P2_Final_Group2_Report_2-6-24

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Jun 19, 2024

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1 Project 2: Managerial Economics Report Group 2 Daija Braxton, Dominic Dowe, Alexandrea Leger, Syed Raza, Heidi Sand, Hannah Stringer MBA 620 9042 Dr. Richard Works February 6, 2024

2 Supply and Demand 1. Explain why an understanding of the law of demand and the law of supply is important to being an effective manager. The law of demand illustrates the inverse relationship between price and demand: as the price of a product or service increases, its demand decreases, and vice versa. Conversely, the law of supply dictates a direct correlation between price and quantity supplied. Achieving equilibrium between these forces is crucial in business operations. Understanding these principles enables management teams to strategically price for optimal profitability. Supply and demand dynamics are fundamental to business functionality, with the law of demand indicating that higher prices lead to reduced demand, and vice versa. This understanding empowers managers to make informed decisions, such as boosting advertising to stimulate demand. Conversely, the law of supply suggests that higher prices prompt greater quantities supplied, impacting supplier selection and pricing strategies. Failing to meet demand due to insufficient supply can result in lost revenue opportunities. Both supply and demand considerations inform pricing strategies, ultimately contributing to higher profitability and sustained revenue generation. 2. Identify the supply factors that are most important in determining the market equilibrium for the Deluxe box. Several key factors contribute to determining the market equilibrium for the Deluxe box, including cost, seller expectations, and demand. Sellers generally anticipate selling their supply, thus affecting the product's scarcity and subsequent price increase to meet demand as supply diminishes. The quantity of sellers willing to provide deluxe boxes also impacts supply. Additionally, price influences supply, with decreasing prices leading to increased supply as production costs potentially decline in the Deluxe box industry. Equilibrium price represents the equilibrium point where demand and supply factors are in

3 balance (Shaprio, et.al, 2022). Equilibrium is achieved when Deluxe boxes are sufficiently scarce, leading to inventory depletion; any adjustment in production would result in either a surplus or a shortage of inventory. 3. Identify the demand factors that are most important in determining the market equilibrium for the Standard box. The market equilibrium for the Standard box is influenced by various demand factors, including the product price, buyer expectations, and supply. As the price of the Standard box rises, demand typically decreases, as consumers may opt for alternative options. Buyer expectations determine the price and quantity at which businesses can maximize profits, with some buyers seeking to purchase Standard boxes for personal use. Also, buyers can affect demand, with higher prices often correlating with increased demand. However, if prices become too high, consumers may shift to purchasing Deluxe boxes instead. Supply also plays a role, as lower prices may reduce profitability for companies manufacturing and selling Standard boxes. Equilibrium is reached when every box is sold at a designated price, and any alterations to the price lead to either surplus or shortage of inventory. Market Structure 1. Explain why an understanding the market structure in which a company operates is important to being an effective manager. A major part of being an effective manager revolves around the understanding of market structure as it pertains to company operations. This is because market structure itself classifies different industries based on their services and goods (Corporate Finance Institute, 2023). For the purpose of this report, it is essential to note the four main types of market structures as defined in Principles of Microeconomics 3e:

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4 ● Perfect Competition : this occurs when firms undergo the following conditions: “(1) many firms produce identical products; (2) many buyers are available to buy the product, and many sellers are available to sell the product; (3) sellers and buyers have all relevant information to make rational decisions about the product that they are buying and selling; and (4) firms can enter and leave the market without any restrictions” (Greenlaw, Et.Al, 2022). ● Monopolistic Competition : these markets “feature a large number of competing firms, but the products that they sell are not identical”, meaning there are many firms in competition to sell “similar but differentiated products”. (Greenlaw, Et.al, 2022). ● Oligopoly : this occurs when “a few large firms have all of most of the sales in an industry” (Greenlaw, et.al, 2022). ● Monopoly : Monopolies are divided into two categories, Natural Monopolies and Legal Monopolies. Natural Monopolies surround “economic conditions in the industry…that limit effective competition” while legal monopolies pertain to “legal prohibitions against competition, such as regulated monopolies and intellectual property protection” (Greenlaw, et.al, 2022). This classification creates the ability to analyze the competition within specific markets, and allows for individual companies to measure their success against industry standards and benchmarks (Greenlaw, Et.Al, 2022). Alongside this, the understanding of market structure ensures a better understanding of consumer culture pertaining to individual services and goods through an analysis of supply and demand. Thus allowing for the formation of a competitive advantage and new innovative business strategies that will in turn maximize profit. 2. Explain the market structure that is most likely operating in the market for the Deluxe boxes. Based on the different market structures previously mentioned and the data provided, it is clear that the competitive market for the deluxe boxes correlates to that of a monopolistic market. This is due to LGI’s ability to manufacture these Deluxe boxes, and differentiate them from the

