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January 17, 2018 

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MARGINAL UTILITY AND DEMAND: An explanation of the law of demand and the negatively-sloped demand curve can be found in the analysis of marginal utility and especially the law of diminishing marginal utility. This explanation rests on two propositions. One, the law of diminishing marginal utility means that the marginal utility obtained from consuming a good declines as the quantity consumed increases. Two, the marginal utility of a good underlies the demand price that buyers are willing and able to pay for a good. When combined, these two propositions indicate that the demand price buyers are willing and able to pay for a good declines as the quantity demanded (and consumed) increases. And this is the law of demand.

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INDUSTRY:

A group of firms producing goods or services that are close substitutes-in-consumption. The similarity of the products makes it possible to analyze the production in a market framework. An industry can be broadly defined, such as the manufacturing industry, or narrowly specified, such as the root beer industry. For most economic analysis the term industry is used interchangeably with the term market.
An industry is a group of firms that produce similar products. For most economic analysis the term industry is used synonymous with the term market. However, the term industry is often defined more broadly. That is, a company might be part of the automobile industry but produces goods sold in the sports car market, the light truck market, or the sports utility vehicle market.

Industrial Delineation

Identifying the boundaries of an industry and which firms are included is always a challenge. Ideally an industry includes those firms that produce close substitutes-in-consumption. However, the exact specification of an industry often depends on the purpose of an analysis. In some cases, a broad classification is desired. In other cases, a narrower delineation is more appropriate. In many cases, a geographic specification is necessary.

Consider, for example, the soft drink industry. The firms included in this industry might seem relatively straightforward. This industry includes firms that produce soft drinks. However, delineating this industry is not as easy as it might seem. One question that arises is: What exactly constitutes a soft drink? Another pertinent question is: Does it matter where the soft drink is produced and consumed?

  • What: A number of soft drink products are obvious candidates for inclusion in the soft drink industry. Carbonated beverages--colas, root beers, fruit-flavored, citrus-flavored--are all viable candidates. However, should non-carbonated drinks be included, such as sweetened fruit drinks? What about 100 percent pure fruit juices? Would this include frozen concentrates or only canned juices? What about powdered drink mixes? Are tea and coffee suitable soft drink beverages? How about bottled water? Is milk considered a soft drink? And while alcoholic drinks (beer, wine, and liquor) are excluded by definition (hard versus soft), should "near beer" or non-alcoholic carbonated "wine" be included?

  • Where: An industry often needs to be delineated based on where the production and consumption occur. Some industries have a national market area, others are confined to a smaller state, city, or regional locale. In particular, does it make sense to analyze the "national" soft drink industry or is it more appropriate to deal only with smaller, local soft drink industries?

Cross Elasticity of Demand

The key to answering questions about what constitutes an industry is often found with the cross elasticity of demand. This is the relative response in the demand for one good relative to a change in the price of another good.

Substitutes-in-consumption have a positive cross elasticity of demand. In other words, if the price of one good increases, then buyers purchase less of that good and more of the substitute good. If the price of root beer increases, then buyers are likely to switch to a substitute good, such as a cola drink.

The greater the cross elasticity of demand, then the closer two goods are as substitutes-in-consumption. In fact, if the cross elasticity of demand is the same as the price elasticity of demand, then two goods are effectively the same good. As far as buyers are concerned, the two goods are perfect substitutes.

As such, the ideal way to determine which goods and firms are included in a particular industry is to identify the cross elasticity of demand between goods. Those goods with a greater cross elasticity of demand are better candidates for inclusion. Even more important, those goods with a zero cross elasticity of demand can be excluded from the market.

If, for example, the cross elasticity of demand between milk and carbonated drinks is zero, then milk can be excluded from the soft drink market.

Industrial Structures

In economic analysis, it is often convenient to categorize an industry into one of four alternatives--perfect competition, monopolistic competition, oligopoly, and monopoly.
  • Perfect Competition: Perfect competition is an industry with a large number of relatively small firms that sell virtually identical products and that have ease of movement into and out of the market. The key feature of perfect competition is that each firm has no market control--that is, a firm has no ability to control the price. While real world markets come close to this ideal of perfect competition, NONE are PERFECT competition.

  • Monopolistic Competition: Monopolistic competition is an industry with a large number of relatively small firms that sell similar but not identical products and that have ease of movement into and out of the market. Monopolistic competition is very similar to perfect competition, the primary difference is that products sold by monopolistic competition firms are slightly different. Product differentiation gives each firm some market control and some ability to control the price. A large portion of real world markets are monopolistic competition. In fact, monopolistic competition can be considered the real world's best effort to achieve perfect competition.

  • Oligopoly: Oligopoly is an industry with a small number of relatively large firms. The key feature of oligopoly is that entry into and out of the industry is usually restricted. This restriction tends to limit the number of firms in an industry and gives each firm a great deal of market control, with a substantial ability to control the price. A large portion of real world industries are oligopoly.

  • Monopoly: Monopoly is an industry with a single seller of a good that has virtually no close substitutes. For a monopoly market structure, the single business IS the industry, it has complete control over the market price. And it has this control because buyers have no substitutes available. Several real world markets come close to monopoly, but like perfect competition, no markets are complete monopoly.

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Recommended Citation:

INDUSTRY, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: January 17, 2018].


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