Exercise 8 - 1 Game Theory

The Concepts of Game Theory:

Mutual Interdependence, price setting and different forms of collusion are common among firms in a Oligopoly Market.
Game theory is related to the economics example of the "Prisoners Dillema". It explores collusion and competition among competetive forces using a payoff matrix to outline variable profits received against the decision to cheat or not to cheat.

A Payoff Matrix is used to graphically compare the pros and cons of cheating or being honest when pricing their products. Firms may choose to cooperate with their rival and if cooperation is reciprocated  each firm will share the combined maximum of profits. Increased profits are temptations to cheat and also result in punishing the honest firm. Combined cheating offers the lowest possible result.

Game Theory measures behaiviour and interdependence of firms. John Nash discovered and did initial research in this economic concept. Nash Equilibrium is used in Game Theory to measure the anticipated actions of game participants. (Sayre,Morris)

Game Theory is evident in our local marketplace in the competition among phone, cable and internet providers. The two major suppliers of fully bundled services in Calgary are Shaw and Telus. These companies periodicly lower prices, aggressively advertise and offer incentives to change consumers over to the competition. The high cost of exchanging back and forth a small percentage of the total market is unproductive and wasteful.

A Cartel is a form of Collusive Oligopoly where the member/suppliers of the cartel agree upon a set price and influence the market by controlling the output of product. A cartel is only successful if all the members stay honest and do not sell below the agreed upon price. A cooperative cartel acts like a large monopoly.

Links:
http://www.web-books.com/eLibrary/ON/B0/B63/056MB63.html

Exercise 7 - 1 Defining Monopolostic Competition

Defining Monopolistic Competition

Monopolistic Competition, one of the 4 basic market structures, has 4 major characteristics:

• There are many small firms;
• Each firm sells the same product, although products are slightly different;
• Firms are free to enter or exit the market without any significant barriers;
• Buyers have knowledge of alternative prices, product differences, brand names and techniques used in the industry.

Firms differentiate themselves from each other with their products and/or services:

• Physical differences of products can have multiple forms which may include materials, flavour or presentation;
• Perceived differences where identical products have only a small change which may be something small as different packaging;
• Support services for products and services differentiate firms by elements which may include increased level of service or self serve options.

Monopolistic Companies

Size:	Small Company	Medium Company	Large Company
Features:
Differentiated products	Opa! - Greek Fastfood	Earls - Evolving menu	Starbucks - Signature tasting espresso
Control over price	Booster Juice - offers a more advanced product and charges for it. i.e. They grow grass for drinks in-store.	Tim Hortons -  Guaranteed fresh coffee more affordable than Starbucks	Walmart - Economies of scale give retail giant enormous purchasing power
Mass advertising	Red Lobster- Television	Little Caesars - Television, Print and Public media	Mcdonalds - multimedia marketing
Brand name goods	Spolumbos - Brand used on menus and supermarket features, sponsorship	Izod -	Adidas

Source: http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=monopolistic%20competition

Exercise 6 - 2 Starbucks



STARBUCKS: An Investigation into Perfect Competition

Starbucks is an American success story. The company, started in Pike Place Market in Seattle by Howard Shultz in 1971, has grown into a large multi-national company, buying 4% of the total coffee market all premium Arrabica beans. Starbucks original artisan coffee practices have become more automated with their astounding growth and subject to the public scrutiny. Recent store closures, increasing competition, fair trade issues and a degradation of their core products have resulted in a company under re-alignment. (Fellner)

Coffee is a homogeneous product and an example of a business operating in a monopolistic competitive market is the coffee house.The coffee house industry has many buyers and sellers who are price takers. Preference is shown in the core product as most shops have  different specialty and/or multiple coffee products, the market has easy entry for buyers and sellers and market information is readily available.(Sayre, Morris) Starbucks would be considered to be operating in perfect competition if and only if they were competing amongst themselves and even then, the heterogeneity of the service industry will still exert some preferences for certain stores.