5 standard boxes which in turn creates value. It is important to note that the long term success of these sales and demand relies heavily on the price point of the boxes, meaning that LGI must move beyond just identifying the price equilibrium based on their current supply and demand data. LGI must maintain a price equilibrium as demand increases, while also ensuring the previous differentiations of their product stays up to par and their consumers are still purchasing from them specifically in order to keep their competitive advantage over the market. 3. Explain the market structure that is most likely operating in the market for the Standard boxes. When analyzing the pre-existing data surrounding the market for the Standard boxes, it’s evident that LGI is operating within a perfect competition. When analyzing a perfectly competitive market it is key to identify any evident differentiation of products produced by LGI in comparison to their competition, while also understanding the consumer’s role within this market. Within perfectly competitive markets, consumers tend to choose the product that is more cost-efficient (being the cheapest) if all available products are of the same or similar quality. This is evident based on the price elasticity data available, when LGI lowers the cost of Standard boxes, there is a tendency that more boxes are being sold when the cost has shifted down by approximately $1. Price Elasticity 1. Discuss what actions the company should take in setting the price of the Standard box given its price elasticity of demand. Given the Standard box price of elasticity of demand, LGI should keep their original price of $18.00. If the company increased their prices to $18.40, they will lose $200,000 in monthly profit. Additionally, as seen on Tab 2 / Question 2, if LGI decreased their box price to $17.60, this will have no impact on increasing or decreasing the company’s profits.

6 2. Discuss what actions the company should take in setting the price of the Deluxe box given its price elasticity of demand. Similar to the Standard box, LGI should maintain their original price of $28.00. If the company were to increase the price by one-dollar to $29.00, their profits actually decrease by $250,000 per month. Similarly, if the company were to decrease the box price two-dollars to $27.00, their profits will also decrease by $600,000 per month. 3. Assuming the price elasticity of supply for the Standard box is inelastic, explain the key factors that the company must consider in expanding production. If the Standard box is inelastic, it is important for the company to understand that generally due to the inelasticity of the box, the quantity demanded will not be responsive to the changes in price. Similarly, consumers are relatively insensitive to the boxes’ price changes…. consumers will continue to buy boxes whether price increases or decreases. Another consideration in inelastic markets is that the total revenue tends to follow in the same direction as the price changes. Lastly, price elasticity can vary in the short versus long run. Even though Standard boxes are in an inelastic market, there's a change due to consumer purchasing, that the market becomes more elastic over time (Shaprio, et.al, 2022). Profit Maximization 1. Explain under what conditions profit maximization would be appropriate for the Standard box. Profit maximization occurs when the marginal revenue (MR) equals the marginal cost (MC). However, if MR never equals MC, profit maximization can occur under the highest monthly profit, as long as MR value is greater than MC (Shaprio, et.al, 2022). 2. Explain why the concepts of marginal revenue, marginal cost and economies of scale are important to the financial objective of maximizing profit.

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7 Marginal revenue is important to maximizing profit because it examines the additional revenue generated by producing or selling one more unit of a good or service. Similarly, marginal cost examines how much the total cost would increase if the production level was increased by unit. Economies of scale simply means as a company increases its production levers, the average cost per unit of output will decrease. Essentially, economies of scale are looking at the business advantages when producing on a larger scale (Shaprio, et.al, 2022). 3. Assuming the company only manufactures these two product lines and they have customers who purchase both products from them, discuss what the overall company financial objective should be. The company should focus on making sure that their cost of goods sold is low and their operating overhead costs are kept low as well. These are two areas that the company can lower to maximize their profit while keeping their prices competitive as well. This will allow the company to make additional profits without affecting their price. After getting that achieved they should shut ensure that they follow the market price of their items and keep on par. The company could also experiment with increasing the price slightly while increasing their credibility with their customers. That will allow customers to be willing to pay more for their goods over their competitors. This will increase their “good will” on their balance sheet. Economics and Decision Making 1. Explain how an understanding of economics is important to being an effective manager. Managers must make effective financial decisions to ensure company success, and this success is achieved through attaining the most functional and productive strategic framework. Managers should not only be able to define problems and find solutions, but they also need to be able to conduct things such as cost-benefit analyses, understand risk management, and compare their

