The beer industry was once populated by dozen of firms and an even larger number of brands. It now is an oligopoly dominated by a handful of producers.
The brewing industry has undergone profound changes since World War II that have increased the degree of concentration in the industry. In 1945 more than 60 independent brewing companies existed in Canada. By 1967 there were 18, and by 1984 only 11. While the three largest brewers sold only 19 percent of the nation's beer in 1947, the Big Three brewers (Labatt, Molson, and Carling O'Keefe) sold 97 percent of the nation's domestically produced beer in 1989, the same year Molson and Carling O'Keefe merged. Currently, the Big Two— Labatt (at 41 percent) and Molson (at 52 percent)—produce most of the beer in Canada. The industry is clearly an oligopoly.
Changes on the demand side of the market have contributed to the shakeout of small brewers from the industry. First, consumer tastes have generally shifted from the stronger-flavoured beers of the small brewers to the light products of the larger brewers. Second, there has been a shift from the consumption of beer in taverns to consumption of it in the home. The significance of this change is that taverns were usually supplied with kegs from local brewers to avoid the relatively high cost of shipping kegs. But the acceptance of aluminum cans for home consumption made it possible for large, distant brewers to compete with the local brewers, because the
former could now ship their products by truck or rail without breakage.
Developments on the supply side of the market have been even more profound. Technological advances have increased the speed of the bottling and canning lines. Today, large brewers can fill and close 2000 cans per line per minute. Large plants are also able to reduce labour costs through automating brewing and warehousing. Furthermore, plant construction costs per barrel are about one-third less for a 4.0 million hectolitres plant than for a 1.5-million-barrel plant. As a consequence of these and other factors, the minimum efficient scale in brewing is a plant size of about 4.0 million hectolitres, with multiple plants. Because the construction costs of a modern brewery of that size is $450 million, economies of scale
Part Two • Microeconomics of Product Markets may now constitute a significant barrier to entry.
Blindfold taste tests confirm that most mass-produced Canadian beers taste alike, so, brewers greatly emphasize advertising. Here, Labatt and Molson, who sell national brands, enjoy major cost advantages over producers that have regional brands (for example, Creemore Springs, Upper Canada, and Okanagan Spring). The reason is because national television advertising is less costly per viewer than local spot TV advertising.
Mergers in the brewing industry have been a fundamental cause of the rising concentration. Dominant firms have expanded by heavily advertising their main brands such as Labatt Blue, Molson Canadian, Blue Light, Canadian Light, and Mol-son Special Dry, sustaining significant product differentiation despite the declining number of major brewers.
Two factors dominate the Canadian beer industry: high transportation costs and provin cial policies and practices. High transportation costs have translated into a regional structure of production compared with the brewing industry in the United States. As a consequence, a large number of breweries exist in Canada relative to the size of the domestic market. Especially outside the larger breweries in Ontario and Quebec, unit costs are markedly higher because of the inability to achieve economies of scale.
Even more important than transportation costs, provincial policies and practices in the past had a dominant impact on the Canadian brewing industry; until recently, brewers were not allowed to transport beer produced in one province to be sold in another. This restriction has now been relaxed, and brewers will centralize operations in the future to capture economies of scale.
Imported beers such as Beck, Corona, Foster's, and Guinness constitute over 10 percent of the Canadian market, with individual brands seeming to wax and wane in popularity. Some local or regional microbreweries such as Upper Canada (purchased recently by Sleeman), which brew specialty beers and charge premium prices, have whittled into the sales of the major brewers. Labatt and Molson have taken notice, responding with specialty brands of their own (for example, John Labatt Classic and Molson Signature Spring Bock). Overall, however, it appears that imports such as Heineken and Budweiser may pose more of a threat to the majors than the microbreweries do.
Sources: Based on Kenneth G. Elzinga, "Beer," in Walter Adams and James Brock (eds.), The Structure of American Industry, 9th ed. (Englewood Cliffs, NJ: Prentice-Hall, 1995), pp. 119-151; Douglas F. Greer, "Beer: Causes of Structural Change," in Larry Duetsch (ed.), Industry Studies, 2nd ed. (New York: M. E. Sharpe, 1998), pp. 28-64; authors' updates; the Conference Board of Canada, The Canadian Brewing Industry: Historical Evolution and Competitive Structure (Toronto: International Studies and Development Group, 1989).
