Economics in Plain English » Market structure

Market structure and the iPad

Andrew McCarthy — Tue, 14 Sep 2010 02:00:05 +0000

The launch of the iPad earlier this year, heralded a new period of competition in the market for tablet and slate computers. The three videos below, suggest that although Apple may have seized the lead the in the growing market, many other competing firms will be launching new products to entice customers to part with their money.

Click here to view the embedded video.

From first impressions, the market seems to be oliogopolistic in nature, where a few large firms (Apple, HP, Lenovo/IBM) share a large portion of the total market. At the moment it appears that Apple has the lead, and has created a product with unique selling points such as touch capability and a book reader. You can envisage from the video that HP will closely follow developments and try introduce other selling points eg. USB ports, built-in camera.

Discussion Questions:

What are the key difference between an oligopoly and monopolistic market structure?
What do you think will happen to Apple’s profits once more and more firms begin releasing their own version of the iPad? What must Apple do to try to maintain its profits in the tablet PC market?
What are “barriers to entry”? What are some of the barriers to entry that exists in the market for tablet computers?
Do you think firms in the tablet market would opt for price competition or product differentiation strategies to gain market share? Explain the advantages of each.

The “delicate balance of terror”: How game theory can be used to predict firm behavior (oh, and save the human race from utter annihilation)

Jason Welker — Fri, 27 Feb 2009 11:16:46 +0000

This week in AP Microeconomics students get to play online games, watch movies, and compete with their classmates in strategic competitions in which there are proud winners and sad losers. That’s right, we’re studying oligopoly!

What makes oligopolistic markets, which characterized by a few large firms, so different from the other market structures we study in Microeconomics? The answer is that unlike in more competitive markets in which firms are of much smaller size and one firm’s behavior has little or no effect on its competitors, an oligopolist that decides to lower its prices, change its output, expand into a new market, offer new services, or adverstise, will have powerful and consequential effects on the profitability of its competitors. For this reason, firms in oligopolistic markets are always considering the behavior of their competitors when making their own economic decisions.

To understand the behavior of non-collusive oligopolists, economists have employed a mathematical tool called Game Theory. The assumption is that large firms in competition will behave similarly to individual players in a game such as poker. Firms, which are the “players” will make “moves” (referring to economic decisions such as whether or not to advertise, whether to offer discounts or certain services, make particular changes to their products, charge a high or low price, or any other of a number of economic actions) based on the predicted behavior of their competitors.

If a large firm competing with other large firms understands the various “payoffs” (referring to the profits or losses that will result from a particular economic decision made by itself and its competitors) then it will be better able to make a rational, profit-maximizing (or loss minimizing) decision based on the likely actions of its competitors. The outcome of such a situation, or game, can be predicted using payoff matrixes. Below is an illustration of a game between two coffee shops competing in a small town.

As illustrated above, the tools of Game Theory, including the “payoff matrix”, can prove helpful in helping firms decide how to respond to particular actions by their competitors in oligopolistic markets. Of course, in the real world there are often more than two firms in competition in a particular market, and the decisions that they must make include more than simply to advertise or not. Much more complicated, multi-player games with several possible “moves” have also been developed and used to help make tough economic decisions a little easier in the world of competition.

While Game Theory can be useful in predicting firm behavior in oligopolistic markets, believe it or not that is not its most useful application developed. In fact, would you believe me if I told you that Game Theory may be precisely what saved the world from nuclear holocaust during the 20th Century? It’s true. The US government employed Game Theory to avert annihilation by nuclear attack from the Soviet Union during much of the 20th Century. This video tells the story!

Click here to view the embedded video.

Starbucks instant coffee: a sign of the times?

