Assignment 2: Operations Decision
Using the regression results and the other computations from Assignment 1, determine the market structure in which the low-calorie frozen, microwavable food company operates.
Use the Internet to research two (2) of the leading competitors in the low-calorie frozen, microwavable food industry, and take note of their pricing strategies, profitability, and their relationships within the industry (worldwide).
Write a six to eight (6-8) page paper in which you:
- Outline a plan that will assess the effectiveness of the market structure for the company’s operations. Note: In Assignment 1, the assumption was that the market structure [or selling environment] was perfectly competitive and that the equilibrium price was to be determined by setting QD equal to QS. You are now aware of recent changes in the selling environment that suggest an imperfectly competitive market where your firm now has substantial market power in setting its own “optimal” price.
- Given that business operations have changed from the market structure specified in the original scenario in Assignment 1, determine two (2) likely factors that might have caused the change. Predict the primary manner in which this change would likely impact business operations in the new market environment.
- Analyze the major short run and long cost functions for the low-calorie, frozen microwaveable food company given the cost functions below. Suggest substantive ways in which the low-calorie food company may use this information in order to make decisions in both the short-run and the long-run.
TC = 160,000,000 + 100Q + 0.0063212Q2
VC = 100Q + 0.0063212Q2
MC= 100 + 0.0126424Q
- Determine the possible circumstances under which the company should discontinue operations. Suggest key actions that management should take in order to confront these circumstances. Provide a rationale for your response. (Hint: Your firm’s price must cover average variable costs in the short run and average total costs in the long run to continue operations.)
- Suggest one (1) pricing policy that will enable your low-calorie, frozen microwavable food company to maximize profits. Provide a rationale for your suggestion.
- In Assignment 1, you determined your firm’s market demand equation. Now you need to find the inverse demand equation. Having found that, find the Total Revenue function for your firm (TR is P x Q). From your firm’s Total Revenue function, then find your Marginal Revenue (MR) function.
- Use the profit maximization rule MR = MC to determine your optimal price and optimal output level now that you have market power. Compare these values with the values you generated in Assignment 1. Determine whether your price higher is or lower.)
- Outline a plan, based on the information provided in the scenario, which the company could use in order to evaluate its financial performance. Consider all the key drivers of performance, such as company profit or loss for both the short term and long term, and the fundamental manner in which each factor influences managerial decisions.
- Calculate profit in the short run by using the price and output levels you generated in part 5. Optional: You may want to compare this to what profit would have been in Assignment 1 using the cost function provided here.
- Calculate profit in the long run by using the output level you generated in part 5 and cost data in part 3 and assuming that the selling environment will likely be very competitive. Determine why this would be a valid assumption.)
- Recommend two (2) actions that the company could take in order to improve its profitability and deliver more value to its stakeholders. Outline, in brief, a plan to implement your recommendations.
- Use at least five (5) quality academic resources in this assignment. Note: Wikipedia does not qualify as an academic resource.
Operations Decision–Managerial Economics and Globalization
The focus of this analysis is Amy’s and ConAgra Foods, one of the leading producers of low-quality microwaveable foods. A combination of various dynamic factors has seen an increase in the demand for microwavable foods. The evolving nature of the workplace is one of the key factors leading to increasing demand for microwavable foods among the working class. The emergence of a 24-hour economy and individuals taking more than one jobs means that such individuals have little time to prepare meals at home. The availability of low-calorie microwavable foods becomes a favorable alternative to the millions of people who do not have adequate time to prepare a meal at home. The low-calorie microwavable foods also provide a cheaper alternative to eating at restaurants. Since the firm currently operates under an imperfect market structure, price determination will change as explained in the next section.