1. The distinguishing features of monopolistic competition are (a) enough firms are in the industry to ensure that each firm has only limited control over price, mutual interdependence is absent, and collusion is nearly impossible; (b) products are characterized by real or perceived differences so that economic rivalry entails both price and nonprice competition; and (c) entry to the industry is relatively easy. Many aspects of retailing, and some manufacturing industries in which economies of scale are few, approximate monopolistic competition.
2. Monopolistically competitive firms may earn economic profits or incur losses in the short run. The easy entry and exit of firms result in only normal profits in the long run.
3. The long-run equilibrium position of the monopolistically competitive producer is less socially desirable than that of the pure competitor. Under monopolistic competition, price exceeds marginal cost, suggesting an underallocation of resources to the product, and price exceeds minimum average total cost, indicating that consumers do not get the product at the lowest price that cost conditions might allow.
4. Nonprice competition provides a means by which monopolistically competitive firms can offset the long-run tendency for economic profit to fall to zero. Through product differentiation, product development, and advertising, a firm may strive to increase the demand for its product more than enough to cover the added cost of such nonprice competition. Consumers benefit from the wide diversity of product choice that monopolistic competition provides.
5. In practice, the monopolistic competitor seeks the specific combination of price, product, and advertising that will maximize profit.
6. Oligopolistic industries are characterized by the presence of few firms, each having a significant fraction of the market. Firms thus situated are mutually interdependent: the behaviour of any one firm directly affects, and is affected by, the actions of rivals. Products may be either virtually uniform or significantly differentiated. Various barriers to entry, including economies of scale, underlie and maintain oligopoly.
7. Concentration ratios are a measure of oligopoly (monopoly) power. By giving more weight to larger firms, the Herfindahl index is designed to measure market dominance in an industry.
8. Game theory (a) shows the interdependence of oligopolists' pricing policies; (b) reveals the tendency of oligopolists to collude; and (c) explains the temptation of oligopolists to cheat on collusive arrangements.
9. Noncollusive oligopolists may face a kinked-demand curve. This curve and the accompanying marginal-revenue curve help explain the price rigidity that often characterizes oligopolies; they do not, however, explain how the actual prices of products are first established.
10. The uncertainties inherent in oligopoly promote collusion. Collusive oligopolists such as cartels maximize joint profits—that is, they behave like pure monopolists. Demand and cost differences, a large number of firms, cheating through secret price concessions, recessions, and the anti-combines laws are all obstacles to collusive oligopoly.
11. Price leadership is an informal means of collusion whereby one firm, usually the largest or most efficient, initiates price changes and the other firms in the industry follow the leader.
12. Market shares in oligopolistic industries are usually determined based on product development and advertising. Oligopolists emphasize nonprice competition because (a) advertising and product variations are harder for rivals to match and (b) oligopolists frequently have ample resources to finance nonprice competition.
13. Advertising may affect prices, competition, and efficiency either positively or negatively. Positive: It can provide consumers with low-cost information about competing products, help introduce new competing products into concentrated industries, and generally reduce monopoly power and its attendant inefficiencies. Negative: It can promote monopoly power via persuasion and the creation of entry barriers. Moreover, it can be self-cancelling when engaged in by rivals by boosting costs and increasing economic inefficiency while accomplishing little else.
14. Neither productive nor allocative efficiency is realized in oligopolistic markets, but oligopoly may be superior to pure competition in promoting research and development and technological progress.
terms and concerts monopolistic competition, p. 274
product differentiation, p. 274 nonprice competition, p. 276 excess capacity, p. 281 oligopoly, p. 282
differentiated oligopoly, p. 283 mutual interdependence, p. 283 concentration ratio, p. 284 interindustry competition, p. 285
import competition, p. 285
homogeneous oligopoly, p. 283 Herfindahl index, p. 285
game theory model, p. 286 collusion, p. 287 kinked-demand curve, p. 288 price war, p. 291 cartel, p. 292
tacit understandings, p. 293 price leadership, p. 295
Part Two • Microeconomics of Product Markets study questions
1. How does monopolistic competition differ from pure competition in its basic characteristics? from pure monopoly? Explain fully what product differentiation may involve. Explain how the entry of firms into its industry affects the demand curve facing a monopolistic competitor and how that, in turn, affects its economic profit.
