this is also the perfectly competitive equilibrium).$200 .5 = -1.5Q 200Q-1 = 0.395 - .TC = $31(10) .5 Q2 = 200/0. MGMT Panel .5Q 200Q-2 = 0.5(10) = $31 million π = P Η Q . .5 Q-2 Q2 = 2/200 = 100 Q = 10 and P = AC = $200(10-1) + $6 + $0.Monopolistic Competition and Oligopoly Slope of average cost curve = Slope of new demand curve -200Q-2 + 0. Set MC = AC to determine the point of minimum average costs.$0.

MGMT Panel .TC = $26(20) . total industry output rises to 23.36 Q 2 + 12 67(Q 2 .Chapter 13 Q = 400 = 20 and P = AC = $200(20-1) + $6 + $0. Guangdong University of Finance.$0.5(20) = $26 million π = P Η Q .$6(20) .12) -5(Q 2 + 12) -2 10(Q2 + 12) 10Q2 + 120 57Q2 Q2 = = 67(Q2 . If the high-price/low-output equilibrium is achieved in the long run.804 = 924 = 16. total industry output rises to 16.5(202) = $0 C.12) = 67Q2 .Q1 P 2 + P1 EP = x P 2 .2 Conversely.396 - .4 supercomputers because: Presented by Suong Jian & Liu Yan.2 supercomputers because: Q 2 . if the low-price/high-output equilibrium is achieved. .12 31 + 36 x 31 .P1 Q 2 + Q1 -2 = Q 2 .$200 .

4 No.744 = 984 = 23. Gray would have the capability to continuously undercut new rivals and make profitable entry very difficult. Therefore. by virtue of its role as an industry leader of dominant proportions.12 26 + 36 x 26 . Presented by Suong Jian & Liu Yan.36 Q 2 + 12 62(Q 2 . Moreover. if not impossible. the minimum optimal firm size. Guangdong University of Finance.Q1 P 2 + P1 x P 2 . the industry does not have the potential to support more than one firm of Q = 20 size class.12) = 62Q2 . (Supply).10.4 for total industry output. Entry into this industry is unwise. (Note: Fractional output can be completed during subsequent periods).Monopolistic Competition and Oligopoly EP = Q 2 .2 and 23. = 60. a substantial share of the projected long-run potential of between 16.000P (Demand).397 - . MGMT Panel .000 . = = 62(Q2 . Gray currently sells 12 supercomputers per year. Cartel Equilibrium.5 Calculate the perfectly competitive industry equilibrium price/output combination.12) -10(Q 2 + 12) -2 = -2 20(Q2 + 12) 20Q2 + 240 42Q2 Q2 D. . P13. The Hand Tool Manufacturing Industry Trade Association recently published the following estimates of demand and supply relations for hammers: QD QS A.P1 Q 2 + Q1 Q 2 .000P = 20.

C.) Compare your answers to parts A and B. The profit-maximizing activity level is found where MR = MC.000P = $0.000 . (Hint: As a cartel. when the industry is organized into a cartel and acts like a monopolist. P13.10.000P = $6 .000P P = $2 At P = $2.000 = ? QS = ? 20.10. Guangdong University of Finance.000 B.10. Now assume that the industry output is organized into a cartel.000(2) = _ 40. the equilibrium output is 40.000(2) 40.0001Q (Demand) Presented by Suong Jian & Liu Yan.398 - . Therefore.000 . industry MR = $6 . SOLUTION The industry equilibrium price is determined by setting: QD = QS 60.Chapter 13 B. Calculate the price/output effects of the cartel. Here it is important to recognize that the industry supply curve represents the horizontal sum of the marginal cost curves for individual producers.000 because: QD 60. Calculate the industry price/output combination that will maximize profits for cartel members. MGMT Panel .000 . the industry supply curve represents the relevant marginal cost curve: QS MC = P = 20.$0.$0.000P = 20.0002Q. .00005Q (Supply) From the demand curve: QD P = 60.5 A.

