Game Theory

For all of us non-economists, the Game Theory which was invented by John von Neumann and Oskar Morgenstern in 1944 might seem like a very unfamiliar and complicated theory. To quote the Stanford Encyclopedia for Philosophy, "Game theory is the study of the ways in which strategic interactions among economic agents produce outcomes with respect to the preferences (or utilities) of those agents, where the outcomes in question might have been intended by none of the agents." (Ross, Don) Confused yet? I would be. It doesn't need to be so complicated. To put it simply, game theory is based strictly on the strategic decisions that one person or business might make to try to out do it's competitor. More often than not though, this has a negative impact on both parties, and not just the one who is having consumers stolen from them.

They say pictures are worth a thousand words, so let's take a look at one to make this crystal clear. I may have a small addiction to Subway, so let's use it in an example along with Quizno's; two companies which could be considered interdependent due to their similar pricing.


Let's say that between the two sub companies, they have a combined total of 200 customers per day. Now, we can clearly see that if both companies charged $7 for a foot long sub, and we'll assume that customers are divided equally (100 & 100) that revenue's of $700/day are achieved. Now, let's say that Subway got a little greedy and lowered their price to $5/sub effectively stealing away 25% of the market share from Quizno's (top right box), their number of consumers may increase, but you can see that revenues have decreased for both competitors. Quizno's due to the loss of customers, and Subway due to the lower price. In the bottom left box, it shows the same scenario only with Quizno's lowering their price instead. Now, the bottom right box is very important. If Subway lowered their price down to $5/sub, Quizno's may choose to do the same in order to gain back the lost clientele. However, this clearly shows that now BOTH companies are making less revenue per day with the same amount of output as they originally had at $7/sub. In summary, lowering the price to steal customers from the competition may seem like a good idea but just ends up having a negative impact for each producer.

Sometimes companies may choose to work in cahoots with a competitor either directly (illegal) or indirectly (not illegal). Parties who work in unison legally or illegally are called cartels.

In order to maximize revenues while maintaining minimal output, some companies may choose to get together to discuss such things as price fixing, or quotas among one another. A good example of this would be OPEC as discussed in section 11.6 of the text. (Sayre, Morris) This illegal activity is known as collusion and comes with stiff penalties and fines if caught.

On the other hand, companies can often predict the actions of their competitors and can make decisions based on that alone. This is known as noncollusion as they are not directly discussing their future actions with one another.

To summarize; if each party in the cartel is honest, everyone wins.


References:

Morris, Alan; Sayre, John, Principles of Economics, p. 390-392

Ross, Don, "Game Theory", The Stanford Encyclopedia of Philosophy (Fall 2011 Edition), Edward N. Zalta (ed.), URL = http://plato.stanford.edu/archives/fall2011/entries/game-theory/.

Defining Monopolistic Competition

When a monopolistic competitive market exists, it means that there are many firms offering similar but differentiated products. Monopolistic markets include most retailers from clothing to gasoline and also includes most firms that provide a service that it specifically directed at home owners. For example, plumbing and electrical companies. On occasion this type of market may include large manufacturers as well such as furniture or textiles.

Four key factors must be present in order for this type of market to exist.

1. There must be many different firms that are all working independently of one another. Costs of production within each firm are also very similar.
2. There must be freedom to enter the industry. This does not mean that there are no costs involved however, but that no significant barriers will prevent a firm from entering into the market. This could include for example, a patent obtained by another firm that grants them exclusive rights for a period of time.
3. All firms have some control over the price but generally speaking there is minimal price competition between firms. Often there is an unwritten understanding as to what prices shall be and instead firms try to compete with their differentiated or "better" products.
4. Each firm sells a differentiated product.

The table below outlines the differences between small and large companies that are all part of the monopolistic market.

Size:	Small Company	Medium Company	Large Company
Features:	Bump to Baby Boutique (Municipal)	Toys r' Us (National)	Walmart (International)
Differentiated Products	More current and local fads and fashion trends. More personalized service.	Lower quality of customer service. More brand name products. More luxury.	Even more recognized brands offered at reduced prices.
Control Over Price	Some	Some	Some
Mass Advertising	Word of Mouth, Social Media, Mail-outs (fliers)	Word of Mouth, Social Media, Newspaper & Magazine Ads, Radio	Internet, Newspaper & Magazine Ads, Television, Billboards,
Brand Name Goods	Few	Some	Many
Service Quality	Excellent	Fair	Poor

Competing as Starbucks

Perfect competition is a theoretical or ideal market that is often used as the benchmark to describe other market structures. This market is best described as one where the four following criteria are met:

1. An infinite number of buyers and sellers exists giving no one the power to change the market single-handed. Also known as "price-takers".
2. There are no preferences shown as all products are homogeneous or undifferentiated.
3. There is easy entry and exit into the market for both consumers and producers. No association fee's etc.
4. All buyers and sellers have the same access to market information regarding availability, prices and quality of product being sold.

