Business Proposal

Describe the current global economic conditions and their effects on local macroeconomic indicators for your good or service.

Descrive the local economy’s stage in the business cycle.

Describe how current credit market conditions affect your planning or operating decision for your good or service.

No more than 2100 words and that includes the 1454 already completed.

Basically you will read my proposal and answer the questions.

  

I say 20 for now but if you do a good job I will pay more!

Business Proposal Paper

Shawna Adkins

ECO/561

October 30, 2013

Farah Farahati

Running head: Business Proposal Paper

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Business Proposal Paper

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Choice of product and the market structure

My choice of product is automobile/Car. And suppose that the company is Ford. The American automotive industry has traditionally been oligopolistic in nature. The American automotive industry although started with hundreds of manufactures, but by the end of 1920s it was dominated by three big companies- Ford, General Motors, and Chrysler. This trend of dominance by few firms continued even after the post-world war II period with companies like Ford, General motors, Chrysler and AMC dominating the market (i.e. holding the largest share of the automobile market). Careful study of American automobile industry implies that there has not been much change in the market structure of American automobile industry post World War II; it continues to be dominated by few firms even now as in 1960s and 1970s. The Major players in the American automobile market are; Ford, General motors and Chrysler (known as big three) with foreign companies like, Toyota, Nissan coming up gradually in terms of market share. Hence the market structure of Car/automobile industry is oligopoly with few large firms dominating the market and large number of buyers. Firms in this industry are interdependent on each other in terms of their output and price decision. This is so because each firm in this market has the enough market power to affect market condition and therefore whenever a firm decides about any of its policy or action; it always considers the corresponding actions which will be taken by its rivals. As if other firms are charging a price which is relatively lower than the price charged by the given firm, then there is a change that this firm may lose its all customers. So each firm’s decision is interdependent on other firm’s decision.

In the automobile industry, products of each are differentiated from each other in some form. This differentiation might be in the form of quality, brand name, size, weight, color, features etc. These differentiations among goods produced by different producers allow them to have some partial control over the price of their product in the short run i.e. this product differentiation allows firm to behave like monopolies in the short run as it gives them power to set their price in the short run. Also this product differentiation and hence the resulting market power imply a downward sloping demand curve for each monopolistic firm.

Elasticity of demand and how pricing is related to elasticity of demand

The elasticity of demand of a product plays an important role in the determination of pricing strategy by a firm.

If demand is elastic i.e. Ed>1 (or if absolute value of elasticity is less than one), then proportionate decline in quantity demanded of a good (as a result of increase in price) will be larger than proportionate increase in its price and therefore in this case, increase in price would cause total revenue to fall. So in such a case, the price charged by the business would be at lower levels. If demand is inelastic i.e. Ed<1 (or if absolute value of elasticity is less than one), then proportionate decline in quantity demanded of a good (as a result of increase in price) will be less than proportionate increase in its price and therefore in this case, increase in price would cause total revenue to increase. So in such case, the price charged by business would be high. This relationship can be seen using profit maximizing condition;

MR = MC or, {given MR = [1-(1/e)}

P[1-(1/e)] = MC, implies P = MC/[1-(1/e)]

Here it can be noted that Price and elasticity values (in absolute terms) are negatively related i.e. price charged by business falls with rise in the absolute value of elasticity (e).

For example, MC = 100 and e = 2

Then profit maximizing price P* = 100/[1-(1/2)] = $200

Now suppose ‘e’ changes to 1.5, then profit maximizing price P* = 100/[1-(1/1.5)) = $300

Thus we note that lower is elasticity, higher is profit maximizing price. This proves that elasticity plays a significant role in determining profit maximizing price and quantity.

The demand for car by Ford is elastic in nature. This is because there are substitutes available to it (for example; Cars by GM or Chrysler). In other words, if price of car by ford rises, people are more likely to switch to other companies’ cars. Given this, the price of ford car should kept at the comparable level-a level which neither too high nor too less.

Effect of changes in the quantity supplied as a result of your pricing decisions on marginal cost and marginal revenue

Profit = total revenue – total cost

So profit is maximized at a point where the difference between total revenue and total cost is maximized. There can be two ways to derive profit maximization point;

the point where the difference between total revenue and total cost is maximized

The point where marginal revenue (MR) equals marginal cost and marginal cost (MC) curve intersects marginal revenue curve from below.

So, Ford’s pricing strategy is likely to be determined by this rule. To be concrete, Ford’s pricing strategy at the profit maximization point (as explained above) is given by;

P* = MC/[1-(1/e)]

If price is charged according to this rule, marginal revenue would be equal to marginal cost and Ford would be maximizing its profit. However if price charged is greater than P*, then quantity supplied would decreases and MR would not be equal to MC; in fact, MR would be greater than MC. On the other hand, if price charged is less than P*, then although quantity supplied would increase but MR would again be not equal to MC; in fact, MR would be less than MC. In both of these cases, profit of Ford would not be maximized. So the price charged by ford should be P*.

Non-pricing strategies and barriers to entry

The automobile industry already has natural/in build entry deterrence in the form of large entry cost. A firm entering in this market would need huge investment initially, in form of setting up cost, approval cost, research and development cost etc. This makes entry difficult for most firms with low capital formation. Also the market is already filled with many big manufacturers, which makes the existence of a new firm difficult because of intense competition from these big manufacturers.

Generally, the existing firms try to deter entry by taking actions that increases their rivals cost, thereby making their entry difficult. The one of such action could be grand fathering of rights. Under this, the existing firms convince the government set some standard criteria such as in terms of fuel efficiency, mileage and product life to be the preconditions for a firm to enter. This implies that the new firm will have to meet these criteria to enter which makes the entry difficult for them. Also sometimes the existing firms illicitly collude with each other and thereby collectively try to deter the entry by the new player.

The most common action used in securing the market share by the existing firm is to invest in advertisement. These firms invest heavily in advertising for their product and thereby try to maintain their dominance (or increase their market share). They also invest heavily in research and development. The automobile industry requires continuous invention/exploration as the need for new features/technology are ever increasing. Also as the concerns regarding global warming are rising, companies are spending lots of money on R&D to make the car more fuel efficient and environment friendly. This creates additional difficulty for new firms to enter the automobile manufacturing industry as they might not have required technology to start with.

Effect of changes in business strategy on the mix of fixed and variable costs

Business strategies are mainly directed towards maximizing the firm’s profit. As explained above, profit a firm is maximized when the difference between total revenue and total cost is maximized. This means to maximize the profit, Ford will follow those business strategies which generates maximum revenue at the lower possible cost. This implies that business strategies followed by Ford are likely to have negative impact on the mix of fixed and variable costs i.e. both are likely to fall/ be at minimum. Some of business strategies could be; efficiently utilizing the available resources, following an effective and significant market strategy, and participating in innovative and cost effective techniques.

References:

Mankiw, G N (2006) , Principles of Microeconomics, 4th edition, Cengage Learning.

Snyder, C and Nicholson W (2008), Microeconomic Theory: Basic Principles and extensions, 10th edition, Cengage Learning.

How the US automobile has changed, published on April 2012, available at: http://www.investopedia.com/articles/pf/12/auto-industry.asp#axzz20Z7qv7zh [accessed on: 30/10/2013]