Sunday, December 20, 2015

Module Name: Managerial Economics



OPEN UNIVERSITY MALAYSIA
FACULTY OF BUSINESS MANAGEMENT
BMME 5103
Managerial Economics


Name: Adam Khaleel


Lecturer: Ahmed Munawar
Learning Centre: Villa College



Trimester:  May 2014



Contents



1.0 Executive Summary

This assignment contains four questions. The first three questions are the calculations and theory questions. The purpose of first question is to enable to learn how to estimate a demand function, to analyze the demand function and to use the results for making decisions. The purpose of the second question is to enhance the skill to estimate a production function and to apply its use in any relevant industry. The purpose of the third question is to know how to differentiate economics and accounting profits and to apply the concept of opportunity cost.
The last question is a proposal which talks about the appropriate market structure for entering the gourmet coffee market. In addition to this it gives the factors to consider in order to successfully penetrate the market and the factors that would be most beneficial to determining the correct location and size for the outlets.The purpose of this question is to evaluate levels of competitiveness in various market structures and to introduce the correct strategies in order to obtain competitive edge in a selected market.

2.0 Question – 1. (Answers)

a) 1.








Q – 1.
b) 1.



Y = 390.38 – 14.26X1
2.
Yes, the selling price is a significant determinant of sale. As per the ANOVA table and the p-value shows that the level of selling price is 99.9% significant and 0.1% is not significant. Hence, the coefficient of selling price (-14.26) can be accepted.


3.
Y = 390.38 – 14.26X1
Y = 390.38 – 14.26(12) = 219.26
Ep = -14.26(12 ÷ 219.26) = -0.78
A 1% increase in price reduces the quantity demanded by 0.78%.
b)
1.

Y = 311.61 -12.31X1 + 2.75X2
2.
Step 1. H0 : β1 of (a) = β1 of (b),    Ha : β1 of (a)  ≠ β1 of (b)
H0 : -14.26 = -12.31,    Ha : -14.26 ≠ -12.31
Step 2. Significance level of 5%.
Step 3.
Step 4.  Decision;
Since the observed test statistic t = -0.67 is greater than critical test statistic values -4.9 and -3.7 (and falls in the rejection region) I reject H0 in favor of Ha at 5% level of significance.  Therefore, there is sufficient evidence at 5% level of significance to conclude that Co-efficient on selling price in (a) and (b) are not same.
The coefficient on selling price in (a) and (b) are -14.26 and -12.31 respectively. This shows a difference of 1.95. The reasons for this could be due to; 1. The second equation has an additional independent variable (disposable income). 2. The additional independent variable has high p-value or less significant compared to the first independent variable (selling price). By combining the less significant independent variable can affect the co-efficient of selling price. 3. The sampling can have errors.
3.
Y = 311.61 -12.31X1 + 2.75X2
Y = 311.61 -12.31(12)+ 2.75(18.5) = 214.765
EI = 2.75(18.5 ÷ 214.765) = 0.24
EP = -12.31(12 ÷ 214.765) = -0.69
A 1% increase in income will increase the quantity of demanded by 0.24%. Meantime, A 1% increase in price reduces the quantity demanded by 0.69%.
c)
1.



Y = 310.24 – 12.20X1 + 2.68X2 + 0.0077X3
2.
R-squared is a statistical measure of how close the data are to the fitted regression line. 100% indicates that the model explains all the variability of the response data around its mean.The R-Square statistic near the top of the output represents the percent of the total variation in the dependent variable that is explained by the independent variables, i.e., the model's overall goodness of fit. But whether a model is really a "good" fit or not depends on context. R-squares for cross-sectional models are typically much lower than R-squares for time-series models. The first equation has the R-square value of 75%, the second equation has the adjusted R-square value of 73% and the third equation has the adjusted R-square value of 68%.  Hence, the last equation is 68% fit and so on. This indicates the percentage of the variation in Sales which is accounted for by the variation in other independent variables.
3.
In the single variable equation R-square value is taken but for the multiple variable equation the adjusted R-square value shows the more accurate answer. When the independent variable increases the R-square value decreases meaning that less percentage of data are able to be explained. We can always increase R-square by throwing another independent variable (any variable) which is less significant in the model. The above workings for the three equations show more details. The first independent variable is more significant than the last two and the second independent variable is more significant than third independent variable. Hence, by removing the last two variables brings high R-square value. In addition to this, when the sales increases the directly related variables increases (disposable income and advertising expenditure) and inversely related variable decreases (selling price).
The real objective is to test the hypotheses, not to maximize R-square by including irrelevant variables in the model and then making up some "hypothesis" after the fact to "explain" the results we got. Regression models are powerful tools for predicting a score based on some other score. They involve a linear transformation of the predictor variable into the predicted variable. The parameters of the linear transformation are selected such that the least squares criterion is met, resulting in an "optimal" model. The model can then be used in the future to predict either exact scores, called point estimates, or intervals of scores, called interval estimates.
d)
The below table shows the sales forecast by using the estimated regression equation in (c), i.e.       Y = 310.24 – 12.20X1 + 2.68X2 + 0.0077X3
Example: Y = 310.24 – (12.20×15) + (2.68×19) + (0.0077×150) = 179.32



