Market Structures & Price Elasticity of Liquor Industry

AIS St. Helens

International Business Programme

2.113 Business Economics

Semester 3, 2011

Topic: Market Structures & Price Elasticity of Liquor Industry

Prepared for:

Saida Parvin

Prepared by:

Name: Sayed Kafil

Student ID: 20111419

Date: 04-11-2011

Disclaimer: The information furnished in this assignment is purely for academic purposes and in no way does it reflect the firm’s position in reality

Table of Content Page No.

1.0 Introduction .......................................................................................................................3

2.0 Discussion and analysis........................................................................................................4

2.1 Market Structure ..........................................................................................................................4

2.1.1 Discussions of Market Structures ..................................................................................................4

2.1.2 Analysis of Market Structures .........................................................................................8

2.2 Price Elasticity .................................................................................................................................8

2.2.1 Discussions of Price Elasticity & it’s co-efficient ........................................................................9

2.2.2 Analysis of Price Elasticity of demand for the case .....................................................................11

3.0 Conclusion & Recommendation .......................................................................................12

3.1 Conclusion .........................................................................................................................12

3.2 Recommendation ...........................................................................................................................12

References ............................................................................................................................................13

1. INTRODUCTION

“Cheap wine Changing kiwis Drinking Purchases”

This case study provides a summary description of the present situation the beverage

alcohol industry of New Zealand is experiencing. Lion’s new boss in New Zealand

emphasize on how the Beer market is affected due to supply of cheap wine resulting from

oversupply of grapes. Furthermore, the case also enlightens that, though the beer market from

volume perspective has declined there has been some value growth as people are trading

towards more premium beer brands. The case study also tells that though the brewing firms

had benefited by investing in the recent years, they had to close due to recent seismic activity

like the earthquake at Christchurch that damaged the brewery beyond repair. Due to this huge

loss the brewing firm’s like “The Pride” had to brew brands that it never brewed before,

which added cost to the business.

The report is divided mainly into two sections. The first section will briefly emphasize

on the various types of market structures available and which type of market structure the

case study is based on. The second section then focuses on price elasticity of demand and its

co-efficients and to which price elasticity of demand the case study is related and followed by

conclusion and recommendation.

2. DISCUSSION & ANALYSIS

2.1 Market Structure:

In economics market structure is also known as the number of firms producing identical or differentiated products. Market structure classifies some of the key characteristics of a market, including the number of firms, similarity of the products sold, ease of entry into and exit from the market and weather the market is a price taker or a maker.

There are majorly four types of market structures as shown in the figure below

Source: (Layton, Robinson, & Tucker, 2009)

A. Perfect competition

This market structure features as follows:

1. A large number of small firms

A perfectly competitive market is made up of thousands of small firms. They act independently rather than coordinating decisions centrally.

2. Price Takers

Since no firm produces a significant share of total output, so no firm can by itself affect the market price, hence the firms are price takers.

3. Homogeneous (identical) product

A perfectly competitive market sells homogeneous such as small crops and international commodity markets.

4. Entry barriers

There are no barriers to enter or exit from the market. Barriers can be financial, technical or legal

Graph of Perfect Competition:-

The graph is horizontal in nature as the consumers as highly sensitive to small change in price.

Source: (Layton, Robinson, & Tucker, 2009)

B. Monopolistic Competition

It is the market structure in which we find more firms than any other structure. Its features are

1. Many small sellers:

Each firm is so small, relative to the total market, that each firm’s pricing decisions have a negligible effect on the market price.

2. Product differentiation

A monopolistic competitive market sells differentiated products such as motels and boutiques.

3. Price Makers

Since no firm produces identical goods or services, firms can by itself affect the market price, hence they are known as price makers.

4. Non-price competition

In monopolistic markets, firms compete with each other using non-price techniques such as advertising, packaging, product development and better service. This avoids having to compete by lowering prices.

5. Entry barriers

A monopolistic firm features low barriers to entry. Thus entry for new firms is fairly easy, especially if they can differentiate themselves from competitors.

Graph of Monopolistic Competition:-

The graph is less sloppy in nature as the consumers are neither too elastic nor too inelastic to price

change.

Source: (Layton, Robinson, & Tucker, 2009)

C. Oligopoly

Oligopolistic markets tend to be dominated by a few large firms. Its features are

1. Few sellers

In oligopoly, a small number of firms dominate the market.

2. Price Makers

In oligopoly firms are large relative to the total market, so they can affect the market price. Hence oligopoly firms are price makers.

3. Homogeneous/differentiated product

Oligopolistic markets produce homogeneous products, such as copper, oil or steel and also differentiated products, such as Motor vehicles, and Air travel.

4. Barriers to entry

Oligopolistic markets feature formidable barriers to entry, such as large financial requirements, control of essential resources, and legal barriers such as licenses or patents

Graph of Oligopoly:-

The graph is kinked in nature as the consumers are both elastic as well as inelastic to the price change.

Source: (Layton, Robinson, & Tucker, 2009)

D. Monopoly

Monopoly market is dominated by a single large firm. Its features are

1. Price Makers

Monopoly firm is a price maker, as they are only provider of a product or service.

2. Unique product

Monopoly firm provides unique product or service such as public utilities.

3. Barriers to entry

Monopoly firm sets high barriers and make difficult or impossible for other firms to enter the market.

Graph of Monopoly:-

The graph is steep in nature as the consumers are inelastic to the price change.