The coffee market has a storied history, one full of human strife and agony in many developing countries of the world since the Middle Ages. To lessen the brutal realities associated with the coffee trade, Starbucks, in a accordance with their re-alignment, have increased their profit sharing with the coffee bean growing countries to further sustain their developing economies. Challenges to business associates to have a  more entrepreneurial spirit are continually stressed by founder, Howard Shultz .(Fellner)

Store closures are resulting from numerous factors as outlined in Starbucks Gossip ..the commoditization of the Starbucks experience. The infamous "memo", from Starbucks founder Howard Shultz recognized generic stores, impersonal staff, machine processed coffee and increasing competition as the major reasons for store closures.(Starbucks Gossip.com) Starbucks total revenue has rebounded since the low 2008 levels, proof that their re-alignment to some extent has been successful.(Starbucks Gossip.com)

To gain increasing returns on their business, Starbucks has compromised many of its original benchmarks in order to maximize profits and increase productivity. The degradation of the products and services Starbucks is experiencing, as mentioned in the "infamous memo", shows a diminishing return in response to an overly saturated marketplace. Risks involved in decisions made regarding training, automation and service were relatively small but have become increasingly large when the accumulated effects were observed.(Starbucks gossip.com)

Starbucks uses only select quality Arrabica beans, grown only in  temperate climates at high altitudes.  The patented flavour valve on their coffee bags, which retains the coffees freshness, allows for mass production and storage. Starbucks is therefore able to control the price of their coffee as the coffee industry goes through cycles of glut and scarcity.(Fellner)

Coffee prices at Starbucks although slightly more expensive than their major competitors (and depending on level of service), are justified since the coffee beans have a higher perceived quality. If coffee prices at Starbucks were lowered it would result in lower revenues as coffee as a product is inelastic.

Sources:
http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html
http://www.cbc.ca/news/business/story/2008/07/01/starbucks-closures.html
http://site.ebrary.com.libresources1.sait.ab.ca/lib/sait/docDetail.action?docID=10251786
Wrestling with Starbucks : Conscience, Capital, Cappuccino
Fellner, Kim
Pages: 295
Publisher: Rutgers University Press
Location: New Brunswick, NJ, USA
Date Published: 06/2008
Language: en

Exercise 5 - 5 Economies of Scale

Fusion Wine Craft

A viable business I would like to create would be a winery named Fusion Wine Craft,  specializing in unique varietal blends and having an on-site restaurant. Located in the Okanagan Valley it would produce high quality wines and have a world class dining facility. A small winery with a wine production/ restaurant facility capable of seating 50 people and having 15 full time and 10 part-time employees .

Visitors to the Okanagan Valley would enjoy our restaurant and shop for goods in the facilities wine boutique. Hand crafted wines would be shipped and then sold at selected liquor stores across the country and internationally. The Restaurant would focus on the enjoyment of the experience and would acquire a tour operator service. Exceptional food in a scenic atmosphere would describe the dining room.

A winery is a monopolistic competition.  Fusion Wine Crafts  products and services would be marketed to people who appreciate good wine with an extra promotional emphasis on the baby boomer market. Wines would be sold in more niche market stores catering to more refined wine drinkers.

Long-run costs would include a plan using Minimum Efficiency Scale to ensure the winery's size and output capabilities are set to achieve economic capacity. Short run costs would include utilities, grapes, supplies and labour. Fixed costs would include insurance, rent and business license renewal.

An example of a business with a similar style operation is the Summerhill  Pyramid Winery : http://www.summerhill.bc.ca/Wines

Firms Strengths:  An established brand with a good reputation Summerhill Pryamid Winery has a great location and adequate size. It has Canadian and U.S. markets for its organic artisan style wine. An economy of scope is displayed with included restaurant and a scenic visitor area with unique architecture inspired by Egyptian Pyramids.

Firms Weakness: winery costs would be dependent on the quality of crops. A competitive wine market will lead to the firm being a price taker which could result in a lower price for their high end product. Production capabilities would be limited by the fixed amount of land and diminishing rate of return on increasing other factors of production.

Exercise 5 - 3 Diminishing Returns in Relation to Tobacco Legislation

The research article titled, "The Diminishing Returns to Tobacco Legislation" by Pierre Lemiex reports on reactions to different forms of government regulation. The major points outlined in this article have their merits and lessening points and the arguments give reasonable evidence demonstrating diminishing returns due to reformed smokers. Possible non cost solutions and the implications of tobacco's supply, demand and sin taxes are also explored in relation to the article.

The debated points with merit include:  

• The relationship of diminishing rate of sales due to smokers quitting with the increasing rate of government taxation.
• Smoking warning information overload has had a diminishing effect on quit rates and may be causing public complacency.
• Stringent government imposed regulations and taxation increase black market involvement.

