BUSINESS ENVIRONMENT Lecturer: Judith Robb-Walters

Lesson7

Business Environment

LO 3: Understand the behaviour of organisations in their market environment

September – November 2014

THE BASIC SYLLABUS

- Understand the organisational purposes of businesses.

- - Understand the nature of the national environment in which business operates.

- Understand the behaviour of organisations in their market environment.

- -Be able to assess the significance of the global factors that shape national business activities.

LEARNING OBJECTIVES

At the end of the class, students should be able to:

Explain how market structures determine the pricing and output decisions of businesses

OVERVIEW The focus is on how the environment varies

along a continuum in terms of "degree of competitiveness." The four standard "types" of market structure are identified: 1) Perfect Competition, 2) Monopoly, 3) Monopolistic Competition, and 4) Oligopoly and aligned along the continuum of competitiveness.

Overview of Market Structure Analysis-Steven E. Crane, Marquette University

PERFECT COMPETITION Also known as pure competition, perfect

competition is a situation in which a number of business entities compete for the attention of consumers, but there is no single company that dominates that market to the point of setting the standards in terms of pricing. Markets with this type of condition normally have large numbers of sellers who are capable of meeting the needs of a sizable consumer market, and actively compete with one another for the business of those consumers. Considered the opposite of a monopoly, a situation of perfect competition essentially means that all the businesses engaged in the market are free to set their own prices, without any one company setting the general market price.

PERFECT COMPETITION

There are several advantages to the existence of a perfect competition situation within a given consumer market. One has to do with the options open to customers. With a number of smaller companies offering similar products, the consumer is free to pick and choose from any of them, in order to satisfy his or her needs. This situation empowers the consumer, who does not have to make do with one or two brands of the desired product, but can try multiple products when and as desired. Since markets with perfect competition tend to be easier to break into, the influx of new providers means the consumer can enjoy additional options over the course of time.

PERFECT COMPETITION

MONOPOLY A monopoly is simply a market with only one seller

and no close substitutes for that seller's product. Technically, the term "monopoly" is supposed to refer to the market itself, but it's become common for the single seller in the market to also be referred to as a monopoly (rather than as having a monopoly on a market). It's also fairly common for the single seller in a market to be referred to as a monopolist.

Monopolies arise because of barriers to entry that inhibit other companies from entering the market and exerting competitive pressure on the monopolist. These barriers to entry exist in multiple forms, so there are a number of specific reasons that monopolies can exist.

MONOPOLY

MONOPOLISTIC COMPETITION Monopolistic competition was defined as an industry

with one seller (i.e., a monopoly) of a very narrowly defined product. The demand for this product is very elastic

because there are many close substitutes for it. The close substitutes provide the competition.

Examples given included Coca Cola, McDonalds, and personal computers. In essence, monopolistic competition has four main characteristics:

1. One seller of a narrowly defined product (such as Diet Coke)

2. Many close substitute products --- the products of the competitors are differentiated

3. Good information on the part of buyers and sellers 4. Relatively easy entry and exit from the industry

MONOPOLISTIC COMPETITION Monopolistic competition is the way that most actual

competition occurs. In most cases where there is sufficient competition, the products of the various competitors are differentiated. Supermarkets sell dozens of brands of cereal, ice cream or frozen yogurt, soaps, toothpaste, and so forth. Companies spend billions of dollars in advertising, trying to differentiate their products from those of their competitors. There are several reasons that this product differentiation is so common. First, and most obvious, is the fact that the tastes of different people are different. In some cases (for example aspirin), there are no actual differences between the products. But people perceive that there are real differences. For example, one coffee company ran a series of commercials showing that customers in fancy restaurants could not tell the difference between their instant coffee and fresh coffee. Yet, most buyers still prefer the fresh coffee to instant coffee.

MONOPOLISTIC COMPETITION

Some prefer coffee strong while others prefer it weaker. Some prefer it sweeter while others dislike sweet coffee. Companies try to produce for all of these different preferences. Second, there are differences in income that cause people to buy different goods and services. For this reason, sellers will sell color television sets that range in price from $300 to several thousands of dollars. The Honda Motor Company produces Civics, Accords, and the Acuras.

MONOPOLISTIC COMPETITION

OLIGOPOLY Oligopoly is one form of imperfect competition,

and oligopolies have a number of specific features:

Several large firms - Oligopolies generally consist of a few large firms, and this is part of what sets them apart from competitive markets.

Similar or identical products - While it is possible to have an oligopoly with slightly differentiated products, firms in oligopolies usually sell non-differentiated products.

Barriers to entry - There are barriers to entry into an oligopoly, making oligopolies different from competitive markets with a large number of relatively small firms.

OLIGOPOLY

In essence, oligopolies are named as such because the prefix "oli-" means several, whereas the prefix "mono-", as in monopoly, means one. Because of barriers to entry, firms in oligopolies are able to sell their products at prices above their marginal costs of production, and this generally results in positive economic profits for firms in oligopolies. This observation of markup over marginal cost implies that oligopolies do not maximize social welfare.

OLIGOPOLY

DUOPOLY A market with just two firms is called a

duopoly. Obviously a duopoly is the simplest sort of oligopoly, and many of the concepts and results that we will describe can be extended to the case of an oligopoly with more than two firms. Duopoly analysis by economists dates back to the 19th century. Some of the central concepts of duopoly analysis have to do with strategic behavior, and the analysis of strategic behavior is the heart of the 20th century discipline called game theory. So game theory builds on duopoly theory. We will turn to game theory in the next lesson.