0001Q)Q = $6Q . By 1983. assume that a two-firm duopoly dominates the market for spreadsheet application software. and that the firms face a linear market demand curve Presented by Suong Jian & Liu Yan.399 - .000 P = $6 .$0. Cournot Equilibrium. VisiCalc. P13. .60 C. Mitch Kapor used his previous programming experience with VisiCalc to found Lotus Corp. Generally speaking. MGMT Panel .0001(24. introduction of the DIF format made spreadsheets much more popular because they could now be imported into word processing and other software programs. Guangdong University of Finance.6 With a cartel. and introduce the wildly popular Lotus 1-2-3 spreadsheet program. To illustrate the competitive process in markets dominated by few firms.00025Q = 6 Q = 24.$0. Excel dominates the market for spreadsheet applications software. introduced Excel with a much more user-friendly graphical interface in 1987. Despite enormous initial success.00005Q 0.000) = $3. monopolists offer consumers too little output at too high a price. and Lotus represents a small part of IBM=s suite of instant messaging tools. when compared with the perfectly competitive industry. the first computer spreadsheet program.000 to 24.60.0002Q And the profit-maximizing activity level is found by setting MR = MC and solving for Q: MR = MC $6 .0002Q = $0. A year later.000 units and price rises from $2 to $3. was released to the public in 1979. Lotus 1-2-3 stumbled when Microsoft Corp. Today.$0. the level of industry output falls from 40.$0.0001Q2 MR = ΜTR/ΜQ = $6 .Monopolistic Competition and Oligopoly TR = PΗQ = ($6 .$0.

Derive the output reaction curves for Firms A and B.6 A.$2QA .QB QA = 600 . MGMT Panel .Q where P is price and Q is total output in the market (in thousands) .Chapter 13 P = $1. . have no fixed costs and marginal cost MCA = MCB = $50. Guangdong University of Finance.5QB Notice that the profit-maximizing level of output for Firm A depends upon the level of output produced by itself and Firm B.250 . Calculate the Courtnot market equilibrium price-output solutions.5QB Presented by Suong Jian & Liu Yan. the profit-maximizing level of output for Firm B depends upon the level of output produced by itself and Firm A. In this circumstance.250 .QB Similar total revenue and marginal revenue curves hold for Firm B. These relationships are each competitor=s output-reaction curve Firm A output-reaction curve: QA = 600 .QAQB Marginal revenue for Firm A is MRA = ΜTRA/ΜQA = $1.QA2 . Firm A=s profit-maximizing output level is found by setting MRA = MCA = 0: MRA = MCA $1. A.QB = 50 $2QA = $1. total revenue for Firm A is TRA = $1. For simplicity.400 - .250 . Thus Q = QA + QB. B.200 . SOLUTION Because MCA = 0.$2QA . P13.250QA . Similarly.0.0. also assume that both firms produce an identical product.

MGMT Panel .0. the market equilibrium level of output is Cournot equilibrium output = QA + QB = 400 + 400 = 800 (000) units The Cournot market equilibrium price is Cournot equilibrium price = $1.5QB QA = 600 . With just two competitors.$1(800) = $450 P13. and can be used to illustrate how leading firms maintain dominence of Presented by Suong Jian & Liu Yan. QB = 600 .7 Stackelberg Model. Guangdong University of Finance.401 - .0.75QA = 300 QA = 400 (000) units Similarly. from the Firm A output-reaction curve QA = 600 .25QA 0. the profit-maximizing level of output for Firm B is QB = 400.250 .0.0. For example. simply insert the amount of output produced by competitor Firm A into Firm B=s output-reaction curve and solve for QB. To find the amount of output produced by Firm A. The Stackelberg model allows for strategic behavior by leading firms. simply insert the amount of output produced by competitor Firm B into Firm A=s output-reaction curve and solve for QA.5(600 .250 . from the Firm B output-reaction curve.5QA) QA = 600 .Monopolistic Competition and Oligopoly Firm B output-reaction curve: B. To find the amount of output produced by Firm B.Q = $1.5QA The Cournot market equilibrium level of output is found by simultaneously solving the output-reaction curves for both competitors. .300 + 0.

QAQB = $1.0.250QA .250QA . A. For simplicity. SOLUTION To illustrate Stackelberg first-mover advantages.7 A.0.0. marginal revenue for Firm A is Presented by Suong Jian & Liu Yan.QB Similar total revenue and marginal revenue curves hold for Firm B.250 . In this circumstance.5QA2 With prior knowledge of Firm B=s output-reaction curve. have no fixed costs and marginal cost MCA = MCB = $50. QB = 600 .QAQB Marginal revenue for Firm A is MRA = ΜTRA/ΜQA = $1. Also assume that the firms face a linear market demand curve P = $1. B.QA2 .QA(600 .QA2 . correctly anticipates the output reaction of Firm B.5QA) = $650QA . Thus Q = QA + QB. MGMT Panel . as a leading firm. also assume that both firms produce an identical product. the following firm. reconsider the Cournot model but now assume that Firm A.Chapter 13 important industries.5QA. Guangdong University of Finance.402 - . again imagine that a two-firm duopoly dominates the market for spreadsheet application software for personal computers. To illustrate the concept of Stackelberg first-mover advantages.Q where P is price and Q is total output in the market (in thousands) .250 . Firm A=s total revenue curve becomes TRA = $1.250QA . . total revenue for Firm A is TRA = $1.$2QA .QA2 . Calculate the Stackelberg market equilibrium price-output solutions. How do the Stackelberg equilibrium price-output solutions differ from those suggested by the Cournot model? Why? P13. With prior knowledge of Firm B=s output-reaction curve.