Hence the sales forecast for market segment 1 is RM 179.32 (RM 179320).

3.0 Question – 2. (Answers)

a)




Given
Q = α Lβ1 k β2
Then   
ln (Q) = ln(α Lβ1 k β2)
          = ln α + ln(Lβ1) + ln(k β2)
          = lnα + β1lnL + β2lnK
From the results the estimated equation in the log-linear form:
ln (Q) = -4.755 + 1.078ln (L) + 0.415ln (K)
It must be noted that     Intercept = lnα = -4.755   
Therefore,     A = e-4.755= 0.008608544
Thus, the estimated equation in its multiplicative form is:
Therefore,α = 0.00861, β1 = 1.078, β2 = 0.415
b)
The p-values show the significance level of capital 99.1% and labour 99.9%. Meantime, the t statistics for capital and labor (which are 3.09 & 4.32 respectively) exceed the value of three (3), meaning that there can be 99% confidence that capital and labor have an effect on output. The chance of observing such high t statistics for these two variables when in fact capital and labor have no effect on output is less than 1%. The probability for both capital and labor is less 0.05, which means the coefficients of capital and labor are statistically significant.
c)
The R-square value is 94.82% and adjusted R-square value is 93.95%. Since there are two independent variable, adjusted R-square value is more accurate. Hence, the percentage of the variation in output that is “explained” by the regression equation is 93.95%. And 6.05% cannot be explained.
d)
Estimated parameters;
Labour (β1) = 1.078 and Capital (β2) = 0.415
The dependent variable is Output (Q) and the independent variables are the two factors of production, labor (L) and capital (K).  There are three parameters (α = 0.00861, β1 = 1.078, β2 = 0.415). The exponent appears as a parameter (ln α is the intercept, β1 and β2 are the slopes of the equation).  The coefficients (β1 and β2) are elasticity of labour and capital. β1 is the labour elasticity of output and β2 is the capital elasticity of output which are EL and EK. Therefore, 0.42% changes in output when 1% changes in capital. Meantime, 1.08% changes in output when 1% changes in labour.
e)
The exponents (β1 + β2)
β1 + β2 = 1.078+ 0.415= 1.493
β1 + β2 (1.493)> 1
Therefore, the production function exhibits slight increasing returns to scale.

4.0 Question – 3. (Answers)

a).
Hamid’s accounting profits: 
 C:\Users\Adam\Desktop\1a.PNG


b).
Hamid’s Economic profits: 
 C:\Users\Adam\Desktop\1b.PNG
c) If these calculations are representative of Hamid's regular performance, he would be better off financially by selling the farm and working for someone else. This analysis ignores many intangible factors that may affect Hamid's decision.


5.0 Question – 4. (Proposal)

PROPOSAL

5.1Section1: Introduction

Today we stand witness to a new coffee era. Over the past decades, the world coffee market has undergone a significant transformation. The global coffee consumption has increased steadily with the market share. Meantime, the popularity of gourmet coffee has grown steadily over the past fifteen years. In fact, gourmet coffee market is now growing at about 15% annually. Gourmet coffee is rapidly gaining market share, with 18.12% of the coffee drinkers in the United States indicating that they drink gourmet coffee beverages daily (Gaebler.com, 2013). Hence, this new firm can enter and start a great business in the specialty and gourmet coffee market.
In this paper, I will assess the potential of profitably entering the gourmet coffee market. To achieve this, the present paper is organized as follows. First section determines and discusses the most probable market structure of the coffee industry. Second section deals with the recommended factors that must be considered in order to successfully penetrate the market. This is followed by recommended factors that should be considered to determine the correct location and size for the outlets to open several distribution points of the firm. The last section refers to the conclusion giving summary of the proposal and my opinion in entering this new market.