Starbucks does not meet all of the above conditions and therefore cannot be part of the ideal market known as perfect competition - not that any market has ever been or ever will be "perfect". I believe that Starbucks is in a league of it's own when it comes to the coffee market as their prestigious prices could only be compared to the smaller Ma & Pop stores that have much higher production costs due to lower sales. Starbucks however has nearly 17000 stores and more than likely buy their products at a reduced cost due to the high quantity they would be purchasing. I personally think that the price of a coffee at Starbucks is quite extreme (although I still treat myself a couple times a year) but they have managed to gain a great reputation even though customer service is not what it once was. Starbucks is a very trendy coffee shop, and the people who drink it and are willing to pay the outlandish prices will continue to do so religiously.

After reading the Starbucks Gossip memo that was allegedly sent in by Chairman Howard Schultz, I'd have to agree when he says that the extreme growth they have experienced since 2006 has lead to "the watering down of the Starbucks experience". They seem to have lost sight of their original ideas to spread their love of coffee in exchange for popularity and huge profits; but isn't this what all entrepreneurs strive for? A retirement plan? In the short term, the costs for breaking leases which was an estimated $120-$140 million according to Melissa Allison and a reported $8 million in severance packages would be a hard pill to swallow. However, in the long run, the reduction of overhead and non-profitable stores would lead to more efficient employees and greater profits.

I think that the closure of so many stores across the nation was a smart business decision for such a large franchise. In my opinion, there really isn't much point in keeping an unprofitable location open when there is another doing well just down the street. At one point on Robson Street in Vancouver, there was an intersection with a Starbucks on every corner, taking over all prime locations in order to prevent competitors from getting a piece of the pie. Overkill? I think so.

References:

Allison, Melissa, Starbucks closing 5 percent of U.S. stores, http://seattletimes.com/html/businesstechnology/2008028854_starbucks02.html

site accessed on November 30, 2012

Schultz, Howard, Starbucks chairman warns of "the commoditization of the Starbucks experience",
http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html

site accessed on November 30, 2012



Better Book Keeping

If I had the means to start a business of my own, it would definitely be in book keeping as this is the field that I am studying. This type of business would be very low cost to start up as I could work directly out of my home, I already have a computer, and accounting software is fairly inexpensive if you only have a few accounts to look after. This business would be quite small to begin with (I'd probably have to keep my full time job.) until I developed efficient procedures and gained the trust of any current clients.

 In time, hopefully my name would spread by word of mouth and I could eventually open up a small accounting firm that would have a target market of small business owners. I would target this specific type of market because they are generally the ones who source outside help for this type of service. I find that many small business owners attempt to do the accounting on their own to begin with and often lose site of the important things such as marketing, quality of their products and customer service aspects. Another reason why they may source outside help in this area would be due to growth of their business. Keeping the books and doing payroll becomes far too much of a burden and they may not want to spend so much time focusing on the process when someone else could give them the numbers each month.

 

Long run costs for this type of business would be the amount of accountants employed, the cost of rent for an office space if I were to expand outside of my home and the number of software licenses that needed to be purchased.  

 

The short term costs as I mentioned earlier would be things such as up to date accounting software, a computer if necessary, office supplies and furniture.

 

Fixed costs for a home based book keeping business would be things such as an internet connection for keeping in contact with clients and a portion of the mortgage and utility bills could also be deemed a fixed business expense.

 

A business that I would eventually aspire to be like would be The Small Business Accountants who are locally owned and do exactly as their business name describes. http://www.smallbusinessaccountants.ca/. They provide several different types of services, including book keeping, tax planning, financial planning, business consulting and training services. I think that a lot of business owners are afraid of the monetary aspect of things in large part because a lot of it has a connection to the government and that's where a company such as The Small Business Accountants could step in to relieve some of the stress. Targeting specifically small businesses is a great strength because many larger companies have their own accounting departments and don't have the need to source outside help. According to the website startupcan.ca, between 2002 and 2007, an average of 104,000 small businesses were started each year. That being said, I think that getting into small business accounting could potentially be a very lucrative business as outputs could be quite large while maintaining low average costs.