In perfectly competitive markets, the interaction of market demand and supply forces determines the equilibrium price (Lipsey & Harbury, 1994). This means that firms in perfectly competitive markets are simply price takers. In other words, these firms cannot set their own prices but have to take the equilibrium price determined by the interaction of demand and supply forces. On the other hand, firms operating in imperfectly competitive markets face a different scenario. As such, price determination under imperfect competition is different from that in perfectly competitive markets. Under imperfect market structures, the firm is a price searcher since the market demand function is also the firm’s demand function (Lipsey & Harbury, 1994). The firm can maximize profits in the long-run by setting the long-run marginal revenue curve to equal the long-run marginal cost curve. In the short run, the firm could maximizing profits if the marginal cost curve intersects the average total cost curve at the lowest point.
One of the likely factors to have caused the change in the business operations is advertising and product differentiation. Through advertising, the firm may have led the consumers to believe that its products vary greatly from those of other firms (Harbury, 2013). Product differentiation involves making the consumers believe that the product is unique or different in some way from those of the competitors. The differentiation may only exist in the minds of the consumers. If consumers perceive a high degree of product differentiation, whether real or imagined, the monopolistic powers of the firm increases. The higher the degree of product differentiation the higher the monopolistic powers of the firm (Harbury, 2013). Advertising and product differentiation may thus increase the monopolistic powers of the firm, which falls under the imperfect market structure.
Another likely factor that might have caused the change is increasing economies of scale due to the large size of the firm. The firm could have become larger thus enjoying economies of scale. As the firm increases in size, it is able to enjoy the economies of large-scale production (Harbury, 2013). These mainly stem from the fact that a large firm is able to apply highly capital-intensive methods in the production process. This is though application of modern technologies. This gives the firm production cost advantages over other firm. By having the cheapest way of producing a product, the firm gains monopolistic powers. This is because other firms may not be able to engage in direct competition with the firm. The primary manner in which the change would affect the business operations is by altering the product prices. The firm will be able to set its own price by searching the market demand curve rather than being a price taker.
Under the monopolistic market structure, the firm faces a downward-sloping demand curve (McEachern, 2009). The demand curve facing the firm is more elastic. The effect of this is a slight difference between the price and marginal cost of the firm. The firm produces in the short-run at the point where the marginal revenue curve intersects the average total cost curve at the lowest point. In the long-run, the firm is able to increase its production capacity in response to demand. The firm can maximize profits at the point where the long-run marginal costs equals the marginal revenue. The monopolistic firm may restrict output and increase prices (Mukherjee, 2010). This leads to earning higher profits. The monopolistic firm will continue earning higher profits even in the long-run due to the existing barriers to entry.
TC = 160,000,000 + 100Q + 0.0063212Q2
VC = 100Q + 0.0063212Q2
MC = 100 + 0.0126424Q
Assignment 1 indicates that QD = 350,000 – 100P
QS = 79.0989P – 7909.89
Average total cost (ATC) = TC/Q
ATC = (160,000,000/Q) + (100Q + 0,0063212Q2)/Q
= (160,000,000/Q) + 100 + 0.0063212Q
Average fixed cost (AFC) = 160,000,000/Q
Average variable cost (AVC) = 100 + 0.0063212Q
Output can be maximized when MC = ATC
Therefore: 100 + 0.0126424Q = (160,000,000/Q) + 100 + 0.0063212Q
0.0063212Q = 160,000,000/Q
Q = 159,096.35
The cost of production is: ATC = (160,000,000/Q) + 100 + 0.0063212Q
= (160,000,000/159,096.35) + 100 + 0.0063212(159,096.35)
One of the possible circumstances under which the firm should discontinue operations is when the equilibrium price falls below the average total cost. In order for the firm to make profit, the equilibrium price should be above the marginal cost curve. The firm may discontinue operations where the price falls below the average cost curve. The firm can discontinue operations when the marginal revenue is below the marginal cost (McEachern, 2009). This would signify a situation where the firm is perpetually making losses. The firm may also discontinue operations where there are no more barriers to entry and new firms enter the market, driving the prices down below the marginal cost. In this case, it may be difficult to engage with new competitors because of their use of advanced technology or their strong cost advantages. If the competitors succeed in reducing the operational costs, they may decide to pass on the benefits to consumers.