Jason Welker — Tue, 24 Feb 2009 23:32:15 +0000

Chicago, Seattle first markets to get instant Starbucks — chicagotribune.com

I consider myself a Seattleite. I discovered the joy of drinking coffee in the home of Starbucks, Tully’s, Seattle’s Best, and countless local coffee shops that inhabit every corner of the rainy city. To me, the experience of drinking a latte, machiato, cappuccino, or simply a “coffee of the week” encapsulates the smells, soft decor and friendly greetings from the barista at my favorite coffee shop. Living overseas, I have turned to Starbucks over and over for a taste of Seattle and a feeling of home.

There is no denying that the Starbucks experience is one that does not come cheap. Here in Switzerland, a grande latte, my drink of choice, sets the consumer back nearly $7. In an economic downturn such as that the US and the rest of the world are experiencing right now, such expenses are often the first to be reduced by cash strapped consumers. In fact, I recently began bringing a thermos of homemade coffee to work every day, rather than stopping at the Starbucks at the train station as I had done for several months not long ago.

Starbucks, which recently announced the closure of hundreds of its locations around the world, is actually expanding its product line while simultaneously closing down shops. It may not be in the way you expect, though. Soon, I’ll be able to get my $7 cup of coffee for as little as $1, it will just come in a different form:

Starbucks Corp. will launch its new instant coffee product next month in Chicago and its home turf of Seattle, with a full-scale, national offensive set for the fall.

Starbucks on Tuesday formally unveiled the new product, called Via Ready Brew. It will be available in Starbucks retail outlets in the Chicago and Seattle areas on March 3, Howard Schultz, the company’s chief executive, said in an interview with the Tribune.

Instant coffee from the king of gourmet blends? Sounds suspicious. Well, it’s all about economics, you see. Starbucks coffee is a normal good, one for which demand falls as incomes fall, as evidenced by falling sales at its coffee shops around the world. In order to maintain its customer base even as incomes fall, a company like Starbucks must expand its product line to include inferior products, or those for which demand increases even as incomes fall. Clearly, instant coffee is viewed as an inferior product, due to its significantly lower price and reputation of poor quality.

Furthermore, Starbucks’ new product is in response to increased competition from lower-end fast food chains that traditionally did not compete in the coffee market, but recently have begun offering various blends and varieties of coffee to the price-sensitive coffee consumers, further harming business at Starbucks’ higher end coffee outlets.

Via marks Starbucks second announcement this month of a cheaper menu alternative, as the famous coffee chain struggles in a weak economy. Starbucks is also now selling pairings of coffee and breakfast offerings for $3.95.

Starbucks’ troubles have occurred at the same time value-oriented fast-food chains, particularly Oak Brook-based McDonald’s Corp., have thrived. McDonald’s owes part of its success to improving the quality of its basic coffee, and expanding into new drinks like iced coffee, and, more recently, flavored specialty coffees such as lattes and cappuccinos.

Still, Schultz said McDonald’s coffee offensive hasn’t really affected Starbucks: “We have a lot of respect for McDonald’s as a company. But we have not seen any significant issues with McDonald’s share of the coffee business affecting Starbucks.”

McDonald’s offers “a different product, a different value proposition,” he said. In fact, Schultz said McDonald’s should expand the overall coffee market, thus leading some customers to “trade up” to Starbucks.

Despite the CEO’s claims that Starbucks and McDonald’s coffees are “different” products, it is clear by his firm’s decision to expand into the instant coffee market that Starbucks is concerned about the loss of customers to lower-end coffee retailers.

The theory of firm behavior as studied in AP and IB Economics teaches us that firms in oligopolistic or monopolistically competitive markets, such as that for coffee shops in the US, tend to compete using non-price methods such as product differentiation and advertising. Rather than slashing the prices of all of its coffee in the face of a recession and falling consumer incomes, Starbucks has instead diversified its product line to include lower end options for consumers whose sensitivity to price and demand for gourmet coffee have been adversely affected by the weak economy.