Reference:
http://www.startupcan.ca/wp-content/uploads/2012/01/Statistics-on-Small-Business-in-Canada_StartupCanada.pdf

 Site assessed on November 27, 2012

Law of Diminishing Returns in the Tobacco Industry

I recently read an article that was published by Pierre Lemieux in 2001 called "The Diminishing Returns of the Tobacco Legislation." In his article, he discusses how governments have imposed, on more than one occasion, something called a "sin tax" for tobacco products in an effort to deter people from using the harmful product at all. A diminishing return is when one factor of production is increased but all others remain constant, but the yield or return in fact decreases. For example, if you add a cook to a kitchen that is already full, he/she may become more of a hindrance than a help in the production process.

I find this to be quite a controversial issue for several reasons. Here's why:

Pierre states that over a decade (1985-1995) prices of cigarettes had been increased by 52% (all taxes!) in an effort to "reduce consumption" (I put this in quotations because I have a very hard time believing that this was their motivation. Can you say gold mine?)Well, their "plan" worked and consumption dropped by 18%. More than likely though this 18% just included all us "social smokers" and people who weren't necessarily addicted. Over the next 4 years (1995-1999), government increased taxes yet again, by another 48%, but this time consumption only dropped by 11%. A clear sign of diminishing returns. 'It worked well and we made a ton of money, ahem, a lot of people quit the first time, so why not try it again!' However, during this period black market tobacco products started popping up more than usual - perhaps this 11% just started shopping else where. According to World Bank economists, nearly this percentage of sales is in fact smuggled. This 11% of people do after all suffer from an addiction that they have to feed and it doesn't matter where they find it at that point. This type of illegal activity could closely be related to someone with a more illicit drug addiction such as marijuana or cocaine. I believe that the government recognises the fact that smoking is an extremely inelastic demand and is taking advantage of people who suffer from an addiction to it.

A few short years later, the government made yet another attempt to convince citizens to kick the habit. Perhaps this time they had our best interests at heart as they didn't introduce another tax hike, but instead passed a law that a certain percentage of the cigarette packaging must be covered by warnings and disturbing pictures of what could potentially happen if we don't quit. Diseased lungs, rotten yellow teeth, blackened lungs. You get the picture. For many of my smoker friends the shock value didn't last long at all and this did not reduce their consumption in the least.

I completely understand why governments from all around the world may want to make certain attempts to get everyone to quit smoking. Health care costs. Call me cynical, but there are pros and cons to every situation and I have a hard time believing that smoking increases cost so much that the government felt the need to raise the cost of cigarettes by 100% in order to pay for it. Unhealthy habits are a detriment to the human doing them by causing their life span to shorten, that's their choice. Think of all the health care costs to the elderly for diseases such as Dementia. This particular disease often requires constant watch and care by a trained health professional; a lot more costly than a person who dies of lung cancer or heart disease within a month.
To wrap it up, I'd have to agree completely with Pierre that in order to keep up the momentum of all this government intervention, they'll have to introduce even more taxes and more gruesome pictures to look at when you reach for that nicotine fix. In my opinion, if this keeps up, more and more people will start turning to the black market and it could become as large of a problem as drugs that are actually illegal. Then police forces will be in need of larger budgets. Vicious circle - sometimes they should just let sleeping dogs lie.

Put that in your pipe and smoke it......

Lemieux, Pierre, The Diminishing Returns to Tobacco Legislation,

http://www.pierrelemieux.org/artdiminish.html
site accessed on November 20, 2012

Tourism industry in Canada

As the second largest country in the world, Canada has a very large domestic and foreign tourism industry. From sea to shining sea, Canada contains a very large variety of stunning landscapes, adventure, food, arts and history. Tourism is extremely important to any economy as it brings monies in from outside sources, provides many jobs to people in those desirable areas and expands our knowledge of the world. The Canadian Tourism Commission carefully advertises to different countries based on the general interest of the population there. For example, the advertise the superb skiing in the Canadian Rockies to Australian's and you will find that many of the hills are even employed by foreigners. 

