Sample ECO500 Economics for Business Assignment

ECO500 Economics for Business Assignment Sample

The Problem/Scenario

Suppose that a new strain of Covid 19, known as Kappa, has been detected in Australia. Kappa is known to be twice as infectious than the existing variants of Covid 19. Kappa has been found also to be immune to the existing Covid 19 vaccines such as Pfizer and Astrazeneca.

KC Pharma, a local startup company, has produced a unique nasal spray vaccine called KC1 that has been found to be 98 per cent effective against Kappa in clinical trials. Based on this information the Therapeutic Goods Administration (TGA) of Australia, Australia’s regulatory body, has approved the use of KC1 in Australia in the short run to combat Kappa. Based on the above scenario, provide a project report on market structures, market model(s), economic strategy(ies) and profitability scenarios. In your assignment writing, you shall include the following issues clearly and sufficiently with diagrams and illustrations where necessary for assignment help:

1. Identify the basic market structure and explain the type of market in which KC Pharma will be operating

2. Based on your answer to question 1 above, show a theoretical market model explaining the
equilibrium position (profit/loss situation) of KC Pharma in the short run.

3. Suppose you are the economic adviser to KC Pharma. Suggest a selling strategy to KC Pharma whereby it can further maximise its profit. Make sure you clearly illustrate the selling strategy to KC Pharma.

4. Critics of TGA argue that KC Pharma is charging a very high price for KC1 and is also unable to keep up with demand. They argue that more firms should contest the market to create efficiency in the market. TGA is convinced by the Critics’ arguments and allows a “large” number of firms to supply vaccines to combat Kappa. Assess and evaluate in which market structure(s) and the type of market(s) KC Pharma will be operating. In your demonstration, you must explain KC Pharma’s equilibrium position after the entry of large number of rivals in the market.

5. Analyse and evaluate economic profitability of KC Pharma in the long run.

Solution

Answer 1:

KC Pharma will operate in an oligopoly market, which is a form of imperfect market condition. In this market structure, few firms compete with each other and produce differentiated products. As per the given scenario, KC Pharma has produced a unique nasal spray vaccine, KC1. However, the company have close competitors like Pfizer and AstraZeneca which produce COVID-19 vaccines that are also safe for people. These companies have captured a large share of the market. This is because new firms cannot enter into the market easily due to legal restrictions the Therapeutic Goods Administration (TGA) of Australia, large amount of capital investment and low economies of scale.

Answer 2:

The oligopoly market is characterised by entry barriers and existence of limited firms. The main feature of the market is interaction as well as interdependency among existing firms. In other words, the action of one firm can influence the action of other firms in the market. Therefore, the oligopoly market often experiences strong competition between firms as each firm has the capability of making decisions on quantities, prices, and advertisement in order to maximise profits (Azar and Vives 2021). As the market is concentrated extremely with few companies, some firms can dominate the industry while other small firms can also perform their business. Likewise, Pfizer and AstraZeneca dominate the vaccine market while a start-up company like KC Pharma can also produce and sell its products. The start-up company can maximise its profit when its marginal revenue (MR) and marginal cost (MC) equate with each other. This situation creates an equilibrium condition where the firm produces equilibrium amount of vaccine at an equilibrium price. The start-up company, here, will experience a kinked-demand curve due to the competition of other oligopolistic firms. In Kinked demand curve model, two theories are seen, which are:

A. If a firm declines its price below the prevailing level then other rival firms will follow him

B. If the firm rises the price above the prevailing level then other rival firms will not follow him

The profit-making equilibrium condition of KC Pharma is presented in the figure below:

Figure 1: Short-run Profit maximisation condition of KC Pharma

The short-run profit maximisation condition of KC Pharma is shown with the help of kinked demand curve theory (Salehi and Makiyan 2021). As per the theory, each firm in the oligopoly market sells differentiated products and each of them experiences two market demand curves for its product. Thus, KC Pharma also faces two different demand curves where at high prices, the firm has comparatively elastic demand curve and at low price the firm has relatively inelastic demand curve. Corresponding to two demand curves, the firm has two marginal revenue curves accordingly. These two demand curves intersect at point k. Here, the MR and MC curves intersect at point E. Therefore, equilibrium quantity of KC Pharma is Q* and equilibrium price is P*. As per the assumption, if KC Pharma increases its price above P* then other vaccine producing firms will not follow the increase in price and hence the company will experience the more elastic market demand curve. If the company will decrease price below P* then it is assumed that other competing firms will follow the price. The main reason of these assumptions is that when KC Pharma will increase its price, it will face a substantial decrease in sales as consumers can purchase similar products from other companies. On the other side, if KC Pharma will reduce its price, other firms will follow it due to the fear of customer loss.

Answer 3:

To increase profit further, KC Pharma can make collusion with other companies. In collusive oligopoly, firms make agreement between each other to make an undifferentiated oligopolistic industry. Here, all vaccine producing firms come together and agree to set prices as well as outputs for maximising total industry profits which is known as cartel (Schlechtinger et al. 2021). Thus, the company along with its competitors can set price in a collective way by the leadership of one firm instead of taking prices from the market. In this situation, profit margin becomes higher compared to that in a competitive market. Sometimes, governments do not support collusion and price-fixing. However, in case of vaccination, the industry can get the permission of fixing price by making a cartel.