Product differentiation in imperfectly competitive markets – the MacBook Wheel

Jason Welker — Wed, 28 Jan 2009 14:14:20 +0000

In IB Economics, we are currently learning about how firms in imperfectly competitive markets differentiate their products in order to increase their market power and their price-making power.

In a market with a few large firms such as the laptop computer market, companies must do what they can to increase demand for their own products over those of their competitors. Apple Computer is an example of a company that has successfully differentiated its line of laptop computers in recent years, regularly improving the features of its line of MacBooks to attract consumers away from its competitors and into the world of Macs.

Last year Apple launched the MacBook Air, the lightest and thinnest laptop on the market, creating a huge buzz in the technology world and converting millions to Apple’s line of laptops. This year, Apple has launched yet another innovation in laptop computing, in the hope of once again increasing demand for its products, and making consumers think they cannot live without the sleek, shiny Apple computers. This year’s innovation? The “MacBook Wheel”… watch:

Apple Introduces Revolutionary New Laptop With No Keyboard

The goal of an imperfectly competitive firm like Apple is to increase its market power by increasing demand for its particular product through product differentiation, advertising, developing brand loyalty, and “hype”: all forms of non-price competition. If Apple were to simply charge a lower price than its competitors for its products, it would also succeed in increasing the amount of computers it sells to consumers, but may also end up accepting lower profits due to the lower prices it must sell for.

Through differentiation, which means making its products unique and attractive to consumers, Apple attempts to increase market demand for its computers, while simultaneously making demand less elastic. With higher, more inelastic demand, Apple gains price-making power over the laptop computer market, as can be seen in the graphs below, which show that after the successful launch of a new product like the MacBook wheel Apple is able to charge a higher price, produce a similar quantity, and earn greater economic profits.

In the video, one customer says that he’d buy “buy almost anything if it’s shiny and its made by Apple”. Such statements reflect that among loyal customers, demand for Apple’s products is highly inelastic. While the firm is certainly not a monopolist in the market for laptop computers, Apple has surely succeeded to increase its market power and thus its power over prices through product differentiation, brand loyalty, and the “hype” surrounding the launch of new products like the MacBook Wheel.

Discussion questions:

In the graphs above, the slopes of the demand curve increases after successful product differentiation by Apple. Why does this happen?
Assuming the market for laptop computers is monopolistically competitive, what will likely happen to Apples economic profits over time? What must Apple do if it wishes to maintain its profits in the long-run?
What are some real ways companies like Apple and its competitors have attempted to differentiate their products over the years? Would YOU buys a MacBook Wheel if it were real?

Is Nokia in denial?

Jason Welker — Wed, 05 Dec 2007 13:23:32 +0000

Nokia Won’t Play iPhone’s Tune

As we know, oligopolistic markets are characterized by a few large firms which act interdependently based on the actions of one another. Examples of such interdependence may include pricing and output behavior, advertising behavior, sales and promotions, non-price competition, services offered to consumers, and so on. The “game” of oligopoly is played with one very important goal in mind: maintaining market share in the face of competition from rivals.

In a previous post I discussed some of the strategies Apple has used to break into the oligopolistic market for cellular phones, which it recently did by introducing the thus far wildly successful iPhone. A chart in that post showed that as of earlier this year, the dominant firm in the mobile phone market was Nokia, with a market share of 35.1%. Apple was not even a competitor in this market until July of this year, which saw the successful launch of the iPhone, causing some of the incumbent mobile phone makers to pay close attention to the newcomer’s behavior.

Nokia executives, however, appear to be in denial of the potential threat posed by the iPhone to its dominance in the cell phone industry:

Nokia managers would never admit to being influenced by the Apple iPhone, which mobile phone industry insiders regard as clever but technologically unimpressive. “We don’t determine strategy based on the competition,” insists Anssi Vanjoki, Nokia executive vice-president and general manager for multimedia. “The consumer is our compass.”

