Economic Factors for Concentration Ratio Industry - Assignment Example

?Economic Factors Before settling on a given type of company and drawing a business plan, it is important to understand the type of industryin which it will be operating under. This is mainly determined by the type of products that the company will be producing and the number of producers in the market who are producing similar types of products and targeting the same market. While taking into consideration the amount of capital required and any barriers to entry, the company should weigh between the advantages and disadvantages of the various types of industries. A thorough analysis of this information should form the basis of deciding whether the company should operate in the low, medium or high concentration ratio (CR) industry. Industry A: 20 firms and a Concentration Ratio (CR) of 30% Name and some of the industry's characteristics An industry with 20 firms and a CR of 30% is called a low concentration industry. This is a type of industry in which its four largest firms control less than 50% of its market. According to Ruffinand Gregory (2000), this type of industry is monopolistically competitive and the market control gained by its four largest firms/industries is moderate. There are many firms producing a similar product. Prices are set through a contestable market model hence the decisions of one firm are not influenced by the decisions of another firm. The above is supported by the fact that in this industry, the key to success is the ability to offer products at a lower price (Weiss, 1989). Even of the sellers were few or even one, they would act as if they were many. Entry and exit from the industry is costless and new entrants are mainly attracted into the industry if a possession of market power if profitable. The pressures of competition help to prevent monopoly and keep the industry operating at a prices and outputs that are competitive. Expected long-run adjustments in case there was an increased demand for a product that pushed up the price of goods When there is an increase in demand of a product that in turn leads to an increase in its price, all the 20 firms in the industry are going to make positive profits and prosper. In the short-run, marginal costs and marginal revenue will be equal indicating an equilibrium or profit maximization. In the long-run, firms will alter the scale of product and leave or enter the industry. Other firms who want to take advantage of the profit will enter the industry leading to a rise in supply of the product. This will push the market prices of the product down to the long-run equilibrium. What the anticipated adjustment process imply about the CR for the industry The above-mentioned anticipated adjustments imply that there is a relationship between the CR of the industry and the properties of the industry. For example, when the CR is low as in this case, monopolistic competition takes place resulting to the market exhibiting elements of both monopoly and perfect competition. The reason behind this is that since the industry is monopolistically competitive, each of its existing firms has the power to set prices. They will compete for a control of the market share by lowering their prices and in the end, many of them will charge the long-equilibrium price. This establishes an equilibrium and eliminates incentives for entry. In other words, a low CR eliminates temporary rise in prices and restores the economy to a long-run equilibrium level, a characteristic of a competitive market. Therefore, it is true to say that the lower the CR, the higher the level of competition of the market. Industry B: 20 firms and a Concentration Ratio (CR) of 80% Name and some of the industry's characteristics An industry having 20 firms and a CR of 80% is called a high concentration industry. 20 firms and a CR of 80% indicate a highly oligopolistic industry. In this type of industry, a significant level of market control is under the power of four of its largest firms (Ruffinand, 2000). The market is dominated by few firms who sell slightly differentiated products. Robert (2006) states that the decisions reached by one firm influence and are influenced by those of other firms. Their strategic planning therefore takes into consideration possible responses from other market participants. Prices are set through the price leadership model whereby one firm is acknowledged as the market leader and therefore, it informally sets the prices of products then it is responded to by other producers (Weiss, 1989). Firms could also agree to restrict production and raise the prices just as in monopoly because the key to success in this industry is determined by the ability to restrict sales. Such an industry experiences low levels of competition and there are many barriers to entry. Because of this, there are high chances of monopoly occurring. The barriers to entry arise from high sunk costs that cannot be recovered by a firm once it enters into the industry. A good example is the aircraft industry. Reasons why industry B has a high CR while Industry A had a low CR Some of the reasons for a high CR in industry B and a low CR in industry A is that industry B is less competitive and this enables some few firms to grip a large market share. This means a summation of the output of its four largest firms gives a significant percentage of its total output. Kwoka (1977) explains that in high concentration industries, the required initial investment acts like a capital barrier that discourages new entrants leading to a high CR. Due to the economic return in the industry, larger firms put in very huge amounts of initial investment. Such requirements and conditions make it very hard for small firms to enter the industry despite its high profits. Therefore, there will be few and very rich firms to compete for the control of the market. As for industry A, there are many rivals due to high competition yet none of them has a significant market share. The possibility for smaller firms to thrive and profit in Industry B It is possible for small firms thrive and profit in industry B. The main reason is that producers in this industry produce similar but not duplicate products. This means they all face downward sloping/elastic demand curve. Small firms can take this as an opportunity by strategizing on their marketing decision. For example, they can cater for the needs of a specific group of customers whose needs are not being met by the major producers in the industry. The small firms should also differentiate their products from those of the larger firms/oligopolists while sharing the market and thus making gains in the industry. However, they should not over-rely on the low price strategy because larger firms can lower their prices even more without making any losses due to the high return of sales. References Robert, F. (2006). Microeconomics and Behavior (6th Ed). New York. McGraw-Hill/Irwin. Kwoka, J. (1977). “Large firm dominance and price-cost margins in manufacturing industries.” Southern Econ J. (1) pp. 183–9. Ruffin, R. and Gregory, P. (2000). Principles of Microeconomics. (7th Ed). New York. Addison Wesley. Weiss, L. (1989). Concentration and price. Cambridge, Mass. MIT Press. Read More