As you can see from the pie chart to the left, visitors from the United States account for most of the tourism in Canada. In fact, according to the numbers from the Canadian Tourism Commissions webpage, in August 2012 Americans accounted for 84% of all Canadian Visits. That's just over 1.8 million Americans who travelled north of the boarder. 



Data source: Canadian Tourism Commission



The chart to the right shows the total number of visitors that came from all other countries, excluding the USA. The United Kingdom, France and Germany are fairly wealthy countries if you factor in the income per capita, and this could be the reason why their visitation is higher than other countries. Personally, if I lived in a place like Australia, I'm not so sure I'd have any desire to leave either... especially on a day like today! (Minus 18 and snowing like crazy.)

The total number of visitors is up 7.4% from August 2011. I believe that this in large part due to the Canadian dollar being on par with the US dollar and also because the recession from last year has nearly come to an end and the economy is quickly recovering.

Tourism to Canada is a very elastic demand as there are many factors that could persuade a person to travel somewhere else, or not to travel at all. How much is it going to cost, can we afford it, would we rather go somewhere else are all questions that people ask themselves first. Effective marketing is very important in maintaining and industry, including tourism

                              

Reference:

http://en-corporate.canada.travel/research/statistics-figures

Site accessed on November 9, 2012

Elasticity & Total Revenue

I recently read an article from the Toronto Star, "Are milk prices too high?" written by Kenyon Wallace. I chose this article for two reasons: One, because I love cows (yes, it's an odd animal to love, I know) and two, because I found it quite fascinating to look at the differences of the farming industry between Canada and the USA. I have a very fond appreciation for farmers, especially dairy farmers: There is no way you'd find me up at 4am every morning milking cows! The farming industry as a whole seems to be a dying one which is why the government needed to step in. Fresh fruits, grains and milk products are a necessity of life and being able to get these goods from our own backyard is extremely important; we can then keep prices affordable, Canadians employed and ensure a higher quality product.

In Canada, we have something called a "supply management system" in which the government sets a quota for each farmer. This reduces over-production and helps farmers focus on providing a better quality product rather than wasting their time searching for buyers. The price of milk is also set by committee's which take into consideration all the factors of production cost's etc. When this article was written in November 2011, Canadians were paying about 59 cents more per litre than in the USA. Prices in the US are determined by free-market wholesale of cheese, butter etc. However, according to Wallace, American farmers are also guaranteed a "safety net" from a tax payer funded corporation, so essentially both Canadians and Americans probably end up paying around the same price for a litre of milk, Canadians just pay up front rather than in the form of taxes. Not such a "free-market" after all.

Price ($ per Litre)	Quantity (Litres)	Total Revenue	Elasticity	Type
10	0	0	19	Elastic
9	1000	9000
8	2000	16000	3
7	3000	21000
6	4000	24000	1	Unitary
5	5000	25000
4	6000	24000
3	7000	21000	.33	Inelastic
2	8000	16000
1	9000	9000	.05
0	10000	0

The elasticity co-efficient is a number that economists use to judge whether or not the demand will be responsive to a change in price and just how responsive it is. With this number we can easily identify which price change consumers will most respond to. Higher elasticity numbers mean higher responsiveness and vice-versa.

As you can see from the chart above, the price at which milk would generate the most revenue is $5. Prices of both $4 and $6 generate the same total revenue, which give this an elasticity of 1 or unitary elasticity. All prices above $6 would be considered an elastic demand because their co-efficients are greater than 1 and the demand at a higher price would be greatly affected. All prices below $4 would be considered inelastic because their co-efficients are lower than 1 and the quantity demanded here would not be very responsive to a change in price.

Below are the results in the form of a graph. This graph shows a downward sloping demand curve. Economists use graphs because they can quickly and clearly see which price will generate the most revenue, and how responsive consumers will be to a change in price.

The graph below clearly shows at which point maximum total revenue (TR) will be generated and also the rise and fall of TR.

According to Statistics Canada, the demand for milk has dropped by 18% over the last 20 years in large part due to the price. However, we need to get the facts before making such decisions; the price of milk in the USA may be lower at first look, but consumers end up paying more in the end. This system would create a larger demand  in comparison to Canada; perhaps Canadians should look at doing something similar to help consumers make healthier choices when it comes to their beverages, keep Canadian farmers farming, keep the quality of our perishable goods high and keep them local!


Kenyon Wallace, Toronto Star, Is the price of milk too high?http://www.thestar.com/news/insight/article/1089581--is-the-price-of-milk-too-high
Site accessed on November 1, 2012