The message seems clear enough: “No one influences our firm’s behavior except the consumer”. If this were true, it would seem that our basic assumption that oligopolistic firms act interdependently based on the actions of the firms with which they compete may be incorrect. But wait a minute, is Mr. Vanjoki being truthful here? Has Nokia really simply ignored the impact that Apple’s launch is having on the mobile market? Let’s look more closely:

Nokia announced a new initiative Dec. 4 that seems aimed squarely at Apple. Beginning next year, higher-end Nokia phones will come with a built-in music service offering unlimited downloads of songs for a year. Nokia has signed up Universal Music to provide its catalog, including top contemporary musicians such as Amy Winehouse and Kanye West. And the handset giant is already negotiating with other major music companies, Vanjoki says.

Hmm… a Nokia cell phone with music playing and downloading capabilities. Surely Apple’s iPhone had NOTHING to do with this new product, right? The presence of Apple on the mobile market has clearly influenced the incumbent firms, even the unflappable Nokia, whose claims of acting only at the behest of consumers seems to ignore the reality of the matter: consumers demand phones that play music because Apple makes a phone that plays music. Is it really a coincidence that Nokia launches their first music playing phone only months after the launch of the iPhone?

In AP Microeconomics we study oligopolistic market structures under the assumption that firms in such markets act interdependently of one another. If a firm like Wal-mart slashes its prices for, say, board games, then Target and K-mart are likely to respond by announcing price cuts on board games or other such products themselves. They don’t behave this way because they want to sell their products at a lower price, they do so because if they don’t, then Wal-mart threatens to increase its market share at the expense of Target and K-mart.

In the mobile phone market, firms respond not only to the behavior of consumers but to the actions of other firms as well. In this case, Nokia knows that the arrival of Apple and the iPhone has changed the name of the game for mobile makers. The iPhone’s technology may be “unimpressive” to Nokia, but who could help but be impressed by Apple’s clever decision to make a user-friendly all-in-one Mp3, video, web-browsing cell phone? Clearly, Nokia is broadening its product selection and features to include such “Applesque” features to try and maintain that 35% market share in the face of Apple’s newfound success in the mobile market.

Does Apple stand a chance?

Jason Welker — Fri, 16 Nov 2007 16:02:05 +0000

China Mobile negotiating with Apple to carry iPhone

Try try as he might, Steve Jobs and Apple can barely launch their hottest new product, the iPhone, before the Chinese have copied it and put a knockoff on the market as quickly as you can say “can you hear me now?” But what is Apple doing making a cell phone anyway? Isn’t the mobile phone market pretty much dominated by a few big name companies already? How will apple ever survive in a market with such well established firms as Nokia, Samsung, and Motorola?

The answer is through product differentiation. The iPhone is truly an innovative little gadget. More than an MP3 player, more than a cell phone, the iPhone has features that differentiate it from most products available from the established firms in the mobile phone market. Like any firm, Apple advertises its iPod through commercials and other media in order to inform consumers about what makes its product special. What message does the following advertisement send about the iPhone?

Click here to view the embedded video.

The table below shows the market shares of the larges mobile phone makers as of late last year (before the release of the iPhone). A simple calculation finds that the four firm concentration ratio in the mobile market was 75.6%, clearly putting the market in the realm of an oligopoly (a market in which the four firm concentration ration is 40%).

With 75% of the market being controlled by Nokia, Motorola, Samsung and Sony Ericsson, the question arises whether Apple will be able to overcome the barriers to entry in the mobile market and establish itself as one of the big boys. Apple’s strategy for profits and market penetration certainly leverages the power of product differentiation and non-price competition, both firm behaviors common among firms in oligopolistic markets.

To make matters worse for Apple, only months after the iPhones release, and in the midst of negotiations between Apple and China Mobile to officially launch the product in China, a cheap, 4 GB knock-off of the fancy device comes along to entice Chinese consumers away from the 5,000 RMB (nearly $700) real deal. Check this thing out… would you be able to tell the difference?