403 - .$1(900) B. Stackelberg equilibrium also results in a lower market price than that observed in Cournot equilibrium.0. = $350 Notice that market output is greater in Stackelberg equilibrium than in Cournot equilibrium because the first mover. produces more output while the follower.5(600) = 300 With just two competitors. Firm Presented by Suong Jian & Liu Yan. Firm B. the Stackelberg market equilibrium level of output is Stackelberg equilibrium output = QA + QB = 600 + 300 = 900 (000) units The Stackelberg market equilibrium price is Stackelberg equilibrium price = $1.$1QA Because MCA = $50.Q = $1.0.$1QA = $50 QA = 600 After Firm A has determined its level of output.5QA = 600 . Guangdong University of Finance. Firm A=s profit-maximizing output level with prior knowledge of Firm B=s output-reaction curve is found by setting MRA = MCA = $50: MRA = MCA $650 . In this example. Firm A.Monopolistic Competition and Oligopoly MRA = ΜTRA/ΜQA = $650 . the amount produced by Firm B is calculated from Firm B=s output-reaction curve QB = 600 .250 . MGMT Panel . . produces less output.250 .

2. S soft-drink market. P13.Chapter 13 A enjoys a significant first-mover advantage. they account for about 75% of industry sales.5X A. If neither duopoly firm is willing to allow its competitor to exercise a market leadership position.xQC = (PC . For simplicity. Set ΜπC/ΜPC = 0 to derive Coke=s optimal price-response curve. P13. Calculate Coke=s optimal price-output combination if Pepsi charges $5 and marginal costs are $2 per 24-pack. SOLUTION To derive Coke=s optimal price-response curve. vigorous price competition and a competitive market price/output solution can result. If Firm A and Firm B cannot agree on which firm is the leader and which firm is the follower.5PC + 1.404 - . Interpret your answer. and price is the wholesale price of a 24-pack. The Bertrand model can be used to show the effects of price competition in this highly differentiated market. and Royal Crown Cola account for most of the rest. participants in oligopoly markets have strong incentives to resolve the uncertainty surrounding the likely competitor response to leading-firm output decisions. assume average costs are constant and AC = MC = X dollars per unit.8 A. Guangdong University of Finance. Together.25PP where output (Q) is measured in millions of 24-packs per month.8 Bertrand Equilibrium. B. Pepper/Seven Up. In that case. MGMT Panel . .5PC + 1. Firm A will produce twice as much output and earn twice as much profit as Firm B so long as Firm B accepts the output decisions of Firm A as given and does not initiate a price war. set ΜπC/ΜPC = 0 Presented by Suong Jian & Liu Yan.X) QC ΜπC/ΜPC = 15 . Cott Beverage. Dr. the total profit and change in profit with respect to own price functions for Coke are πC = TRC . Obviously. a price war can break out with the potential to severely undermine the profitability of both leading and following firms.TCC = PCQC . Coke and Pepsi dominate the U. Suppose the quantity of Coke demanded depends upon the price of Coke (PC) and the price of Pepsi (PP) QC = 15 .25PP + 2.