8 company to the competition to stay ahead within the market. Economics itself plays the biggest role in managerial operations regarding company productivity because economics itself is “the study of production, distribution, and consumptions of goods and services” (Greenlaw et.al, 2022). Economic decision-making involves evaluation choices based on the implications for success in a timely manner as these decisions directly impact the development and implementation of new strategies, production costs, and resource allocation during the current and next fiscal year. Alongside this, managers must have an understanding of economics to better analyze market trends in order to gain insight on the overall health of the economy and how that may impact their corporation long-term based on pricing strategies and cost management. Utilizing an economic decision-making framework provides a structured approach to these assessments while also allowing managers to properly distribute corporate resources and successfully manage costs pertaining to budgeting, profitability margins, and labor expenses. 2. Explain why understanding the economic concept of opportunity cost is essential to managers making better decisions. Understanding the economic concept of opportunity cost directly correlates to the decision-making framework that will maximize a company’s resources and time by its trade-offs. Opportunity cost is the value of the next best alternative, and in the context of managerial decision making, this concept involves considering the benefits that any financial decision can provide based on the current investments, and any possible risks. Effective managers must understand that there is always some form of risk which should always be assessed prior to making any finalized decisions to avoid an increase in risk or missed opportunities. The economic concept of opportunity cost is important because it forces managers to think critically about the trade-off itself and the potential consequences of their decision.

9 The concept of opportunity cost influences managers to make better decisions through utilizing effective evaluations that will determine potential losses or costs, while weighing any other possible outcomes that may effectively steer their organizations to a more successful and profitable path. Managers have the flexibility to consider both positives and negatives within business, and understanding opportunity cost is essential in making critical financial decisions that will lead to the greatest financial gain. 3. Explain why understanding the economic concepts of marginal revenue and marginal cost are essential to managers making better decisions. The ability to understand and assess marginal revenue and marginal cost is imperative for managers in regards to decision making protocol. These concepts provide insights into pricing, production, and profitability, meaning that managers must understand marginal revenue and marginal cost to obtain in depth insights surrounding production and pricing correlating to maximizing profits. For example, if marginal revenue is lower than the marginal cost, then the manager has made bad financial decisions that have increased the risk of financial loss. Meaning, marginal cost allows managers to set their prices for goods and services through the determination of the lowest prices that can be charged to not only cover the cost of production, but make a profit. On the other hand, marginal revenue allows for managers to examine how price changes directly affect revenue, meaning they analyze market statistics to set competitive prices and maximize profits. Managers must act quickly to analyze changes or risk missing opportunities for profit or avoiding potential losses. A thorough comprehension of this concept can enable managers to anticipate impacts forthcoming, as well.

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10 References: Greenlaw, S. A, MacDonald, D., & Shapiro, D. (2022). Monopolistic Competition and Oligopoly. In Principles of Microeconomics 3e. OpenStax. https://openstax.org/books/principles-microeconomics- 3e/pages/10-introduction-to-monopolistic-competition-and-oligopoly Greenlaw, S. A, MacDonald, D., & Shapiro, D. (2022). Perfect Competition and Why It Matters. In Principles of Microeconomics 3e. OpenStax. https://openstax.org/books/principles-microeconomics- 3e/pages/10-introduction-to-monopolistic-competition-and-oligopoly Shapiro, D., MacDonald, D., & Greenlaw, S. A. (2022). Principles of Microeconomics 3e . OpenStax. How demand and supply determine market price. Alberta.ca. (n.d.). https://www.alberta.ca/how-demand- and-supply-determine-market-price

P2_Final_Group2_Report_2-6-24

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