Click here to view the embedded video.

Discussion Questions:

What barriers to entry exist in the market for mobile phones?
Why do you think so few firms produce mobile phones?
Do you think Apple will be able to successfully penetrate the mobile market?
What threat do cheaper “knock-offs” of the Apple iPhone pose to Apples attempts to compete in China’s mobile market?

SAS Economists Podcast #10: Perfect competition and comparative advantage in… the World of Warcraft!

Jason Welker — Tue, 13 Nov 2007 09:15:41 +0000

by Hansen Gu and Elaine Lung

Economics is not just for people living in the “real” world, you know! No it’s not. For some of us in high school, we actually prefer the fantasy life of the World of Warcraft. And yes, there is a real economy in our world too. And yes, it does exhibit characteristics of pure competition, and YES, workers do specialize their production based on their own comparative advantage!

Jeeze, why do I feel like I’m always having to defend myself here? Anyway, to learn more about the economy of our favorite fantasy world, watch this video!

Click here to view the embedded video.

SAS Economists Podcast #8 – Shanghai’s fake DVD market

Jason Welker — Mon, 12 Nov 2007 05:15:44 +0000

by Alice Su and Jessica Ng

Is it true what they say about the DVD market in China? Can you really buy fake DVDs on the streets for ONE DOLLAR? Come on, that’s a bit extreme, isn’t it? In fact, it’s not just under bridges and in dark alleys where you can buy pirated DVDs in Shanghai, but in respectable shops all over the city that on the outside and in look just like a legitimate DVD shop in the states or Europe.

This podcast will explore the economic characteristics of the market for fake DVDs in Shanghai and determine what it would take for the makers of real DVDs to be able to compete with the well established market for fakes.

Click here to view the embedded video.

SAS Economists Podcast #6: The oligopolistic nature of the video game console market

Jason Welker — Mon, 12 Nov 2007 00:43:23 +0000

by Annie Sung and Kristie Chung

Which do you prefer, the Wii? the XBox 360? the PS3? How about other video game consoles? Can you even think of any other video games consoles? Hmm… let’s see… how about the Sega? Wait, no, haven’t seen any of those in a while… what about the Atari? Oh, shoot, nope! Oh yeah, don’t forget the Caleco Vision (for the record, Mr. Welker’s earliest video game memory was of playing Smurfs on a Caleco Vision).

The fact is, today, the market for video game consoles has shrunk to three dominant firms: Nintendo, Microsoft and Sony. This podcast will investigate the video game console market, examine its characteristics, including the elasticity of demand for the different consoles, and conclude whether it exhibits the features of an oligopoly.

Click here to view the embedded video.

Non-price competition in the market for… WIKIS!! Wetpaint makes a move to gain market share

Jason Welker — Mon, 05 Nov 2007 14:09:07 +0000

Wetpaint, the free online wiki service, has stepped up its use of non-price competition in an attempt to increase its market share in the wiki market. In addition to releasing several Mac vs. PC parody videos meant to showcase the user-friendly, customizability of Wetpaint’s wikis vs. its rivals, the company also announced this morning that it would be offering ad-free wikis to educators!

As a user of Wetpaint since early this year, the distracting presence of advertisements bothered me; the decision to provide educators with ad-free wikis is huge, and makes Wetpaint even more attractive as a platform for hosting online learning communities for teachers of all grade levels.

Click here to view the embedded video.

You may be thinking, “Huh? There’s a market for wikis?” Well sure there is. Just because something’s free for us consumers does not mean it’s not a profit oriented business. Wetpaint and its rivals compete for consumers in an oligopolistic market in which competition is not based on price (since its products are essentially free), rather on product differentiation based on features and communicated through advertising and public relations.