5.2 Section 2: Market structure of the coffee industry

The following table shows the comparison of four major market structures. The table will be used to determine and discuss the most probable market structure of the coffee industry.
 
(Mrshearingeconomics.weebly.com, n.d.).
Overview of the coffee industry
Starbucks is the world’s number one specialty coffee retailer, currently with more 12,000 coffee shops in more than 35 countries. The outlets offer hot and cold coffee drinks and few food items, as well as beans, some coffee accessories and teas. The company owns about 7,100 of its shops, which are located in about 10 countries though mostly in the U.S.while licenses and franchises operate more than 5,300 units worldwide. In addition, Starbucks markets it coffee through grocery stores and license sits brand for other food and beverage products (Lewis, 2006).
Analysis
In the coffee industry, many producers and consumers exist, the goods and services are mixed, but firms are still able to differentiate their, products. Starbucks is a textbook example of a monopolistically competitive firm: many sellers, low barriers to entry, slight product differentiation (Medasanianus, 2010). Monopolistically competitive firms, like Starbucks are driven by mass advertising and the establishment of brand names and logos. Starbucks attracts their customers over their competitors by their ad campaigns and serene atmosphere of success (Pitek, 2009). Starbucks differentiates from their competition by considering themselves a premium coffee provider, offering premium product and experience, providing customer loyalty programs (Dobrinet al. 2012).
According to Brydonet et at. (2011), the following diagram shows the features of coffee industry structure. It shows that it has almost all the features of monopolistic market structure are present in coffee industry.
 


According to the Dacre-Wright (n.d.), the following diagram also shows the features of coffee industry structure. It shows that it has almost all the features of monopolistic market structure are present in coffee industry.
 

Porter’s five forces analysis
It is found that there is strong competition within the industry but overall the industry is saturated which allows almost all of the competitors to yield very good margins. There is very strong power of substitute products as especially young people might prefer other products, such as beer, cigarettes or soda. There is small barriers to entry for small regional chains or cafés but their expansion is relatively slow due to the increasing speed of the expansion of the major players. There is very limited power of suppliers as they depend on producer’s help and sell a commodity. There is very strong power of customers as coffee shops depend on word of mouth and customer retention (Altmann, 2007).
There is less barriers to entry with medium level of fragmentation in coffee industry. Business differentiation is done by having complex products, with differentiated price, target market and service (Dacre-Wright, n.d.). According to Berger (n.d.), the Market Structure of coffee market is monopolistic structure. There are many companies in the market and competition is fierce. Competitors use location, product mix and store atmosphere differentiation to establish market niche.
It is understood that coffee industry’s market structure is monopolistic market structure according to the various authors. The main features of monopolistic market structure mentioned in table of comparison of various market structure are present. There are many producers, non-price competition and price competition, low berries and product differentiation. Hence, most appropriate market structure for the market of gourmet coffee is monopolistic structure.

5.3 Section 3: Factors to consider to penetrate the market

Market penetration is one of the four alternative growth strategies in the Ansoff Matrix. A market penetration strategy involves focusing on selling the existing products or services into existing markets to gain a higher market share. This is the first strategy most organizations will consider because it carries the lowest amount of risk.
 