The management should take a number of action in order to confront these circumstances. One of the key things is to restrict output. Restricting output enables a monopolistic firm to raise prices (Mukherjee, 2010). If the firm produces more output than the demand, it would have to reduce its prices in order to clear the excess output. This would ensure that the equilibrium price is above the marginal cost curve. It is important for the management to watch keenly the competitors’ behavior and any key developments in the market. This can enable the management to identify trends earlier and react to changes in the market. Lastly, the management should ensure that output falls at the point where marginal costs equal marginal revenue.
The firm can maximize profits by applying perfect price discrimination, also known as first-degree discrimination. Perfect Price discrimination is a pricing strategy applied by firms whereby they charge different prices for the same type of goods and services (Arnold, 2010). Firms can apply three types of price discrimination: first degree, second degree, and third degree price discrimination. Perfect price discrimination or first-degree price discrimination involves charging a different price for each of output produced and sold to consumers. In using first-degree price discrimination, the firm is able to charge the maximum price for each unit of good or service. For every additional unit sold, the firm is able to charge a price that reflects the demand curve. In other words, the firm charges the maximum price that the particular consumer is able and willing to pay (Arnold, 2010). The firm’s marginal cost and marginal revenues equals the market demand for the products.
The function in question is: QD = 350,000 – 100P. As such, the inverse is -100P = 350,000 – Q.
P = (350,000/100) – Q/100
=3500 – 0.01Q
Total revenue is given by price and quantity. Therefore: TR = (3,500 – 0.01Q)Q
=3,500 – 0.01Q2
MR = TR/Q = 3,500 – 0.02Q
The profit maximizing function is MR = MC
Therefore: 3,500 – 0.02Q = 100 + 0.0126424Q
Q = 104,159.01
Q represents the number of units for which the profit will be maximum
There is need for the firm management to have a plan that it can use to evaluate its financial performance. In the monopolistic industry, high likelihood exists of new firms attempting to enter the market due to the high profitability. The firm can use return on equity as the primary measure of its performance. The return on equity concerns the amount of value the company gives to the shareholders. If the returns to the shareholders are high, then the firm has a sound financial performance. However, the management can use return on equity to obscure the deteriorating financial health of the company through stock buybacks and debt leverage. As such, external investors should rely on more than just the return on equity to measure the financial performance of the company.
Evaluation of current financial performance:
The total number of units is 104,159.01 units
ATC = (160,000,000/Q) + 100 + 0.0063212Q
= (160,000,000/104,159.01) + 100 + 0.0063212(104,159.01) = 2,294.52. This translates to $22.95
Since the product is sold at $24.58 and the cost of production stands at $22.95, there is a slight profit of $1.63 per unit.
The company can improve profitability in two different ways. First, the company should aim at reducing operational costs. A substantial amount of costs comprise of the operational costs. These are costs involved in running the daily operations of the company. Energy costs comprise a significant fraction of the total operational costs. The company should look at ways of reducing energy consumption or switch to cheaper energy sources. Another way of reducing the operational costs is by minimizing employee turnover rates. Employee selection and placement costs a significant amount of money. In addition, there is loss of knowledge and skills when highly qualified employees exit the company.
The second way of improving profitability is to engage in continuous product improvement. This is one of the key aspects in total quality management, which involves ensuring the improvement of processes and the quality of products on a daily basis. Continuous improvement can lead to development of high quality products and reduction in costs. In addition, improvement of the systems and processes eliminates wastes in the production system
Arnold, R. A. (2010). Economics. Australia: South-Western Cengage Learning.
Harbury, C. (2013). Economic behavior: an introduction. United Kingdom, UK: Routledge.
Lipsey, R. G., Harbury, C. D., & Oxford University Press. (1994). First principles of economics. Oxford: Oxford University Press.
McEachern, W. A. (2009). Economics: A contemporary introduction. Mason, OH: South- Western Cengage Learning.
Mukherjee, S. (2010). Modern economic theory. New Delhi: New Age International (P) Ltd.