Know-How Exchange : Student Questions

Fred,

I believe that much of the cycle you are describing has to do with psychology versus economics. In the face of a problem, people will find a way to overcome the obstacle. Additionally, according to Maslow (Maslow's Hierarchy), after all other basic needs are satisfied, we strive to live up to their fulfill potential by utilizing our talents to their fullest. Thus, some people devote their time to finding a better way for all things. Another reason for this cycle is the psychological aspects of competitiveness. In order to maintain their position in the marketplace, firms will try to beat their competition. They realize that for each action they take in the marketplace, their competitors will have a matching reaction. They try to think ahead of their competition and keep improving their products and processes.

I hope this helps.

Wayde

Well I think it can be easily explained by Supply and Demand. You need to think about specialization. The way I would explain it would be China VS the U.S.A. The reason the US is such a strong economy is that it has specialized in INNOVATION. When the VCR first appeared it was made in the USA by highly skilled workers that needed a lot of training and high tech equipment. As the technology improved for making the VCRs it became easier and quicker to make them, you didn’t need highly skilled labor and prices dropped. It then became a better use of there time to make new inventions instead of manufacturing them in there own factories so they sent the task to China which specializes in manufacturing because it has lots of low cost, unskilled labor. China has a lower opportunity cost . If you don’t know what the highlighted terms mean then pick up a first year economics text book, and start reading.

Sorry if it is not clear, I am having a hard to explaining it in words.

Fred,

Supply and demand curves are more about price and profit. They relate to Porter's generic strategies in a round about way. See this link for Porter's strategies:
https://en.wikipedia.org/wiki/Porter_generic_strategies
In the early market - when something is first invented, demand is high, supply is low, so the point at which supply and demand cross - the price is high. Also, customers don't really have a language reference to describe their needs except in very basic terms. The market is fragmented because customers couldn't tell the auto manufacturers in Henry Ford's day that they wanted air bags and a 5L hemi. They could only say they wanted cheap, reliable, low cost transportation. Because supply is much lower than supply and the market is fragmented, many entrants can come in and compete and make a reasonable profit. The strategy of this day is differentiation. As the market matures, features settle out and a "standard" product emerges. Customers begin to expect certain things and many manufacturers can supply it. The supply is increased (the slope of the supply curve decreases) and the point at which supply and demand cross is low. Firms who can't meet this low price go out of business, get bought out, or change strategies. A firm who has a dominant market share position can sustain that dominance with a cost leadership position. Other firms can sustain a profitable business through a differentiation strategy - more features that add enough value to command a higher price.

Now suppose a firm who is differentiating figures out how to add features at zero cost impact. The effect of this would be to increase the overall demand - more people would want to buy this new and improved product. The demand curve shifts outward in the short term because people who already have the initial product want a new one, supply curve stays the same in the short term, thus price increases. Competitors see a way to make more profit if they can also match these additional features and begin to produce. Demand shifts back down to where it was after the initial bubble because customers who bought the new improved product to replace the old one are satisfied and now we're left with the normal demand. Price goes back down to where it was, but the product has more features. Again, firms drop out or change strategies.

Suppose a firm finds out how to deliver the product with less cost (manufacture or channel cost reduction). This firm can reduce the price and grab market share. In effect, the supply curve slope shifts downward and the price reduces.

So just in terms of supply and demand, you can say that a firm will keep trying to maximize profits through technology, where the demand increases in the short term and the price with it, or by reducing cost so that they can take a dominant market share position and make more total profit as a result. But, this is a pretty simplistic, mathematical approach where the firm is an entity. It's really about people. The reason for a "firm" to want to maximize profit is because the people want to realize their fullest potential as well as win (competitiveness) - be the alpha male (or female) who dominates the clan.

I hope this helps.

Wayde

By they way, I'm sure you read the last thread I wrote on the closed question concerning the transition from cost leadership to differentiation. No economics here either. It won't happen easily for a firm who has a cost leadership position to move to a differentiation strategy. The ingrained cost-conscious behavior will hinder this. Now, if a technological breakthrough occurred to upset their dominant position they will be forced to change strategies, die, or buy the company introducing the change. More likely, they will add the resources to match the technology (which could be by buying the competitor) and suck the cost out of it and return to their cost leadership strategy. It takes a strong culture to maintain a cost leadership position and cultures take a long time to change.

Wayde

Fred,

I hope this lead helps. Try reading up on Monopolistic competition in the first year economics textbook. To be exact, narrow it down to the Long-run characteristics of the monopolistic structure. It does have the similar characteristics of new firms entering the market and causing no super normal profits. Lots of diagrams too!

But that's just economics.

I hope this helps.

Benny