There are four approaches firm can adopt when implementing this strategy - maintaining or increasing the market share of current products, securing dominance of growth markets, restructuring a mature market by driving out competitors and increasing usage by existing customers. The business can employ a number of strategies to penetrate the market. They are by price adjustments, increased promotion, having more distribution channels and product improvements (Joseph, 2014). It is important to consider the following factors before making decision on implementation of an effective market penetration strategy.
Think and calculate before making decision. There are a few issues to consider before deciding to apply a market penetration strategy at firm’s current stage. Furthermore, firm must think about where they are and if “penetration strategy” is the appropriate strategy amongst other possibilities (Bike', 2012).
Ask the following questions.
  1. Why does firm need higher market penetration?
  2. Does firm need it in order to increase total profitability?
  3. Does firm need it in order to increase profitability per product line?
  4. Does firm need it to secure profitability?
  5. Does firm need it to survive in the market situation?
  6. Is it necessary for firm’s immediate or future development? (Bike’, 2012).
When penetrating the market, firm should consider the following factors:
  1. Market size and potential for growth: whether the market is large enough to implement penetration strategy?
  2. Costs for investments: what are the cost involved like price offers to advertising, training and even processes & systems modifications to adapt to new strategy, etc.
  3. If there is any change in product positioning with all negative and positive implications.
  4. What are the advantages for the whole product line and company from publicity or advertising to your competitors’ reactions? (Bike’, 2012).
Consider its competitors’ reactions and expect to invest more and more in some marketing activities such as special offers or advertising. Once firm’s market penetration strategy takes effect, its competitors will react to protect their market share. Firm needs to be prepared not only with strategic plans and clever marketing activities, but with budgets too (Bike', 2012).
The following are some other factors that the firm can consider when choosing market penetration strategies:
1. Cut price or lower its offer. The easiest and most commonly used market penetration strategy is to offer lower prices through special offers and coupons or more product at a cut price. A cut price can attract new customers to try its product. This means that new clientele will get to know the product and will create a new market share immediately. Some of these clients will like the product, repurchase and become loyal, leading to a more long term market share increase. What to consider: Monitor this marketing strategy carefully because firm’s competitors will react in a similar fashion. Firm might need to further reduce price or maintain the same offer for longer than planned in order to match their offer. Customers get used to lower prices and offers; in this way, it can train them to look for the cheapest. Besides that, firm may enter a price war with competitors and, in the end, only the cheapest will survive. Therefore, firm should only follow this strategy for a short period of time and only occasionally. Otherwise, it may end up with a re-positioned product (Bike', 2012).
2. Promote a new use of the product and enhance its features. This is a very clever and subtle market penetration strategy — use the same product but promote it with additional features. This marketing strategy has the potential to attract both new and existing customers to try the product in a new use. Therefore, it increases the purchased quantity and leads to higher market penetration. Also, it leads to more new customers that get to know the product and offers new market share. What to consider: Be careful not to ignore or depreciate the current characteristics and uses of the product. Firm does not want to lose its existing customers. After the new use is adopted by customers, remind them of the typical use of the product in order to preserve its customer basis. Again, there is a risk of re-positioning by mistake, so monitor its activities and customers’ feedback and take any suspicious signs into consideration (Bike', 2012).
3. More Distribution Channels
Firm can attempt to increase market penetration by increasing the methods it uses to get products into the hands of consumers, making them more readily available. For instance, firm can sell its product through coffee shops. What to consider: The competitors may have more coffee shops located in various good location and additional distribution channels such as telemarketing operation. Competitors may also attempt to gain additional selling space in current distribution channels (Joseph, 2014).
4. Increased Promotion
A promotion is often linked with pricing, such as advertising a special sale price for a limited period. Firm can choose to increase market penetration through greater promotional efforts. It can launch its product through an advertising campaign to generate greater brand awareness or implement a short-term promotion. What to consider:A competitor may counter a successful promotion with one of its own in an attempt to regain lost market share. Competitor may have additional promotional activities for a longer period of time (Joseph, 2014).
Meantime, the firm should consider the some other factors. Are there regulatory issues such as minimum price allowed in the country? How many other companies sell similar products and with what amount of success? How skilled are local distributors in penetrating the market? Is firm’s product (coffee) OK to sell as is or does firm need to invest in localizing it for local tastes? Is there a sufficient business infrastructure to support sale and distribution of firm’s product (coffee)? (Going Global, 2005).

