GB500 Unit 5 Market Structure Case Example

Four Ice Plants and a Construction Camp: A Unit 5 Market Structure Case on a Local Oligopoly

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Purdue University Global

GB500: Business Perspectives

Unit 5 Market Structure Case

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The ice producers, the metro area, the construction project and every figure are composite and illustrative; the economics sources cited are real.

The Industry and the Decision

Packaged ice is sold in 10- and 20-pound bags to grocery stores, convenience stores, gas stations and event caterers, and in bulk to seafood processors and construction crews. Because ice is heavy, cheap and melts, it is rarely trucked more than about sixty miles from the plant. In the Port Calder metro area, four producers sell almost all of it: Gulfline Ice, with about 38 percent of bags sold, and three smaller producers with 27, 21 and 11 percent. A handful of convenience stores make their own ice on site.

The decision belongs to Gulfline. A liquefied natural gas export terminal is being built on the bay, and its contractor will house about 4,000 workers in a camp for two years. The camp's caterer and the construction crews will need ice every day, and demand across the metro area is expected to rise by about 15 percent during construction. Gulfline must decide whether to raise prices or add capacity, in the form of freezer trailers and delivery trucks.

Classifying the Market

Gregory Mankiw describes an oligopoly as a market with only a few sellers offering similar or identical products, in which each seller's decisions affect the others (Mankiw, 2021). The Port Calder ice market fits on each count.

Few sellers. Four producers supply about 97 percent of bags sold, and the largest supplies more than a third.

High entry costs. A new plant with ice makers, baggers, freezer storage and a delivery fleet costs several million dollars, and a new entrant would need to win store contracts held by established producers. No new plant has opened in the area in eleven years.

A standardized product. A 20-pound bag of ice is nearly identical whoever makes it. Producers compete on reliability of delivery, especially on hot weekends and before storms, more than on the product itself.

Visible price leadership. Wholesale prices change about once a year. Gulfline usually announces first, and the others follow within weeks, typically matching to within a few cents a bag.

David Besanko and colleagues note that in local markets where transport costs limit how far a product travels, a national industry can contain many small oligopolies, each with its own pricing (Besanko et al., 2017). Ice is a clear case: the relevant market is the sixty-mile delivery radius, not the country.

The market is an oligopoly because geography makes it one: ice cannot travel far, so four nearby plants are the only real choices for a store.

The Demand Shift

In a supply and demand diagram for the metro market, the construction camp shifts the demand curve to the right. In the short run, supply is limited by plant capacity: each producer's ice makers and freezer storage can produce only so much per day, and on hot summer days Gulfline already runs near its limit. The short-run supply curve therefore rises steeply near capacity. A rightward shift in demand against steep supply raises the market price more than the quantity sold. Over two years, producers could add capacity, flattening supply, but each must decide whether a temporary shift justifies a lasting investment.

What an Oligopolist Can and Cannot Do

Gulfline cannot simply raise its price and expect the others to stay put. If it raises prices sharply and the others do not follow, stores will switch to them, since the product is the same. If the others do follow, all four gain, but each is tempted to undercut slightly to win the new construction business. Mankiw's discussion of oligopoly notes that firms in such markets face a constant tension between cooperating to keep prices high and competing for share (Mankiw, 2021).

Jean Tirole's analysis of price leadership suggests that followers match a leader's price change when it reflects shared cost or demand conditions, because matching avoids a price war none of them wants (Tirole, 1988). What Gulfline can do is lead a modest increase justified by higher demand and costs, which the others are likely to match as they have in past years. What it cannot do safely is raise prices on its regular grocery customers while also competing aggressively for the camp's contract, because a rival could use that contract to win back grocery accounts.

The Recommendation

Gulfline should do both, in proportion. It should announce a moderate wholesale increase of about 6 percent at its usual annual time, in line with its rising labor and electricity costs, and expect the others to follow. And it should add capacity aimed at the camp: two freezer trailers placed at the construction site and one delivery truck, leased for the two years rather than bought. That keeps the construction business, which a rival with spare capacity would otherwise take, without committing to permanent capacity for a temporary demand. When the terminal is finished, the leases end and the market returns to its usual size.

References

Besanko, D., Dranove, D., Shanley, M., & Schaefer, S. (2017). Economics of strategy (7th ed.). Wiley.

Mankiw, N. G. (2021). Principles of economics (9th ed.). Cengage.

Tirole, J. (1988). The theory of industrial organization. MIT Press.