Source: (Layton, Robinson, & Tucker, 2009)

Analysis of the case study for market structure:

In the case study “Cheap wine changing Kiwis Drinking purchases” it is found that the

beverage alcohol industry of New Zealand’s market structure is an Oligopoly structure. The

reasons for the beverage alcohol industry being oligopoly is that there are only few number of

firms involved in it and the products between these firm are usually differentiated but

sometimes homogeneous too, which is one of the main feature of the oligopoly market and

hence they are price makers as we can see from the case study that the wine industry is

setting its own price. And also the entry barrier to the beverage alcohol industry of New

Zealand is not easy, that is due to huge amount of investment involved in it, legal barriers

such as licenses or patents involved in it and also due to high standards set by the existing

firms.

Because of these reasons the brewing firm’s market structure is oligopoly but the

market structure of the alcohol retail outlets in the market is perfect competitive in nature as

there are many number of small firm’s with homogeneous products selling to the consumers

and also the entry options are very easy. Hence they are price takers as no retail outlet can by

itself affect the market price.

2.2 Price Elasticity:

Elasticity is the term used in economics to explain the sensitivity of one variable to changes in another variable. Elasticity is useful for business decision-making (e.g. pricing, marketing) and policy-making.

Price elasticity of demand measures the sensitivity of quantity demanded by consumers to changes in price. The formula for price elasticity of demand is

Ed = percentage change in quantity demanded / percentage change in price

The three elastic co-efficients of price elasticity are elastic, inelastic and unitary elastic demand.

A. Elastic demand (where Ed > 1)

Elastic demand indicates that the percentage change in quantity demanded is greater than the percentage change in price. For example (A mother wants to surprise her children by bringing home some fancy pastry for desert. But, after discovering that the pastry shop has raised its prices to unreasonable levels, she decides to skip the pastry. Her reaction shows very high, virtually infinite, elasticity.) This means consumers are sensitive to the price change i.e. slight change in price will affect the demand of the consumers as shown in the graph below.

Elastic demand graph

Source: (Layton, Robinson, & Tucker, 2009)

B. Inelastic demand (where Ed < 1)

Inelastic demand indicates that the percentage change in the quantity demanded is smaller than the percentage change in the price. For example ( For most people, items that are considered as necessities are items for which the demand is inelastic. No matter how much the price may change, if we think we really need an item, we will buy it. Medicine or basic food items are probably in this category. Milk for a family with children is such a basic food you will always find it somewhere in the refrigerator, no matter its price.). This means consumers are not sensitive to the price change i.e. change in price will have very little effect on the demand of the consumers as shown in the graph below.

In elastic demand graph

Source: (Layton, Robinson, & Tucker, 2009)

C. Unitary elastic demand (where Ed = 1)

Unitary elastic demand indicates that the percentage change in the quantity demanded is equal to the percentage change in price. For example (A rock group decreases its prices from $30 to $15, and quantity demanded rises from 10 000 to 20 000 tickets. So as the price is reduced by 50% the demand is increased by 50%). This means consumers are equally sensitive to the price change i.e. (change in price will have same effect on the demand of the consumers as shown in the graph below).

Unitary Elastic demand graph

Source: (Layton, Robinson, & Tucker, 2009)

Analysis of the case study for price elasticity of demand:

The type of price elasticity which is discussed in the case study “Cheap wine changing Kiwis Drinking purchases” is elastic demand and inelastic demand as well. In the case study the consumers are divided into elastic and inelastic consumers.

The reason for the consumers demand being relatively price elastic is, as the price of the wine reduced due to oversupply of grapes the demand of wine increased by 2% (annually) which subsequently resulted in decline of beer sales by 2% (annually). The consumer demand was sensitive to the price change in the market that is why the consumers consumed more wine than beer.

The reason for some consumers demand being relatively price inelastic is, though the price of the wine got reduced some consumers continued to purchase higher priced beers due to brand or price point loyalty. The consumers were insensitive to the price change, which was something positive to the beer industry of New Zealand.

3. Conclusion & Recommendation

3.1 Conclusion

In conclusion, the demand of the product and the price of the product are directly related to each other. As we can see from the case study that as the price of wine got reduced, as a result the price elastic segment of consumers changed their drinking preferences from beer to wine which resulted in 2% (annually) growth in wine sales subsequently the beer purchases went down by 2% (annually) as the beer market didn’t changed its price. Hence I would conclude that the market structure of the beverage alcohol industry of New Zealand is Oligopoly as there are only few brewery firms operating in New Zealand because of high entry barriers and thus these firms are price makers.

Furthermore the consumers of alcohol beverage are divided into two segments that are Elastic and Inelastic consumers. The consumers who are elastic (sensitive) to price change switched their drinking preferences from beer to cheap wine. And the consumers who are inelastic (insensitive) to price change just stuck to the premium beer brands over to cheap wine.

3.2 Recommendation

As we can see from the case study that when the price of wine decreased it impacted the beverage alcohol industry of New Zealand. As a result of which beer markets growth rate declined by 2 percent (annually) as it didn’t change its price, where as the wine industry reduced its prices due to oversupply of grapes which resulted in 2 percent (annually) sales growth.

Basing on these statistics from the case study and analysis of the report I would recommend the beer industry to reduce its price in order to increase its total revenue. Total Revenue is the revenue a firm earns from its sales, it is basically equal to price multiplied by quantity demanded. In doing so, the elastic segment of the consumers will get back to consume more beer than they are consuming now. As a result the total revenue of the beer industry would increase.

Reference List

Layton, A., Robinson, T., & Tucker, I. (2009). Economics for Today. South Melbourne: Cengage Learning Australia.

www.nzherald.co.nz/viticulture/news/article.cfm?c_id=365&objectid=10739133

Total Words 2000