5.4 Section 4: Factors to determine location and size of the outlets

Factors to determine location of the outlets
Finding the best premises in the ideal location at the best prices is a difficult task. Promotion strategies and prices can always be altered, but signing a retail lease or obtaining a mortgage are long-term contracts and can be difficult to get out of. However, done in the wrong way, firm will end up paying an expensive lease or mortgage for an unsuitable location. If done in the right way, selecting a great location for the firm will not only help improve firm's productivity and attract good employees, but will also make sure that firm targets its market effectively and help boost profits. The following are some of the factors which should be considered when selecting the location and size of the outlets (Nizeyimana, 2013).
1. Visibility – It is important to know how visible coffeehouse is. Is coffee shop buried in a strip mall or pushed back from the road. If the coffee shop is chosen to open a coffee shop in a location that’s not very visible, how will the firm overcome this challenge? (Cherylclaypoole, 2011).
2. Easy in & out access – The majority of customers stop by in the morning, and many of these people will be on the way to work. Make sure there is an easy and efficient way for these customers to enter and exit the coffee house (Cherylclaypoole, 2011).
3. Neighborhood – Know your neighbors. Do people in firm’s target market live or work nearby? Will they pass firm’s location on the way to work? Is there strong pedestrian traffic in the area during the business hours? (Cherylclaypoole, 2011).
4. Cost – Can firm afford the space. If the rent in a particular location is expensive, the cost can be justified only if projected sales will more than cover the expense (Cherylclaypoole, 2011).
5. Prior to starting search for the location, always formulate a list of requirements. Some of the requirements should include; building capacity needed, how will the office be structured, layout and size of the proposed premises, appearance, facilities, parking amenities etc. (Nizeyimana, 2013).
6. Availability of basic infrastructure can affect your choice of small business location. Amenities and infrastructure such as water supply, power supply, good road network and security are things to consider when locating firm (Nizeyimana, 2013).
7. Economic policy: The economic policy or system of a particular region may also affect your decision and choice of location. Some economy favor capitalists and others are driven by socialism; where the government controls all businesses. Other sub-factors to consider are government’s policy, fiscal and monetary policy, exchange rates, taxes, levies and duties (Nizeyimana, 2013).
8. Demographics: Demographics as a factor can have a big influence on your choice of business location. The type of product firm offers and the status of the customers will play a vital in choice of location (Nizeyimana, 2013).
9. Psychographics: The mindset of firm’s customers or the aura of a particular region is also a factor to consider when choosing a location for your small business. In addition the language, ethnicity and culture factors are important to consider (Nizeyimana, 2013).
10. Brand Image – Is the location consistent with the image firm want to maintain? (Martins, 2013).
11. Local Labor Market – Does the area have potential employees? What will their commute be like? (Martins, 2013).
12. Plan for Future Growth – If firm anticipate further growth, look for a building that has extra space should need it (Martins, 2013).
13. Hidden Costs – Firm needs to consider the hidden costs which may incur after choosing a location which include costs like renovation, decorating, IT system upgrades, and so on (Martins, 2013).
14. Competition. Firm can benefit from being located close to competitors, because they are already devoting money to attracting the same customer base. So firm does not have to work as hard. Being located close to similar businesses also opens up possibilities for beating their prices (Martins, 2013).
15. Safety. Think about the safety of both firm’s customers and employees. Also, will firm be located in an area where it is likely to be vandalized or burgled? And the political stability? (Martins, 2013).
Factors affecting size of the outlets
1. Types of Industry: The nature of industry determines the size of the firm. The size of the firm will be large in those industries in which the product or the productive machinery is physically very large as in steel-making and ship-building etc. However, the size of firms in a coffee industry will be small where the product is both small and simple as in the case of manufacture of cutlery, weaving of standard cloths or the baking of bread (FREE MBA.IN, 2008).
2. Nature of Product: When a complex and large product is to be manufactured, the size of the firm will be higher. Size of a firm providing coffee products will be smaller compared to large and complex products (FREE MBA.IN, 2008).
3. Size of Market: If the size of market is sufficiently large such as information technology, firm size will be large. However, the coffee market is a fast growing market, firm size will medium compared to large size markets (FREE MBA.IN, 2008).
4. Capital. The needs of capital and the ability of the management to raise capital also influence the size of a firm. If the management of a company can raise capital conveniently such as by selling shares, there will be a tendency towards large scale operations (FREE MBA.IN, 2008).
5. Attitude of Promoters and Management. The ability and attitude of the promoters and the management also influence the size of a business firm. If they are intelligent, foresighted, enterprising and ambitious, the size of the firm will tend to grow as the time passes (FREE MBA.IN, 2008).