DUOPOLY There are two fundamentally different

approaches to duopoly theory. The first assumes that duopolists compete with each other through their choices of quantity: each firm decides on the quantity it should produce and sell in the market, contingent on the other firm’s quantity. The second assumes that duopolists compete with each other through their choices of price: each firm decides on the price it should charge, contingent on the price the other firm is charging

DUOPOLY

COMPETITIVE ADVANTAGE

A competitive advantage is an advantage gained over competitors by offering customers greater value, either through lower prices or by providing additional benefits and service that justify similar, or possibly higher, prices. For business that are involved in niche marketing, finding and nurturing a competitive advantage can mean increased profit and a venture that is sustainable and successful over the long term. This fact sheet looks at what defines competitive advantage and discusses strategies to consider when building a competitive advantage, as well as ways to assess the competitive advantage of a venture.

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STRATEGIES ADOPTED BY FIRMS A small company can use a number of business

strategies, depending on its situation. For example, new companies may face different challenges than companies that are more established. Therefore, the business strategies they implement may be different from those of key competitors. Four types of business strategies include the growth, product differentiation, price skimming and acquisition strategy.

A growth strategy entails introducing new products or adding new features to existing products. Sometimes, a companies may be forced to modify or increase its product line to keep up with competitors. Otherwise, customers may start using the new technology of a competitive company.

STRATEGIES ADOPTED BY FIRMS

Product Differentiation Strategy: Companies will often use a product differentiation strategy when they have a competitive advantage, such as superior quality or service. For example, a small manufacturer or air purifiers may set themselves apart from competitors with their superior engineering design.

STRATEGIES ADOPTED BY FIRMS

A price-skimming strategy involves charging high prices for a product, particularly during the introductory phase. All companies uses a price-skimming strategy to quickly recover its production and advertising costs.

All companies with extra capital may use an acquisition strategy to gain a competitive advantage. An acquisition strategy entails purchasing another company, or one or more product lines of that company. For example, a small grocery retailer on the east coast may purchase a comparable grocery chain in the Midwest to expand its operations.

REGULATION OF COMPETITION Competition between enterprises is important for the EU

economy as a whole because it creates benefits for consumers and enterprises themselves in the form of lower prices and better products. To ensure fair competition, well-designed and effectively enforced competition rules are essential. In sectors which have only recently been liberalised, such as network industries, competition is gradually developing and performance in terms of prices and productivity is improving. Competition is a means to bring about benefits for the economy as a whole. It encourages enterprises to become more efficient and innovative and ultimately to offer more diverse products and services at lower prices and a higher quality. This in turn increases the welfare of individual consumers and households facing a broader range of choices and having a greater purchasing power. Likewise, enterprises have access to cheaper and better inputs, making them more competitive and able to contribute to higher economic growth.

REVIEW QUESTIONS 1.What is the difference between perfect competition and monopolistic

competition? A) Perfect competition has a large number of small firms while monopolistic

competition does not. B) In monopolistic competition, firms produce identical goods, while in perfect

competition,firms produce slightly different goods. C) Perfect competition has no barriers to entry, while monopolistic

competition does. D) In perfect competition, firms produce identical goods, while in monopolistic

competition,firms produce slightly different goods. E) Perfect competition has barriers to entry while monopolistic competition

does not.

2. What does monopolistic competition have in common with monopoly? A) mutual interdependence B) the ability to collude with respect to price C) a large number of firms D) a downward-sloping demand curve E) barriers to entry

REVIEW QUESTIONS3. Which of the following statements is not true about an oligopoly?

A) An industry consisting of two firms is called a duopolyB) It consists of a small number of firms producing close substitutesC) Oligopolistic firms are price takersD) An oligopoly tends to produce more output than a monopoly but less than

that of a perfectly competitive industry

4.Although firm infrastructure is quite frequently viewed only as overhead expense, it can become a source of competitive advantage. Examples include all of the following except:

A) negotiating and maintaining ongoing relations with regulatory bodies.B) marketing expertise increasing a firm's revenues and enabling it to enter new

markets.C) effective information systems contributing significantly to a firm's overall cost leadership strategy.D) top management providing a key role in collaborating with important customers.

REVIEW QUESTIONS

5.Deregulation in the airline market led to all of the following except

A) Lower barriers to entry. B) More competition in most airline markets. C) Higher average costs for air carriers. D) Reduced numbers of air traffic accidents.

6. Wheat or shrimp are examples of THIS MARKET TYPE has only one seller.

Monopoly Perfect Competition Monopolistic Competition Oligopoly

REVIEW QUESTIONS

7 .If you were to form your own company, in WHICH MARKET TYPE would it be most difficult to succeed?

Oligopoly Perfect Competition Monopolistic Competition Monopoly

8-10 answer True or False 8. Monopolistic Competition – Product

differenation exsists in this type of market which has many sellers.

REVIEW QUESTIONS

Answer True or False

9. Perfect Competition - Product differenation exsists in this type of market which has many sellers

10. Monopolistic Competition – Since the products are a bit different, there is a little price control in THIS MARKET TYPE.

FURTHER READING Overview of Market Structure Analysis-Steven

E. Crane, Marquette University What is Perfect Competition? - Written By:

Malcolm Tatum What Is a Monopoly? By Jodi Beggs Monopolistic Competition Author: Geoff Riley http://www2.palomar.edu/ Introduction to Oligopoly - By Jodi Beggs Lesson 13 Duopoly - Roberto Serrano and

Allan M. Feldman

FURTHER READING

Strategies for Competitive Advantage Cole Ehmke, M.S. Extension Educator, Department of Agricultural and Applied Economics University of Wyoming

Competitive advantage By Ovidijus Jurevicius

Different Types of Business Strategies by Rick Suttle

http://ec.europa.eu/economy_finance