The kinked-demand theory has several limitations for which the industry can move to make a cartel for making higher profits. Firstly, the kinked model does not state the condition by following which a firm can find its kinked point in the market demand curve. Secondly, the theory does not consider the chances of collusion and setting a fixed price and output. Lastly, the kinked-demand model shows that price increase by one firm will not be followed by other firms. Hence, considering these obstacles, it can be said that a cartel is better for KC Pharma to make higher profits.

Now it is essential to discuss the selling strategy that KC Pharma will follow for maximising its profit. The company needs to make a formal agreement with other vaccine producing companies in order to control supply and to manipulate price. Therefore, collusion will form a group of independent business that will perform as a single seller at the fixed price for the vaccines they produce without any competition. In this context, it is essential to mention that a cartel gets less facility compared to that of a monopoly where only a single seller only owns certain products in the market. The cartel of vaccine producing companies will help to set a fixed price for vaccines in a legal way. After forming cartel, each company will select their combined output where their marginal revenue becomes equal with marginal cost. The fixed price of cartel, therefore, will be determined by market demand curve where the cartel selects its output level. By forming a cartel, the vaccine producing firms can charge higher prices together for certain quantity of vaccines like a monopolist. The figure below reflects the situation:

Figure 2: Collusion in the Oligopoly market

The above figure represents a cartel where each firm together set price P2 and produces Q2 quantity of output. At this output level, MR and MC become equal with other. Hence, each firm can earn supernormal profit by the area P1BA2. Therefore, by making a cartel, KC Pharma can successfully earn profit.
However, the company needs to follow some points that can breakdown a cartel. Sometimes, it is seen that other firms have cheating tendency on their quotas for getting higher benefits from higher output and price. Hence, the firm needs to make cartel with small number of firms so that it can easily observe behaviour of others. Moreover, penalties will be charged for each firm who will break quotas.

Answer 4:

As per the given situation, KC Pharma will operate in a monopolistically competitive market. This market structure lies between a monopoly market and a perfectly competitive market. In this type of market, large number of firms produces and sells almost similar type of products in the market to a large number of customers. In this market, each firm will produce products that are close substitutes and hence they can differentiate their products by applying different market strategies. Thus, firms can act as a monopolist as each of them has different brand name, price level and product quality. Like a monopoly market, firms can charge higher prices for selling lower quantity of output than a perfectly competitive market. Therefore, each firm acts like a price maker in this imperfect competition where change in price will not cause any price war that can be seen in the oligopoly market. A monopolistic competitive firm achieves higher profit only in the short-run when its marginal revenue and marginal cost become equal. Moreover, the firm can also incur loss in or gain normal profit during this time. The figure below represents a condition, where the firm gains supernormal profit in the short-run:

TGA allows a large number of firms to supply vaccines for combating Kappa, which is produced by KP Pharma. Therefore, the number of vaccine sellers will increase in the market. However, one type of vaccine cannot substitute another type of vaccine completely as they can be differentiated by their company name, branding, price level and quality. Therefore, each vaccine producing firm will act like a monopolist and can set vaccine price individually in the market for maximising profit (Bertoletti and Etro 2022). Though firms can act like a price maker, they cannot charge higher prices due to strong competition in the market. By charging higher price, a firm can loss its customers and this in turn can reduce profit-making condition of the firm. The diagram above showcases equilibrium position of KC Phrama here the demand curve is slightly elastic. This indicates that if the firm increases price of its vaccine then its demand for product can be declined.

Figure 3: Super Normal Profit of the Monopolistically Competitive Market in the Short-run

In figure 4, it is seen that the short-run equilibrium can be obtained at point E where marginal cost (MC) curve and marginal cost (MC) curve intersects. Hence, the corresponding equilibrium output and price level become Q* and P*. In short-run, the average cost (AC) curve is lower than average revenue (AR) curve. Average revenue curve which is also the demand curve of KC Pharma is elastic but not perfectly elastic as it has negative slope. Hence, the firm gains economic profit by the area CBAP*. In short-run, the monopolistic competitive firm can also face loss if its average cost becomes higher than average revenue.
However, it is essential to mention that a monopolistically competitive firm does not become allocatively efficient as the price does not equal to marginal cost. Moreover, production efficiency also cannot be seen in the market as firms can set higher price than their marginal costs, which means, P > MC. Therefore, the market cannot achieve efficiency level instead of facing competition.

Answer 5:

In long-run, the monopolistically competitive market has free entry and exit and this implies that the existing firm can make only normal profit in the long-run. In other words, when the market gains supernormal profit in the short-run, other firms will enter into the market. This will increase the number of firms and hence their profit making opportunity will decline until it will earn normal profit only.
The following figure showcases equilibrium position of KC Pharma when it will operate in the monopolistically competitive market.

Figure 4: Monopolistically Competitive Market in the long run

As per figure 4, it is seen that the long-run equilibrium can be obtained at point E where long-run marginal cost (LMC) curve and marginal cost curve intersects. Hence, the corresponding equilibrium output and price level become Q* and P*. In long-run, the firm will operate somewhere to the left of the average cost (LAC) curve’s minimum point. Average revenue curve which is also the demand curve of KC Pharma is elastic but not perfectly elastic as it has negative slope. The left side of LAC curve becomes tangent with the AR curve and hence the firm only gets normal profit.

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