Supply and Demand and Cross-price Elasticity
1. Why are the concepts of own and cross-price elasticities of demand essential to competitor identification and market definition? (2 points possible)
The own-price elasticity of demand determines whether a product faces close substitutes, but it does not identify what substitutes are available. Economists can identify substitutes by measuring the cross-price elasticity of demand between two products. The higher is the cross-price elasticity, the more readily consumers substitute between two goods when the price of one good is increased. These factors are major determining factors in defining the market structure.
3. How would you characterize the nature of competition in the toy industry? Are there submarkets with distinct competitive pressures? Are there important substitutes that constrain pricing? Given these competitive issues, how can a toymaker be profitable? (3 points possible)
The toy industry can be described as monopolistic competition since there are many sellers in the market, but each seller is slightly differentiated from the rest. A toys can be horizontally differentiated by the type of toys produced, the quality of the toys, etc. The prices that can be charged for these differentiating features are constrained in large part by the geographic location of the restaurant and the local competition. Consumers will tend to not travel long distances for toys, no matter how differentiated the product. The consumers will weigh the convenience of the location against the price of the toy and so cross-price elasticity of demand may be high. The toy company will be profitable if it is sold in superior locations. Failing that, a toy company can be profitable by creating a loyal following for its horizontally differentiated product, so that consumer demand is relatively inelastic.
The own-price elasticity of demand determines whether a product faces close substitutes, but it does not identify what substitutes are available. Economists can identify substitutes by measuring the cross-price elasticity of demand between two products. The higher is the cross-price elasticity, the more readily consumers substitute between two goods when the price of one good is increased. These factors are major determining factors in defining the market structure.
3. How would you characterize the nature of competition in the toy industry? Are there submarkets with distinct competitive pressures? Are there important substitutes that constrain pricing? Given these competitive issues, how can a toymaker be profitable? (3 points possible)
The toy industry can be described as monopolistic competition since there are many sellers in the market, but each seller is slightly differentiated from the rest. A toys can be horizontally differentiated by the type of toys produced, the quality of the toys, etc. The prices that can be charged for these differentiating features are constrained in large part by the geographic location of the restaurant and the local competition. Consumers will tend to not travel long distances for toys, no matter how differentiated the product. The consumers will weigh the convenience of the location against the price of the toy and so cross-price elasticity of demand may be high. The toy company will be profitable if it is sold in superior locations. Failing that, a toy company can be profitable by creating a loyal following for its horizontally differentiated product, so that consumer demand is relatively inelastic.