25 P13. = ΜTR1/ΜQ = $60 . and increase its own price by 504 with every $1 increase in the marginal cost of production.5PC + 1.$2Q. If Pepsi charges $5 and marginal costs are $2 per 24-pack.25PP +2.$3Q. Safety Service Products (SSP) faces the following segmented demand and marginal revenue curves for its new infant safety seat: 1.25PP + $0.5Q2. Coke=s optimal priceresponse curve shows that Coke should charge $5.000 units.Q. 2.5X = $3 + $0. MGMT Panel . .25PP + 2.5X = $3 + $0.25($5) + $0. = ΜTC/ΜQ = $20 + $1Q.000 units of output. When output exceeds 10.405 - . = ΜTR2/ΜQ = $80 .5X Coke=s optimal price-response curve shows that Coke should increase its own price by 254 with each $1 increase in the price of Pepsi.9 Kinked Demand Curves.25 per 24-pack: PC = $3 + $0.5($2) = $5.Monopolistic Competition and Oligopoly 15 . Over the range from 0 to 10. P2 MR2 = $80 . P1 MR1 = $60 . Guangdong University of Finance.$6Q. The company=s total and marginal cost functions are as follows: TC MC = $100 + $20Q + $0.25PP + $0.5X = 0 5PC PC = 15 + 1. Presented by Suong Jian & Liu Yan. B.

Chapter 13 where P is price (in dollars).9 A. SOLUTION Note that: MR1 MR2 MC = ΜTR1/ΜQ = $60 . all in thousands of dollars. B. P13. and profits at the profit-maximizing activity level.$6Q = ΜTC/ΜQ = $20 + Q Presented by Suong Jian & Liu Yan. How would you describe the market structure of the industry in which SSP operates? Explain why the demand curve takes the shape indicated previously. and marginal cost curves. MR is marginal revenue.$2Q = ΜTR2/ΜQ = $80 . Q is output (in thousands). A. How much could marginal costs rise before the optimal price would increase? How much could they fall before the optimal price would decrease? C. MGMT Panel . Calculate price. Guangdong University of Finance. marginal revenue.406 - . Graph the demand. and MC is marginal cost. D. output. . TC is total cost.

this indicates optimal P = $50 and Q = 10(000). An examination of the graph indicates that the marginal cost curve passes through the gap in the marginal revenue curve.$6Q MC = $20 + $Q Q Q # 10. Analytically. The firm is in an oligopolistic industry.000 Presented by Suong Jian & Liu Yan. . MR1 = $60 .000 C. It faces a kinked demand curve. Graphically. Guangdong University of Finance. Price increases are not followed. MGMT Panel . causing the portion of the demand curve above the kink to be relatively elastic.Monopolistic Competition and Oligopoly B. > 10.407 - . indicating that competitors will react to price reductions by cutting their own prices and causing the segment of the demand curve below the kink to be relatively inelastic.$2Q MR2 = $80 .

000 .$7QM + $0. offers 24-hour telephone answering service for individuals and small businesses in southeastern states. = $50. Recently. the optimal price would increase. N = ΜTCN/ΜQN = $3 + $0.408 - .005QN. Inc. Louisville Communications.5(102) = $150(000) or $150. Guangdong University of Finance. At Q = 10(000). Conversely.10 Price Signaling. and MR2 < MC for the range Q > 10(000).$0.$3(10) = $50. P13.TC = $50(10) .000 + $3QN + $0. So long as marginal cost at Q = 10(000) is in the range of $20 to $40. Ltd. the optimal price would decrease. P2 = $80 .$3Q = $80 . Therefore. Total and marginal cost functions for Memphis (M) and Nashville (N) services are as follows: TCM MCM TCN MCN = $75. and Nashville Recording. price-leading firm in many of its markets. have begun to offer services with the same essential characteristics as Louisville=s service.$20(10) .$2Q = $60 .$100 . . At P = $50 and Q = 10: π = TR .. Alternatively.$2(10) = $40 MR2 = $80 .Chapter 13 MR1 > MC over the range Q # 10(000). SSP will have no incentive to change in price.. if marginal costs at Q = 10(000) fall below $20. Memphis Answering Service.005QM.$6Q = $80 .000 D. Louisville is a dominant.0025Q2 . Inc. 2 = ΜTCM/ΜQM = -$7 + $0.Q = $60 .$6(10) = $20 This implies that if marginal costs at Q = 10(000) exceed $40.$(10) = $50. Presented by Suong Jian & Liu Yan. MGMT Panel .0025QM. SSP will produce 10(000) units of output and market them at a price P1 = $60 .. MR1 = $60 .

