microeconomics - Economics Help

Cigarette tax and smoking rates

16 February 202017 December 2014 by Tejvan Pettinger

In the UK, smoking rates have fallen significantly in the past 40 years. A combination of factors have led to declining smoking rates. Higher tax Health campaigns warning about the dangers of smoking. Regulations to ban smoking in many public areas, making smoking less attractive. Changing social attitudes and decline in the fashionability of smoking. …

Why do bus companies run empty coach services?

16 February 20202 December 2014 by Tejvan Pettinger

Readers Question: Why may it still make economic sense for the company to put on a coach for just one or two passengers, rather than turning them away?

Recently I again had to travel to London by coach and discovered that it was a good idea to book early in case the coach was full! Was the coach company being more sensible now?

If a bus has a capacity of 80 seats. It might need an average of say 30 customers per trip to break even.

If the company are averaging less than 30 customers per journey, their fixed and variable costs will be higher than their revenue and eventually they will go out of business.

Can it make sense to run coaches that are nearly empty?

Running a coach service early in the morning or during winter may mean the bus company can expect less than 30 passengers. From one perspective, this does not make sense. It is below the break-even point – average revenue less than average cost. It may even be a case where the marginal cost is greater than the marginal revenue from an extra service.

In fact running services at unsocial hours of the morning will be unpopular with drivers, and the company may have to pay night-time rates.

However, there can be a good long term profit maximising logic behind running these services – even if only a few passengers use them.

Marketing. It is a strong marketing ploy to be able to offer 24 hour, 365 days coverage. If people know you run a service all around the clock, it will give them confidence to choose coach journeys as their preferred choice of transport.
Attract and hold onto long term customers. Only a few people may use an unpopular service. But, the 24 hour service will encourage many to get the coach in the first place. If customers fear they may turn up and no coaches are available, they may choose other forms of transport, such as car and trains and the company loses the business of customers.
If you lose a customer for one journey, the company might not lose very much. But, if the customer would make 50 journeys a year, that is different. Companies have to be aware that one bad experience could make the company lose their services for a long time.
Barriers to entry. If an existing coach company is running a 24 hour service, it may deter a new coach company from setting up. They may feel that they couldn’t compete with this all round performance, which makes the industry less profitable. On the other hand, a new company could be sneaky and just cherry pick the busiest times of the day to offer services.
Costs. Running a coach service will have both fixed and variable costs. Once you have bought coaches and given drivers an annual contract, the marginal cost of extra services will be relatively low – just the petrol and maintenance. Since you have already paid for many fixed costs (drivers annual salaries, buses, marketing) the marginal cost of an extra journey may be covered by just 10 or 20 passengers. Another way to think about it the topic. Would the company want to lay off drivers for a quiet time in winter? It may lose its drivers. The company might as well keep going through quieter periods.
Non-profit maximising decisions. We may assume every company is a profit maximiser. But, there maybe an element within the company, that they want to provide a good, all round comprehensive bus service, and they don’t mind if a few services are loss making.
Market share vs Profit. Another issue is that firms often concentrate on gaining market share, rather than profit maximisation. See: Profit vs Revenue maximisation

The battle for market share in UK supermarkets

22 January 201813 November 2014 by Tejvan Pettinger

The UK grocery market has become increasingly competitive in the past few years. It is a good example of an oligopoly becoming more competitive. Certainly, the growing strength of discount giants like Aldi and Lidl have really shaken up the market and diluted the cosy oligopoly previous enjoyed by the likes of Tesco and Sainsbury. …

Reasons firms invest in very competitive markets

18 November 20174 September 2014 by Tejvan Pettinger

Readers Question: Why invest capita in purely competitive industries with equilibrium margins that are razor thin and entrants that erode quasi profits? Suppose volume is not exceptionally large, why then?

Economic theory suggests that firms will invest in industries where there is supernormal profit being made. Investment will be more attractive in industries where there is a degree of monopoly power and higher profit margins.

However, in the real world, firms can make decisions based on other factors and decide to enter an industry with low profit marigins.

Why might a firm invest in a very competitive market with low profit margins?

Self belief. An entrepreneur may have great self-belief that it can do better than all the incumbent firms. For example, the coffee shop market may be very competitive in a certain town, but someone with great passion for coffee may feel he can still do it better than all the incumbent firms. Therefore, even though the market is already competitive, they may still enter. This is something that economic theory may not give too much weight to – personal ambition, pride and self-belief – but it is a quite common that people think they can just be better than the competition. This self-belief may even be a motivation for a firm to enter a loss making industry. It’s not quite the same, but recently restructuring specialist Hilco tookover HMV – a record shop making a loss. But, Hilco had the confidence to turn the firm around; initial reports suggest they have been successful.

Expand the market. An entrepreneur may see a very competitive market with low profit margin, but feel they can still expand the market. For example, in the 1990s, the coffee shop industry was probably quite competitive with a low profit margin. But, Starbucks still saw a gap in the market and opened a lot of new coffee shops (often right next to existing coffee shops). They felt they could grow the market, sell extras and increase profit margins. That industry has expanded and become more profitable in recent years.

Multinational companies can afford low profit margins. Many entrepreneurs would be reluctant to risk entering a market with very low profit margins. However, some big companies can afford to enter an industry even if they don’t expect to make much profit. For example, big supermarkets entered the petrol retail industry. They drove down already slim profit margins. Petrol retail is not there core business. They are probably happy for petrol to be a ‘loss leader’ to attract customers to the store. In other words, people come to fill up with petrol at Tesco, and then spend £80 to do their weekly shop. The profit on petrol maybe zero, but if Tesco gain more customers spending £80 on groceries it is a good business decision. It wouldn’t make sense for someone to set up an independent petrol station because profit margins are so poor (in fact many independent petrol retailers have closed down in recent years) There may be many other examples where multinationals feel there is strategic benefit to entering a competitive market with low profit margins.