Low-Calorie, Frozen, Microwavable Packs – Paper 2

Introduction

The purpose of this paper is to analyze the market of the low-calorie, microwavable 3-pack units of frozen food, which is now assumed to be dominated by two leading firms.

The main objective of this paper is to analyze the new scenario where now the market is not perfectly competitive anymore, and it is now dominated by two competing leading firms. It is of interest to analyze the factors that can alter the market structure, cost structure, the pricing policies, shut down conditions and the ways to improve profitability in this new scenario.

Two Competitors in the low-calorie frozen, microwavable food industry

The two companies that will be considered in this paper, for the abovementioned scenario are Weight Watchers and Healthy Choice. These two companies are leaders in the market of microwavable food, with an emphasis on low-calorie food, oriented toward the more health conscientious consumers. These two firms do not necessarily compete with each other, as they product lines are considerably differentiated, which creates different for their different products. So, even though they sell the same generic product (low-calorie, frozen microwavable food), they do not produce homogeneous goods, at least to the eyes of the consumers.

The market these firms operate is not perfectly competitive, because they have strong market power. The market they operate has elements of an oligopoly, where a few firms have a majority of the market share, but it also has elements of a monopolistically competitive market, because it is relatively easy for a firm to enter in the market and compete (due to the relatively low entry barriers) and the fact that the competitors actively look into differentiating their products. Although it is hard to think that a small firm entering the market could compete with giants like Healthy Choice and Weight Watchers, so in practicality there are entry barriers for this market.

These two firms, Healthy Choice and Weight Watchers face downward sloping demands, so that they will decide on their price (or quantity) that will optimize their profit, by following the optimality condition MR = MC (this is, the marginal revenue equals the marginal cost).

Factors that can change the Market Structure

There are several factors that can change the market structure. One possible factor is that firms may have started to differentiate their products using attractive marketing, branding and making their products different from those of the competitors, to the consumers’ eyes. This differentiation makes that the assumption of homogenous good, which is required for perfect competition, is not met anymore. Differentiation is one of the most powerful strategies used for firms to gain market power. And firms like Weight Watchers and Healthy Choice do a great job a differentiating and branding their products.

Another factor that could have likely caused the change in the market structure is that some firms have acquired a sheer volume of operations, large enough to produce economies of scale, which help those firms to reach overall lower long run average cost, so that those firms can easily drive other firms out of business by lowering their prices and still keeping a profit. In the long run, firm will try to reach the optimal scale to minimize the long run average cost. If any firm cannot reach long average costs that are similar to other firms in the industry, it will be driven out of business.

Short Run and Long Run Costs

It will be assumed that the cost functions for Healthy Choice are the ones given below:

& TC=160,000,000+100Q+0.0063212{{Q}^{2}} \\

& \\

& VC=100Q+0.0063212{{Q}^{2}} \\

& \\

& MC=100+0.0126424Q \\

\end{aligned}\]

In the case scenario, Healthy Choice has market power, so it is a price taker firm, but rather a price setter firm. In that context, Healthy Choice will choose a production level Q* that solves the following optimality condition: MR = MC. In the previous paper it was found that the demand function faced by the firm is

The inverse demand is therefore:

which means that the marginal revenue is \(MR=651-0.02Q\). The optimality condition is therefore:

which means that the optimal amount is Q* = 16879.886 \(\approx \) 16,880 units. The equilibrium price is P* = 651 – 16879.886*0.01 = 482.2 cents = $4.82.

In the long run, the firms in this industry will need to expand their scale up to a point of minimum long run average cost. In order to make concrete calculations, estimates of different possible expansions paths for the firms would be required.

Shut Down Factors

In the short run, a firm should shut down if the minimum average variable cost is lower than the price. Mathematically, this is written as:

In the concrete example of the firm being analyzed, the average variable cost is

so then the minimum average variable cost is 100 cents or $1 dollar. Therefore, the minimum price the firm could take before shutting down is $1. For any price below $1, the firm should shut down.

In the long run, firms will expand their scale to achieve optimal average costs, and if possible, they will attempt to reach economies of scale. The firms will only stay in the industry if their minimum average cost is greater than or equal to the price P*, otherwise they will need to shut down because they would be losing money and they have already expanded to their optimal scale, so they have a very hard time at reverting losses.

Pricing Policy

In the context of this scenario, firms are price setters and not price takers, so then they will need to solve the following equation in order to maximize their profits:

Hence, the firms will solve

The conclusion is that the optimal amount to be produced is Q* = 16879.886 \(\approx \) 16,880 units and the equilibrium price is P* = $4.82.

Evaluation of Financial Performance

The key for Healthy Choices is to key a tight accounting control in order to accurately assess and assign costs, in order to determine whether they should keep operating (because they are in profit or they can at least cover the avoidable costs) or they should shut down. Proper accounting information is a key element for firm to assess the proper cause of action. Healthy Choices should also provide financial statements, like the balance sheet and income statement, in order to meet their legal requirement and to keep investors informed.

Healthy Choices should also examine and analyze quarterly sales and profits in order evaluate trends, to identify weaknesses and strengths and in order to have proper managerial direction in terms of their financial goals.

How to Improve Profitability

There are several ways that Healthy Choices can use to enhance profitability. On the one hand, they can work on their branding and marketing efforts in order to shape their products in such a way that consumer exhibit a more inelastic demand for their products. This is achieved by properly enhancing the image of the company and their products, creating deeper and deeper differentiation from competitors.

The other way Healthy Choices can enhance profitability is by working out their cost structure. More specifically, if they are able to reduce their costs, they will then be able to increase profitability. A deep internal analysis of costs should be conducted in order to assess whether their using their resources optimally. Also, new productive processes could be introduced, in order to make production more efficient and reduce costs overall.

References

Varian, H. Intermediate Economics : A Modern Approach (8 ^th Edition) . W. W. Norton & Company (December 3, 2009).

Perloff, J. Microe conomics . Prentice Hall; 6 ^th edition (2011).

Brue, S., Flynn, S. & McConnell, C. Microe conomics . McGraw-Hill Education; 19 ^th (2011).

Mankiw, G. Principles of Economics (6 ^th Edition) . South-Western College Pub (February 10, 2011).

Slavin, S. Economics (11 ^th Edition) . McGraw-Hill Education (October 4, 2013)

Price: $20.19

Solution: The downloadable solution consists of 8 pages, 1219 words.
Deliverable: Word Document