MGMT Panel . SOLUTION Because price followers take prices as given.$0.800 . (Hint: Louisville=s total and marginal revenue relations are TRL = $25QL $0.00005Q2 . E. the supply curves for Memphis and Nashville services are: Memphis PM = MCM = -$7 + $0.0001QL. Assume throughout this problem that the Memphis and Nashville services are perfect substitutes for Louisville=s service. Is the market for service from these three firms in short-run equilibrium? B.19.005QM = 7 + PM QM = 1.0004QL.) L Calculate profit-maximizing output levels for the Memphis and Nashville services. What is the demand curve faced by Louisville? Calculate Louisville=s profit-maximizing price and output levels.Monopolistic Competition and Oligopoly Louisville=s total and marginal cost relations are as follows: TCL MCL = $300. and MRL =ΜTRL/ΜQL = $25 . D. assuming that the firms operate as price takers. C. Guangdong University of Finance. they operate where individual marginal cost equals price. Therefore. .000 + $5QL + $0.10 A.409 - .0002Q2.005QM 0. The industry demand curve for telephone answering service is Q = 500. A.400 + 200PM Presented by Suong Jian & Liu Yan. Determine the supply curves for the Memphis and Nashville services. L = ΜTCL/ΜQL = $5 + $0. P13.600P.

MGMT Panel .005QN = -3 + PN QN = -600 + 200PN B.000PL PL = $25 .0005QL = 40.QM .20.00005QL C.$0.1.19. Presented by Suong Jian & Liu Yan.410 - .00005QL = $25 . .0001QL 20 QL PL = MCL = $5 + $0.$0. Because Louisville is a price leader for the industry.000 .$0. Louisville=s demand equals industry demand minus following firm supply.800 . As the industry price leader.0004QL = 0.200P = 500.600P . set MRL = MCL and solve for Q: MRL $25 .Chapter 13 Nashville PN = MCN = $3 + $0. To find Louisville=s profit-maximizing price and output level.400 .005QN 0.00005(40.QN = 500.200P + 600 .$0.000 units = $25 . Guangdong University of Finance. Remember that P = PL = PM = PN because Louisville is a price leader for the industry: QL = Q .000) = $23 D.

000 units The total industry supply is: QS = QL + QM + QN = 40.600P = 500. . the industry is in short-run equilibrium.411 - .800 .19. The industry is in short-run equilibrium if the total quantity demanded is equal to total supply. MGMT Panel .400 + 200($23) = 6. Yes.19. CASE STUDY FOR CHAPTER 13 Market Structure Analysis at Columbia Drugstores.000 + 6.000 E. Presented by Suong Jian & Liu Yan.800 .400 + 200PM = 1.600($23) = 50.Monopolistic Competition and Oligopoly P = PL = PM = PN = $23 Optimal supply for Memphis and Nashville services are: QM = 1.000 units Thus. Guangdong University of Finance.000 + 4.000 QN = -600 + 200PN = -600 + 200($23) = 4. Inc.000 = 50. The total industry demand at a price of $23 is: QD = 500.

in each area is expected to have a positive effect on profitability given the pricing. based in Seattle. MGMT Panel .3 here Presented by Suong Jian & Liu Yan. Competitors like Wal-Mart would love to have such information available. Both capital intensity. A/S. Columbia asked management consultant Anna Kournikova to conduct a statistical analysis of the company=s profitability in its various markets. Columbia=s proprietary information is shown in Table 13. and average-cost advantages that accompany large relative size. market share and profit information for individual markets. the company has become increasingly concerned with the long-run implications of competition from a new type of competitor. consider the hypothetical example of Columbia Drugstores. the so-called superstore. measured by the ratio of the book value of assets to sales. Given that profitability is measured by Columbia=s gross profit margin. To measure the effects of superstore competition on current profitability. for example. the expected negative effect of high concentration on Columbia profitability contrasts with the positive influence of high concentration on industry profits that is sometimes observed. and sales data covering the last year for all 30 outlets. Nobody should expect Target. Firms jealously guard price. Columbia provided proprietary company profit. Guangdong University of Finance. profitability was measured by Columbia=s gross profit margin. Washington. The first is the relative size of leading competitors in the relevant market. or earnings before interest and taxes divided by sales. measured as the combined market share of the four largest competitors in any given market. among other market characteristics. advertising. along with public trade association and Census Bureau data concerning the number and relative size distribution of competitors in each market. measured by the advertising-to-sales ratio. Assume Columbia operates a chain of 30 drugstores in the Pacific Northwest. it would provide a ready guide for their own profitable market entry and store expansion decisions. Kournikova decided to conduct a regression-based analysis of the various factors thought to affect Columbia=s profitability. During recent years. well-financed rivals. Growth. and advertising intensity. K/S.3 Table 13. MS. the coefficient on capital intensity measured Columbia=s return on tangible investment. to disclose profit and loss statements for various regional markets or on a store-bystore basis. As a first step in the study. are expected to exert positive influences on profitability. the coefficient on the advertising variable measures the profit effects of advertising. measured at the Standard Metropolitan Statistical Area (SMSA) level. GR. Inc.Chapter 13 Demonstrating the tools and techniques of market structure analysis is made difficult by the fact that firm competitive strategy is largely based upon proprietary data. Of course. .412 - . Columbia=s market share. because some disequilibrium in industry demand and supply conditions is often observed in rapidly growing areas. measured by the geometric mean rate of change in total disposable income in each market. To see the process that might be undertaken to develop a better understanding of product demand conditions. CR. Similarly. marketing.. is expected to have a negative effect on Columbia=s profitability given the stiff competition from large. To net out size-related influences. The market concentration ratio. is expected to have a positive influence on Columbia=s profitability.

