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ASPECTS OF EXTERNAL MARKET ENVIRONMENT

ASPECTS OF EXTERNAL MARKET ENVIRONMENT. Product Demand—how price sensitive, can demand be segmented, advertising, etc. Competition—how many firms, product heterogeneity, etc. Entry—how easy to enter, can entry be influenced by incumbents, can new markets be created?

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ASPECTS OF EXTERNAL MARKET ENVIRONMENT

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  1. ASPECTS OF EXTERNAL MARKET ENVIRONMENT • Product Demand—how price sensitive, can demand be segmented, advertising, etc. • Competition—how many firms, product heterogeneity, etc. • Entry—how easy to enter, can entry be influenced by incumbents, can new markets be created? • Strategy—can rivals’ behavior be influenced, is it worth trying to?

  2. PERFECT COMPETITION • Most competitive market. • Pricing—no options. Price discrimination—no options. • Advertising—pointless. • Product attributes—often fixed or standardized. • Entry—easy and often rapid. • Strategy—no point, too many competitors.

  3. SO WHAT’S THERE TO DO? • Output choice in SR: Firm Supply. • Entry/exit in LR: LR Mkt. Supply. • These are the only “strategic” decisions to make, plus cut costs as much as you can.

  4. DYNAMICS OF PERFECT COMPETITION • Entry occurs as long as economic profits are positive. Exit occurs as long as economic profits are negative. • So, in “long run equilibrium,” economic profits are ….. It is hard to beat zero economic profit in a sustainable way!! • This means firm will have long run negative economic profits unless it has comparative advantage: its costs are as low or lower than competitors.

  5. RELAX ASSUMPTIONS OF PERFECT COMPETITION: PRICING • Pricing power—“market power”—can extend from product heterogeneity (brands matter) or from having small numbers of competitors. • Optimal choice of single price determined by elasticity of firm demand and marginal costs. Fixed costs aren’t relevant! • Price discrimination, charging different prices to different groups of customers, is an option. This can be done because demand elasticities differ or because costs differ (this technically isn’t PD).

  6. RELAX ASSUMPTIONS OF PERFECT COMPETITION: STRATEGY • This is feasible when you have a small number of firms sharing most of the market. Then your rivals’ actions can materially affect your finances. • With “puppy dog” strategies, you are nice to encourage passive behavior from your rival. • With “top dog” strategies, you are aggressive to encourage passive behavior from your rival. • Strategies can involve capacity decisions, pricing, output, advertising, and product characteristics. Some are legal and some aren’t (antitrust).

  7. RELAX ASSUMPTIONS OF PERFECT COMPETITION: ADVERTISING • Not useful unless price exceeds marginal cost. When does this happen? • Can have strategic effects (see previous slide) or simply increase demand. It can deter entry. • What did it do in optometry? • Advertising is an input. Optimal input use requires… It is also an investment!

  8. CREATING AND CAPTURING VALUE • Some of these options create value and some only capture value (and may destroy value), and some can do either under different circumstances. • However, when there is a lot of competition, it is necessary to create value in order to capture value. We’ve talked about this! • If time, we will discuss a practical example where costs, production, product & labor market environment all shape business strategy, and discuss how the firm creates & captures value.

  9. TAXONOMY OF MARKET STRUCTURES • Perfect competition. Describe characteristics and SR & LR outcomes. • Monopolistic competition. Describe characteristics, strategies, and SR & LR outcomes. • Oligopoly. Describe characteristics, strategies, and SR & LR outcomes. • Monopoly. Describe characteristics, strategies, and SR & LR outcomes.

  10. MEASURING COMPETITION • Competitiveness in terms of number of firms can be measured using “Herfindahl index” or “concentration ratio.” You will use one or both of these in your dentist assignment. • Competitiveness in terms of product heterogeneity can be measured informally, by measuring “substitutability” across products, or formally, using demand elasticity or cross-elasticity. • Entry barriers influence long run competitiveness.

  11. HEALTH INSURANCE MARKET • Competitiveness: # of firms. • Competitiveness: product heterogeneity. • Entry barriers? • What kind of strategies? • What kind of outcomes?

  12. HOSPITAL MARKETS • Competitiveness: # of firms. • Competitiveness: product heterogeneity. • Entry barriers? Exit barriers? • What kind of strategies? • What kind of outcomes?

  13. PHARMACEUTICAL MARKETS • Two markets, in a way: brand name & generic. In each, think about: • Competitiveness: # of firms. • Competitiveness: product heterogeneity. • Entry barriers? Is this good? • What kind of strategies? • What kind of outcomes?

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