The debated points without merit in the article include:

• Entrepreneurs in Quebec sell warning label pack covers for cigarettes which account for around 1% of cigarette sales. 
• Health bureaucrats addiction to power is involved in increasing tobacco regulations.

Increased government regulations are having a diminishing effect if a lot of ways. Most developed countries have had warnings for over a decade and government and private agencies have been educating the public for a longer period. The effectiveness  of these regulations are diminishing. Taxation on tobacco products has had a diminishing rate in regards to the numbers of smokers it reforms.

Solutions that would lessen diminishing returns on quit rates could include: 

• Increased prohibitive measures of the usage of tobacco in public and private areas.
• Dismantling private for profit tobacco companies
• Decreased taxes and susidies on quiting aids (patches, gum, smoking cessation medication)

Inelastic demand for tobacco products will result in only a small reduction in the quantity demanded in relation to a higher government imposed price increases. Higher taxation on inelastic products like tobacco result in higher tax revenues for the government.

The article clearly demonstrates the diminishing rate of return of quit rates with tobacco legislation and explores the issue of the governments role effecting the quit rate of smokers. The current rate of tobacco taxes and increasing  regulations are becoming ineffective.

Source: http://www.pierrelemieux.org/artdiminish.html

Exercise 4 - 3: Canadian Tourism and Elasticity

Canadian Tourism and Elasticity

Tourism can be a major contributor to economic growth all across Canada . The current state of the tourism industry in Canada has many issues affecting it including an ever increasing travel deficit, decreasing international market share and high taxation and Visa policies.

Canada's travel deficit currently at 14 billion dollars has steadily increased since 2010 as illustrated by Figure 4-3A.


Figure 4 - 3A Canada's Travel Deficit
Source: http://www.tiac.travel/documents/advocacy/gateway_to_growth_june_2011.pdf



Canada is the only country among the top 15 tourist destinations that has not had an increase in international arrivals since 2002. This is an indicator that Canada is falling behind as an attractive destination choice. Figure 4-3B lists the top 15 countries tourist arrivals in 2002 and 2010. A low ranking of 125th among popular tourist destinations in regards to taxation and Visa requirements is also a major deterent for International travellers.(TIAC)



Figure 4 - 3B: International Tourist Arrivals
Source: http://www.tiac.travel/documents/advocacy/gateway_to_growth_june_2011.pdf



The Tourism Industry in Canada is in decline and needs to focus on the following key areas in order to hopefully return to the top 10 of tourism country destinations: an increase in marketing funding, a more competitive government taxation and visa policy, added investment into tourism products like museums, parks, heritage areas, attractions and improvements in training and skills for tourism employees.

(TIAC)

Figure 4 - 3B: Attractions
Source: http://www.tiac.travel/documents/advocacy/gateway_to_growth_june_2011.pdf

Price elasticity is evident in many facets of the Tourism Industry due to the wide amount of substitutes for the Canadian tourism product and a lower percentage of household income due to the downturn of the global economy and looming U.S. economic turmoil. A degree higher than 1 and as high as 2 would be expected in the elasticity of demand of Canadian Tourism products and services.

Source:

http://www.tiac.travel/documents/advocacy/gateway_to_growth_june_2011.pdf

Exercise 4 - 2 Elasticity and Revenue: DVD Retail Example

As reported by the Financial Post, retail sales of items including DVD movies are in decline as they are being replaced by online providers of streaming digital media.

HMV Canada a leader in the DVD retail business is in the process of restructuring after being sold to Hilco UK a restructuring specialist.

Movies as a product are elastic in nature, a hypothetical retail DVD demand model is illustratrated in Figure 4 - 2A.



Figure 4 -2A

Figure 4 - 2B shows total revenue rising when price falls on the elastic part of demand curve and total revenue falling as a result of price falling on the inelastic part of the demand curve.

Figure 4 -2B

References: http://proquest.umi.com.libresources2.sait.ab.ca/pqdweb?index=19&did=2385781741&SrchMode=1&sid=1&Fmt=3&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=1310520611&clientId=5337

Financial Post.  (2011, June 28). HMV sale raises doubt about future of music, DVD retailers. Telegraph-Journal,B.4.  Retrieved July 12, 2011, from Canadian Newsstand Core. (Document ID: 2385781741).