Kournikova used a Adummy@ (or binary) variable where S = 1 in each market in which Columbia faced superstore competition and S = 0 otherwise.4: Table 13.189 coefficient for the market-share variable means that. This is a relatively high level of statistically significant explanation (F = 13. Regression model estimates for the determinants of Columbia=s profitability are shown in Table 13.156% decrease in Columbia=s profit margin. The intercept coefficient of 6.E. high concentration has the expected limiting influence.4 here A. C.E. The standard error of the estimate (S. a 1% (unit) rise in Columbia=s market share leads to a 0. This means that relatively large firms compete effectively with Columbia. Guangdong University of Finance. Given the vigorous nature of superstore price competition. The coefficient of determination R2 = 77.Monopolistic Competition and Oligopoly Finally. The 0. = 2.7% of the total variation in Columbia=s profit-margins can be explained by the regression model. .413 - . The Columbia profit-margin data and related information used in Kournikova=s statistical analysis are given in the preceding table.1931%) means that there is roughly a 95% chance that the actual profit margins for a given store will lie within the range of the estimated or fitted value ∀ 2 Η S. MGMT Panel . and the rate of growth in the market area. as expected. CASE STUDY SOLUTION A.E.155 has no economic meaning because it lies far outside the relevant range of observed data. do superstores pose a serious threat to Columbia=s profitability? What factors might Columbia consider in developing an effective competitive strategy to combat the superstore influence? B. Similarly. a 1% rise in industry concentration will lead to a 0. Describe the overall explanatory power of this regression model. The coefficient on this variable measures the average profit rate effect of superstore competition. Columbia=s profit margin is positively related to capital intensity..7% means that 77. Because of the effects of leading-firm rivalry. suggesting that the model provides useful insight concerning the determinants of profitability. or ∀ 2 Η 2.1931%. Conversely. to gauge the profit implications of superstore competition. as well as the relative importance of each continuous variable. indicating a profit-limiting influence.189% (unit) rise in Columbia=s profit margin.38) for a crosssection study such as this. Kournikova expects the superstore coefficient to be both negative and statistically significant.E. Presented by Suong Jian & Liu Yan. on average. advertising intensity. Based on the importance of the binary or dummy variable that indicates superstore competition.

Both observations suggest that current and potential superstore competition constitutes a considerable threat to the company and one that must be addressed in an effective competitive strategy. like Store No. Yes. Columbia=s still-profitable stores in major metropolitan areas could help fund future growth. Development of an effective competitive strategy to combat the influence of superstores involves the careful consideration of a wide range of factors related to Columbia=s business. 6. it appears that Columbia faces superstore competition in only one of the seven lucrative markets in which the company earns a 20% to 25% rate of return on sales. In the meantime. On the other hand. For example. perhaps Columbia should follow the example set by Wal-Mart in its early development and focus its plans for expansion on small to medium-size markets. a regression-based study of market structure such as that described here can provide a very useful beginning to the development of an effective competitive strategy. . the regression model indicates that superstore competition in one of Columbia=s market areas reduces Columbia=s profit margin on average by 2. Although obviously only a first step. the profit-limiting effect of superstore competition is substantial.Chapter 13 B. the one Columbia outlet able to earn a substantial 20% profit margin despite superstore competition.g. Guangdong University of Finance. prescription drug delivery) or in a slightly different mix of merchandise. 6. It might prove fruitful to begin this analysis by more carefully considering market characteristics for Store No. Given that Columbia=s rate of return on sales routinely falls in the 10% to 15% range. should specialize in service (e.102%. Presented by Suong Jian & Liu Yan. MGMT Panel . C. Looking more closely at the data. this analysis might suggest that Columbia.414 - ..