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Write the economic analysis section of a business proposal. This will include statements about the market structure and the elasticity of demand for the good or service, based on text book principles. You need to create hypothetical data, based on similar real world products to estimate fixed and variable costs.

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Required Elements:

Identify market structure
Identify elasticity of the product
Include rationale for the following questions:
How will pricing relate to elasticity of your product?
How will changes in the quantity supplied as a result of your pricing decisions affect marginal cost and marginal revenue?
Besides your pricing decisions, what are your suggested nonpricing strategies? What nonpricing strategies will you use to increase barriers to entry?
How could changes in your business operations alter the mix of fixed and variable costs in line with your strategy?
No more than 1400 words
Your proposal is consistent with APA guidelines

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 firms decision is interdependent on other firms 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;
a) the point where the difference between total revenue and total cost is maximized
b) The point where marginal revenue (MR) equals marginal cost and marginal cost (MC)
curve intersects marginal revenue curve from below.
So, Fords pricing strategy is likely to be determined by this rule. To be concrete,
Fords 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 firms 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;
a) Efficiently utilizing the available resources
b) Following an effective and significant market strategies
c) 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]

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