2. KEY QUESTION Compare the elasticity of the monopolistic competitor's demand with that of a pure competitor and a pure monopolist. Assuming identical long-run costs, compare graphically the prices and outputs that would result in the long run under pure competition and under monopolistic competition. Contrast the two market structures in terms of productive and allocative efficiency. Explain: "Monopolistically competitive industries are characterized by too many firms, each of which produces too little."
3. "Monopolistic competition is monopolistic up to the point at which consumers become willing to buy close-substitute products and competitive beyond that point." Explain.
4. "Competition in quality and service may be just as effective as price competition in giving buyers more for their money." Do you agree? Why? Explain why monopolistically competitive firms frequently prefer nonprice competition to price competition.
5. Critically evaluate and explain:
a. "In monopolistically competitive industries, economic profits are competed away in the long run; hence, there is no valid reason to criticize the performance and efficiency of such industries."
b. "In the long run, monopolistic competition leads to a monopolistic price but not to monopolistic profits."
6. Why do oligopolies exist? List five or six oligopolists whose products you own or regularly purchase. What distinguishes oligopoly from monopolistic competition?
7. KEY QUESTION Answer the following questions, which relate to measures of concentration:
a. What is the meaning of a four-firm concentration ratio of 60 percent? 90 percent? What are the shortcomings of concentration ratios as measures of monopoly power?
b. Suppose that the five firms in industry A have annual sales of 30, 30, 20, 10, and 10 percent of total industry sales. For the five firms in industry B the figures are 60, 25, 5, 5, and 5 percent. Calculate the Herfindahl index for each industry and compare their likely competitiveness.
8. KEY QUESTION Explain the general meaning of the following payoff matrix for oligopolists C and D. All profit figures are in thousands.
\ $57 $60\
\ $59 $55
\ $50 $69\
a. Use the payoff matrix to explain the mutual interdependence that characterizes oligopolistic industries.
b. Assuming no collusion between C and D, what is the likely pricing outcome?
c. In view of your answer to 8b, explain why price collusion is mutually profitable. Why might a temptation to cheat on the collusive agreement exist?
9. KEY QUESTION What assumptions about a rival's response to price changes underlie the kinked-demand curve for oligopolists? Why is there a gap in the oligopolist's marginal-revenue curve? How does the kinked-demand curve explain price rigidity in oligopoly? What are the shortcomings of the kinked-demand model?
10. Why might price collusion occur in oligopolistic industries? Assess the economic desirability of collusive pricing. What are the main obstacles to collusion? Discuss the weakening of OPEC in the 1980s in terms of those obstacles.
11. KEY QUESTION Why is there so much advertising in monopolistic competition and oligopoly? How does such advertising help consumers and promote efficiency? Why might it be excessive at times?
12. (Advanced analysis) Construct a game theory matrix involving two firms and their decisions on high versus low advertising budgets and the effects of each on profits. Show a circumstance in which both firms select high advertising budgets even though both would be more profitable with low advertising budgets. Why won't they unilaterally cut their advertising budget?
13. (The Last Word) What firm(s) dominate the beer industry? What demand and supply factors have contributed to the small number of firms in this industry?
internet application questi
1. Indigo at <www.indigo.ca> is Canada's largest online bookseller, but it still has to compete with the very popular Amazon at <www.amazon.com>. Search both sites for Viktor Frankl's Man's Search for Meaning (in paperback). Find the price and determine which company sells the book at a lower price (convert Amazon's price into Canadian dollars using the current exchange rate at Yahoo's financial site, <finance.yahoo.com/ m3?u>. Identify the nonprice competition that might lead you to order from one company rather than the other.
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