5.5 Section 5: Conclusion

The global coffee consumption has increased steadily with the market share and this new firm is going to enter into the gourmet coffee market. In order to enter into this market, the probable market structure is identified based on various authors’ arguments and models. Although there are various market structures, it is found that the appropriate structure for coffee industry is monopolistic structure because the major features in coffee industry match with the features found in monopolistic structure.
After selecting the appropriate structure various factors to consider to penetrate the market are given. These factors include market size and potential for growth, costs for investments, regulatory issues and competitors etc. In addition to this the various market penetration strategies with the factors to consider are given.    
After this various factors to determine location and size of the outlets are given. Factors to determine location of the outlets include visibility, easy in access, cost economic policy, demographics, psychographics, hidden cost, competition, safety etc. Factors affecting size of the outlets types of industry, nature of product, size of market, capital, attitude of promoters and management. In my opinion, the firm can successfully enter and penetrate this market by selecting monopolistic structure as well as considering the factors given.

6.0 Reference

Altmann, M. (2007). Coffee Shop Industry - A Strategic Analysis (Scholarly Research Paper). Katz- Graduate School of Business - Pittsburgh/ USA. Retrieved June 03, 2014, from http://www.scribd.com/doc/83253168/Coffee-Shop-Industry-A-Strategic-Analysis
Bike', M. (2012). TASK: How to develop an effective market penetration strategy? Retrieved June 05, 2014, from http://www.task.fm/How-To-Develop-An-Effective-Market-Penetration-Strategy
Brydon, J., Gutierrez, R., Henson, J., Hutchins, C., Nelson, J., Rehak, M., Rustmann, K. &Wolf, K. (2011). An Industry and Company Analysis. Retrieved June 05, 2014, from http://www.scribd.com/doc/55421271/Industry-Analysis-Starbucks
Cherylclaypoole. (2011). Choosing the Right Coffee Shop Location. Retrieved June 02, 2014, from http://www.crimsoncup.com/coffee/choosing-the-right-coffee-shop-location
Dacre-Wright, I., Horgan, R., Mitchell, A &Hamlet, T. (n.d.). Coffee shop industry (Power point presentation). Retrieved June 03, 2014, from
Dobrin, D., Foster-Baker, C., Allison, J., MacLennan, G & Volk., R. (2012). Starbucks:
Now and beyond (Power point presentation). Retrieved June 06, 2014, from http://www.scribd.com/doc/229821407/week5starbuckspptdraft-130126005607-phpapp01
FREE MBA.IN. (2008). Masters of Business Administration Notes. Retrieved June 05, 2014, from http://www.freemba.in/articlesread.php?artcode=221&substcode=14&stcode=8
Gaebler.com. (2013). Resources for Entrepreneurs: Starting a Gourmet Coffee Business. Retrieved June 03, 2014, from http://www.gaebler.com/Starting-a-Gourmet-Coffee-Business.htm
Going Global. (2005). Analyzing foreign markets. Retrieved June 02, 2014, from http://www.going-global.com/articles/analyzing_foreign_markets.htm
Joseph, C. (2014). Examples of Penetration Strategies. Retrieved June 04, 2014, from http://smallbusiness.chron.com/examples-penetration-strategies-11699.html
Lewis, K. N. (2006). Starbucks Campaign Market Analysis. Retrieved June 05, 2014, from http://www.scribd.com/doc/9683015/Starbucks-Campaign-Market-Analysis
Martins, A. T. (2013). Top business ideas: How to Choose a Business Location. Retrieved June 06, 2014, from http://www.mytopbusinessideas.com/choosing-a-business-location/
Medasanianus. (2010). Market Structure and Supply and Demand of Starbucks. Retrieved June 05, 2014, from http://www.studymode.com/essays/Market-Structure-And-Supply-And-Demand-526134.html
Mrshearingeconomics.weebly.com. (n.d.). Market Structures. Retrieved June 04, 2014, from http://mrshearingeconomics.weebly.com/market-structures.html
Nizeyimana, E. (2013). SSCG Advisory Services: Market Entry & Growth Strategies for Africa: Factors for Consideration (Power point presentation). Retrieved June 07, 2014, from http://www.slideshare.net/SUBSAHARAN/market-entry-expansion-strategies-for-africa-factors-for-consideration
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