Question

What are the income elasticity, and cross-price elasticity, what are the market approaches in understanding consumer demand, how the regression results are interpreted, what are the sources of market barriers? How to measure market power? Explain the oligopoly, the kinked demand (Sweezy oligopoly), game theory. Explain the strategic entry deterrence, and cooperative models (cartel).

Answer 1

Income Elasticity: The income elasticity of demand measures the responsiveness of quantity demanded to a change in income. Normal goods have a positive relationship between income and demand which is reflected in a positive income elasticity of demand. On the other hand, inferior goods have an inverse relationship between income and demand, which results in a negative income elasticity of demand. It's the percentage change in quantity demanded divided by the percentage change in income, as follows

Income elasticity of demand = percent change in quantity demanded / percent change in income

Cross-price Elasticity:  A change in the price of one good can shift the quantity demanded for another good. If the two goods are complementary, like tea and sugar, then drop in the price of one good will lead to an increase in the quantity demanded of the other good and vice-versa. However, if the two goods are substitute, like tea and coffee, then a drop in the price of one good will cause people to substitute toward that good, and to reduce the consumption of other good. Cheaper coffee leads to less use of tea, and vice-versa. The term Cross-price refers to the idea that price of one good is affecting the quantity demanded of a different good.

Cross price elasticity of demand (XED) measures the how a change in the price of one good will affect the quantity demanded of another good.

XED =% Change in quantity demanded of Good A/ % change in price of a Good B

Following are the market approaches in understanding consumer demand.

1) Cognitive Approach: Cognitive approach to consumers demand focuses on information processing capabilities of consumers. Specifically, according to cognitive approach environment and social experiences provide individuals with abundant information to be processed, and the outcome of information processing results in individuals behaving in certain ways as consumers.

2) Behaviorist Approach : This approach is associated with the impact of external events. Practical implementation of this approach in the field of marketing can be observed in relation to Nescafe products. Specifically, integrated marketing strategy of Nescafe attempts to foster a specific pattern of behavior amongst target customer segment whereby consumption of a cup of Nescafe coffee has to be the first thing to do in the morning.

3) Psychodynamic Approach: It includes all theories in psychology that see human functioning based upon the interaction of drivers and forces within the person, particularly unconscious and between the different structures of the personality.

Regression is a statistical method used in finance, investing and other disciplines that attempts to determine the strength and character of relationship between one dependent variable (usually denoted by Y) and a series of other variables( known as independent variables).

Regression results are interpreted through P-Values and Coefficients in Regression analysis.

Regression analysis is a form of inferential statistics. The p-values help determine whether the relationships that you observe in your sample also exist in the larger population. The p-value for each independent variables tests the null hypothesis that the variable has no correlation with the dependent variable. If there is no coorelation, there is no association between the changes in the independent variable and the shifts in the dependent variable. There is insufficient evidence to conclude that there is effect at the population level.

The sign of regression coefficient tells you whether there is a positive or negative coorelation between each independent variable and the dependent variable.

Sources of market barriers:

1) Economies of scale: It occur when the unit cost of a product declines as production volume increases. When existing competitors in an industry have achieved economies of scale, it acts as a barrier by forcing new entrants to either compete on a large scale or accept a cost disadvantage in order to compete on a small scale.

2) Product Differentiation: Established competitors have gained customer loyalty and brand identification through their long-standing advertising and customer service efforts. This creates a barrier to market entry by forcing new entrants to spend time and money to differentiate their products on the marketplace and overcome these loyalties.

3) Capital Requirements: This form a particularly strong barrier when the capital is required for risky investments like research and development.

4) Switching costs: A switching cost refers to one-time cost that is incurred by a buyer as a result of switching from one supplier's product to another'. High switching costs form an effective entry barrier by forcing new entrants to provide potential customers with incentives to adopt their products.

5) Acccess to channels: In many industries, established competitors control the logical channels of distribution through long-standing relationships. In order to persuade distribution channels to accept a new product, new entrants often must provide incentives in the form of price discounts, promotions, and cooperative advertising. Such expenditures act as a barrier by reducing the profitability of new entrants.

6) Government policy: Government policies can limit or prevent new competitors from entering industries through licensing requirements, limits on access to raw materials, pollution standards, product testing regulations, etc.

Market power measured: Concentration ratios are the most common measures of market power. The four-firm concentration ratio measures the percentage of total industry output attributable to the top four companies. For monopolies the four firm ratio is 100% while the ratio is 0 for perfect competition.

The Oligopoly: Oligopoly is a market structure with a small number of firms, none of which can keep the others from having significant influence.

The Kinked demand( Sweezy oligopoly): The Sweezy model, or the kinked demand model, shows that price stability can exist without collusion in an oligopoly. This suggests that prices are rigid and that firms will face different effects for both increasing price or decreasing price.

Game theory: Game theory is concerned with predicting the outcome of games of strategy in which the participants(for example two or more businesses competing in a market) have incomplete information about the others intentions. Game theory analysis has direct relevance to the study of the conduct and behavior of firms in oligopolistic markets.

Strategic Entry deterrence : It refers to any action taken by an existing business in a particular market that discourages potential entrants from entering into completion in that market. Such actions, or barriers to entry, can include hostile takeovers, product differentiation through heavy spending on new product development, capacity expansion to achieve lower unit costs and predatory pricing.

Cooperative models (cartel) : A cartel is defined as a group of firms that gets together to make output and price decisions. For example, if each firm in an oligopoly sells an undifferentiated product like oil, the demand curve that each firm faces will be horizontal at the market price. The organization of petroleum exporting countries (OPEC) is the most prominent cartel, which serves the common interests of its members. Cooperative or collusive oligopoly is a form of market in which few firms form a mutual agreement to avoid competition. They form a cartel and fix the output quotas and the market price.