The Concepts of Own and Cross-Price Elasticities

1. Why are the concepts of own and cross-price elasticities of demand essential to competitor identification and market definition?

These concepts are important to understand your own impact due to a price change in your product. Also, you may run sequential steps using the competitors' changes in prices and the effect it will have on your product. From a strategic point of view, the impact would likely be entered into a model for a company to run sensitivity analyses to determine the impact of prices on quantities sold. Ultimately, I would use this information in conjunction with game theory or a decision tree to determine if the firm takes a dominant strategy. (As an example)

The concepts of own and cross-price elasticities of demand are essential to make decisions in business and to influence consumer purchasing decisions. The cross-price elasticity of demand measures the consumers' perceptions of substitutability between two products. If products can be substituted for one another, changing product price will affect related products. For example, price of butter increases to $3 per kilogram at Christmas time. The consumers will buy margarine as a substitute for butter. Competitor identification is important to recognize in order to compete strongly to the market. The firm should consider purchasing factors of consumers to forecast an expansion capacity of substitutes and the potential for more profits. Geographic competitor identification requires surveys to gather specific information in catchment area such as competitors, customers' locations, and consumer travel pattern by using flow analysis. As a result, a firm will be able to find out appropriate strategies to support goods and services in order to overcome in geographic market.

3. How would you characterize the nature of competition in the restaurant industry? Are there submarkets with distinct competitive pressures? Are there important substitutes that constrain pricing? Given these competitive issues, how can a restaurant be profitable?

Monopolistic competition best describes the nature of competition in the restaurant industry. It has numerous sellers which do not react to fluctuations in a single competitor. The products in serving restaurant are vertically differentiated such as Italian, Japanese, Mexican cuisines. Customers have high power to select their food depending on the consumers' preferences as well as price. KFC participates in horizontal differentiation when it compares with Church's fried chicken. Submarkets concern geography as well, with location a distinct competitive factor in horizontal differentiation. Substantial competition and the SSNIP criterion are important substitutes that constrain pricing.

In highly competitive conditions, restaurants may decide to provide alternative advertising media - such as direct mail, TV commercials, online advertising, and coupons, in order to approach prospective and current customers. The many forms of advertising can reduce consumer search costs. They persuade consumers to choose one product over others, and these restaurants are able to increase their market shares. If the products are in horizontal differentiation, low search costs may cause lower prices and lower profit for all firms.

4. How does industry-level price elasticity of demand shape the opportunities for making profit in an industry? How does the firm-level price elasticity of demand shape the opportunities for making profit in an industry?

An industry's price elasticity of demand is less elastic than for any firm in that industry. If price elasticity is low (absolute value < 1), the good is considered a necessity. Therefore, provided that a good or service in an industry maintains its perceived value or utility, firms may raise prices and expect total revenue to rise. However, if the good is seen as a luxury, higher prices will cause total revenues to fall.

However, at the firm level, elasticity is higher, because competitors' goods are seen as close substitutes. Individual firms must be creative - perhaps even "reinvent" the product, market it as superior to all the others to lower elasticity, or optimize their resources to help drive costs down to increase margin. The firm level elasticity forces companies to minimize the perception of close substitutes or be a low-cost leader in order to survive in a competitive environment.

7. Numerous studies have shown that there is usually a systematic relationship between concentration and price. What is this relationship? Offer two brief explanations for this relationship.

The relationship is that as concentration goes up in a market, price goes up as well. One reason may be that less competition means a greater difference between price and marginal cost - because of the difference between price and marginal revenue, from more steeply downward-sloping demand curves faced by the fewer firms in the market. With fewer players in a given market, it could be because one firm is a first mover and others follow the lead in raising prices.

9. The following are the approximate U.S. market shares of different brands of soft drinks: Coke-42 percent; Pepsi-30 percent; Dr Pepper/7-Up-18 percent;