Economic Analysis
Abstract
The paper discusses an economic analysis section of a business plan. The analysis is done for a hypothetical product called Sopsmart, which is a powder detergent that is yet to be introduced in the market. The paper investigates how pricing is done based on the market structure, demand elasticity, cost and non-pricing evaluations. The studies of the soap industry identify the market structure as monopolistic competition. Further, the price elasticity for Sopsmart is not definite as it exists between perfect competition and monopoly markets. Nonetheless, the soap industry nears a perfect competition market. The pricing is done for both the short and long run. To maintain the market share from short run, strong non-pricing strategies are adopted.
Key words: Sopsmart, demand elasticity, market structure, non-pricing, pricin
Introduction
The following economic analysis is provided for Sopsmart, a powder detergent. The paper provides an outlook on the market structure, demand elasticity, pricing and non-pricing analysis. The economic analysis adopts a theoretical framework with hypothetical values to put into the economic analysis perspective the contextual framework.
Market Structure for Sopsmart
The soap market is a monopolistic competition market. In monopolistic competition, there are many firms producing similar but differentiated products. The products are differentiated through branding, prices and quality amongst other characteristics. The soap market has close substitutes like bar and liquid soaps. Similarly, there are no entry or exit barriers for firms. To create the niche, the firm beats competition by winning customers and competition. Markets are created through brand loyalty. The basis of the competition strategy of a firm in monopolistic competition is the marketing strategy (Pride, Hughes, & Kapoor, 2012).
Price Elasticity of Demand
Firms that do undergo a monopolistic competition experience a down sloping demand curve. In this case, the demand curve remains less elastic when compared to markets experiencing perfect competition. On the other hand, it is more elastic than what is experienced in monopolistic situations. The elasticity in prices is, therefore, experiencing average elasticity since it is possible for a firm to sell more of its products within a very small range of prices. The demand curve is negatively sloped based on the availability of close substitutes and competition in the market (Tewari, 2003).
The control of a firm over price is pegged on their market share. The rule for price elasticity in monopolistic competition markets is that if the market conditions move towards monopoly, the market will be more inelastic. On the other hand, if the market conditions move towards perfect competition, the price elasticity will be more elastic. In this case, the detergent industry is inclined more towards perfect competition hence the demand curve is more elastic (Mastrianna, 2013).
Demand curves for monopolistic competition markets (Baumol & Blinder, 2011)
Pricing of the Product Based on the Elasticity
Pricing in the Short Run
The demand curve for Sopsmart slopes to right in the short run. As a result, there is a shift of the marginal revenue to the right. However, it is steeper. The pricing model rule holds that the marginal revenue must be cut by the marginal curve from below if a firm is to generate revenue. From the price elasticity, Sopsmart in its entry strategy will make economic profits based on the pricing and non-pricing strategies. Sopsmart will be able to sell more products at a relatively lower price. It is expected that, compared to the industry, the demand curve of Sopsmart will be more to the right. It is because the firm is able to maximize its profits through the production of output. It enables it to equalize its marginal cost with its marginal revenue. The oil detergent’s units’ profit maximization hypothetical is 15,000 in the first year of production. It is possible for the company to realize a profit of 0.5 for every unit at the demand curve’s point P. The company has to maintain its prices to wade off competition from similar products or substitutes (Baumol & Blinder, 2011; Mastrianna, 2013; Pride, Hughes, & Kapoor, 2012).
The Long Run Effect of Quantity Supplied on Marginal Revenue and Marginal Cost
Evidently, it will be possible for the company to maintain profits through a supply of 30,000 units in the short run. The output level is chosen, where there is equality between marginal revenue and the marginal cost. The market model based on the price helps ensure the full purchase by consumers, taking into consideration the quantity being demanded as is indicated in the curve (Aryasri, 2010).
Pricing in the Long Run
In the long run, profits realized in the short run attract other firms in the market. The increase in supply leads to lower prices. As a result, prices fluctuate until equilibrium price. Firms enter and leave the market until equilibrium is reached. The business plan for Sopsmart projects a profitable case scenario.
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The market experiencing monopolistic competition does receive differentiated products for the same price, which is equal to the average total cost of production of a firm in the long run. Based on the elasticity of the price, the curve representing the average total cost cannot be touched by that of the revenue. Even though the market for Sopsmart resembles that of a perfect competition, the price is higher than it would be in perfect competition. The long run equilibrium position in the industry creates excess capacity for each firm in the market. As a result, there is a leftward shift of the demand curve. The entry of the firms leads to equalization of the MC curve and MR curve. This leads to profit maximization at point E.
The point also equates point price P and average cost AC such that the economic profits are reduced to zero. Thus, it is expected that the market volume for Sopsmart will reduce by 1,000 units to 29,000 units in the first year.
Effect of Quantity Supplied on Marginal Cost and Marginal Revenue in the Long Run
The supply side in the long run is such that the marginal cost for producing an extra unit is lower. The entries of other firms equate MC curve and MR curve to maximize profits at point E. From the figure above, the marginal cost for the production of 15,000 units of detergents is lower than that of 20,000 units. As a result, the marginal revenue of the product continues to fall below average revenue of demand curve. The marginal revenue, in the long run, is lower compared to that of the shorter run because demand falls (Aryasri, 2010).
Non-Pricing Strategies
The non-pricing strategies adopted by the company include adverting, branding and consistent product improvement. The engagement in the market notes that price reductions, as a strategy, can easily be adopted by competitors in the industry. The company will adopt comparative advertisement that is also known as competitive advertisement strategy. The advisement will aim at building and convincing customers in the market that Sopsmart is a superior powder detergent in the market. Consequently, the powder will be white to distinguish it from the other two market leaders whose powders are blue and yellow respectively. By producing a white powder and keeping the upper part of the wrapping transparent, customers obtain a suitable visual appeal. Further, in the branding strategy, special design make ups will be done for the bottom part of wrappers. Finally, the company will invest in its research and development team to ensure that the product remains of superior quality in the industry (Tewari, 2003).
The Effect of Changes in Business Operations on Fixed and Variable Costs Based on the Strategy
The strategy adopted is to maintain the profits from the short run into the long run. From the above description, it is expected that the firm loses out its profits due to entry of other firms. However, the use of non-pricing strategy on branding, advertising and product improvement will help to create a market niche based on brand loyalty. Customers will view the product as superior. At the same time, the company will expand its market share in the long run to maximize its efficiency.
| Cost | Item | Price |
|---|---|---|
| Fixed Costs | Buildings | $20,000 |
| Equipments | $20,000 | |
| Furnishing | $5,000 | |
| Variable Costs | Raw Materials | $3,000 |
| Advertising | $1,000 | |
| Personnel | $7,000 | |
| Utilities | $3,000 | |
| Logistics | $15,000 | |
| Total | $74,000 |
Conclusion
In conclusion, from the tabulation above, the first three items show the fixed costs and variable costs in the short run for the production of 15,000 units in one year. In the short run, it is not possible to stretch fixed costs. However, there will be a need for increasing the costs as incurred on raw materials, logistics, as well as personnel if the company is to realize an increase of the production capacity of the machine to 20,000 units. The advertisement fee increase due to consideration of new markets. In the long run, the company increases the production. Thus, there is no variable as well as fixed cost. Thus, all costs are variable. This is because both fixed and variable costs increase with increased production. As companies enter the market to capture the abnormal profits, the company will capitalize on its economies of scale on labor, technology and marketing to enhance its grip on competition (Steven, Ward, & Baker, 2007).