Only a handful of firms offer consumers the service that Wetpaint does, free websites that can be collaborated on and built by individual users (see our Econ wiki, Welker’s Wikinomics). Wetpaint and its competitors earn their revenue by selling advertising space to marketers eager to place their ads on free wikis built by the community of users attracted to the wiki companies for their various features. But how does a company like Wetpaint attract new customers when its product (and that of its rivals) is essentially free! Clearly it can’t just lower its price, as firms in other oligopolistic markets do when they wish to increase their market share. This is where non-price competition comes in.

As we have learned, purely competitive markets are characterized by a large number of identical firms providing a standardized product. In other words, as a consumer you could care less whether you get your product from one firm or another, it’s all the same to you! A firm in an imperfectly competitive market, however, does not produce a homogeneous product, and therefore often times engages in non-price competition such as marketing, advertising, and PR in order to promote its own product’s attributes and to draw more customers away from its rivals.

In the oligopolistic market for free user-created wikis, in which only four or five firms compete, differentiation and non-price competition are crucial to gain market share, thus a greater share of advertisers dollars. The more users are attracted to Wetpaint’s wiki service, the more advertisers will be willing to pay Wetpaint to embed their ads onto its wikis. Therefore, it is important for Wetpaint to market itself as something special, better than “other wikis”, more user friendly, more customizable, basically the “cool” wiki on the block! And that’s just what these ads are meant to do!

By differentiating its product based on the ease of use, customizability, multiple “widgets” to make their product more entertaining and engaging, and now ad-free service to educators, Wetpaint is attempting to attract new consumers to its service. Whether Wetpaint draws new consumers into the Wiki market or attracts away customers from its rivals, the company’s unique attempts at product differentiation and non-price competition should succeed in increasing its market share, thus its attractiveness to advertisers, thus its revenue and profits.

The future looks bright for Wetpaint, not to mention for the thousands of teachers out there who now have access to a free, adless online landscape for creating unique learning experiences for their students to engage in.

Click here to view the embedded video.

SAS Economists Podcast #3: Competition in the Baked Goods Market at SAS

Jason Welker — Mon, 22 Oct 2007 03:04:27 +0000

By Nicole Wong and Katherine Yang

Podcast number 3 investigates the competitive market among groups selling baked goods here at Shanghai American School. The annual Relay for Life requires teams to raise 5,000 RMB (equal to about $650) in order to enter in the Relay. The most popular method of raising this entry fee is through bakes sales. This means that the month or so before Relay for Life SAS enters its “bake sale season” when countless teams try and push their products on teachers and students alike.

This podcast will explore the nature of the market for baked goods at SAS, determine the elasticity of demand for baked goods, and explore the prospects for increasing profits among teams hoping to make an easy kuai in the month leading up to the Relay for Life.

If the image is off, right click on the viewer and click “zoom” and “full screen”

SAS Economists Podcast #1: Demand for Eurest cafeteria food at SAS

Jason Welker — Mon, 15 Oct 2007 11:04:36 +0000

By Emily Yeh and David Xu:

Introduction: So today on SAS Economists podcast we come to examine the economic practices of our beloved catering service, Eurest. For the last several years Eurest has held our stomachs and their breaths, as they poured out food for the school community’s enjoyment. But how much does the community really enjoy the services provided by Eurest? Too often complaints about the variety of food or taste and appeal are expressed by students and teachers when the name “Eurest” is mentioned.

Today, we will examine the alleged gap between price and quality for Eurest’s food. We’ll try to find out whether the prices charged for cafeteria food truly reflect the costs to Eurest, or whether it is monopoly power that result in the prices many students consider to be unreasonable. Does a lack of competition result in x-inefficiency on behalf of Eurest? If students had the benefit of greater variety and the freedom to eat off campus, how would Eurest match up against greater competition? What can the company do to achiever a higher level of customer satisfaction? These questions and more in the first EVER SAS Economists podcast!

To play, click on the viewer below and wait a couple of minutes for the video to load. It will play automatically once it has buffered.