Sotheby's Institute Week 4 Whitaker 20110928


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Principles of Business I: Week 4

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  • Melting ice caps – strand polar bears
  • You pay direct cost of power use, plus apportionment of overhead
  • Re picture – was thinking petrol is so much more expensive in Europe than gasoline in the US because of taxation
  • That this is your work and something about how cost intensive the start up of a wind farm is but then how beneficial once it exists – give some ballparks for how much it costs per kwh for fossil fuel and for wind power and how you try to equalize that
  • We are looking at perfect competition again. In perfect competition, people are price-takers.
  • Sotheby's Institute Week 4 Whitaker 20110928

    1. 1. Principles of Business I<br />Market Power, Structure, and Failure<br />Labor Economics<br />Week 4 – September 28, 2011<br />Professor Whitaker<br />
    2. 2. Agenda for Class<br />1. Market Power and Structure<br />[break]<br />2. Market Failure<br />[break]<br />3. Labor Economics<br />[questions]<br />
    3. 3. Market Power and Structure<br />
    4. 4. Market Structures<br />
    5. 5. Perfect vs. Imperfect Competition<br />Efficiency vs. Power<br />In perfect competition, firms are powerless – They do not set price. They can only respond.<br />Economists believe perfect competition creates efficiency which allocates resources effectively – “allocative efficiency.”<br />
    6. 6. monopolyone seller, many buyers<br /><ul><li>Single seller
    7. 7. High barriers to entry
    8. 8. Price-maker not price-taker
    9. 9. No substitutes (pure monopoly), or power in proportion to availability of substitutes</li></li></ul><li>Barriers to Entry<br />High start-up costs (airlines, taxi medallion, solar panels in developing countries)<br />Intellectual property (pharma, operating systems))<br />Trade secrets, R&D, expertise (art consulting, Coke, professional sports)<br />Regulation (utilities, education)<br />Partnerships and long-term contracts (computer parts manufacturing, city contracts)<br />
    10. 10. Examples of Barriers to Entry<br />Pharmaceutical company: scientists, patents, money to fund clinical trials, marketing support<br />Beer company: recipe, vast factories, access to ingredients, distribution and bottling system, partnerships, marketing, merchant relationships<br />Gallery: expertise of owner in choosing artists, cost of space, language barrier, relationships with clients<br />Conferences (e.g., Artelligence): reputation, relationships, money to secure space (risk and cash flow)<br />Artist: space and time to work vs. gallery representation<br />Auction Party vs. Auction House: cost of compliance and marketing <br />
    11. 11. Availability of Substitutes<br />
    12. 12. Other substitutes?<br />
    13. 13. Competitive industryPrice signallingCollusion<br />
    14. 14. Monopolistic Competition<br />Competition on brand or other forms of market segmentation<br />The determination has to do with whether there are substitutes – perfect, imperfect, improvised or otherwise<br />You<br />Are<br />Here.<br />
    15. 15. Strategy of Monopolistic Competition<br />Non-price competition - differentiation<br />Influence over demand via advertising, branding<br />Increase switching costs - stickiness<br />Bolster number of complements<br />Extended service agreements, frequent upgrades<br />Network externalities<br />Technical standards (Blue Ray v. HD DVD)<br />
    16. 16. Differentiation - Tactics<br />Quality – strong warranties, reliability, customer satisfaction data<br />Innovation – technological sophistication, uniqueness<br />Customer responsiveness – service reputation, speed and ease of problem resolution, ability to customize<br />Examples: Nordstrom, Mercedes, Apple, Dell<br />
    17. 17. Cost and Differentiation<br />cutting-edge production technologies, just-in-time production <br />improved information systems: communications, ordering, data analysis<br />Cost Controls<br />Cost-shifting to customer via self-service provisioning<br />Disintermediation of value chain<br />Off-shoring, outsourcing<br />Differentiate products to satisfy more segments and sub-segments<br />Smaller production runs for “mass customization”<br />Parts standardization and other operational efficiencies<br />Enable larger runs of same platforms despite “differentiated” final products<br />Examples: Target, Uniqlo, Southwest<br />
    18. 18. Cost, plus <br />focus and differentiation<br />
    19. 19. Pure monopolists are the whole market<br />For competitive firm: MR = MC = P because P is “taken.” <br />If you tried to raise price, you would lose all sales. <br />For monopolist, MR  P; rather...<br />MR is always less than P so long as demand curve is downward sloping<br />
    20. 20. Demand Curves(market power means being able to set price)<br />P<br />P<br />Q<br />Facing the individual firm<br />The market overall<br />Q<br />
    21. 21. The Monopolistic Firm is the Market<br />P<br />D<br />Q<br />
    22. 22. What this looks like<br />P<br />(Price)<br />D<br />(Demand)<br />Q<br />(Quantity)<br />MR<br />
    23. 23. Marginal Revenue for Monopolists<br />Example:<br />Perfect competition: price = $5<br />MR = $5 no matter what<br />Monopoly: To sell more units, you have to lower price:<br />At price of $5, you sell 20. TR = 100.<br />At price of $4, you sell 30. TR = 120.<br />MR = Change in total revenue divided by change in output = (120-100)/(20-30) = 20/10 = 2<br />
    24. 24. Oligopolies - groups of firms that together behave as monopolies<br />
    25. 25. Group of eyeglasses firms dominating the industry<br />
    26. 26. Tests of Market Power<br />Number of producer firms<br />Size of each firm<br />Barriers to entry<br />Availability of substitute goods<br />In essence, is the market contestable?<br />
    27. 27. Red Flags for Antitrust<br />Patents<br />Competitors must establish alternate means of producing or license process from patent holder<br />Supply & Distribution Control<br />Control distribution outlets<br />Also: control essential supplies, resources<br />Mergers and acquisitions<br />
    28. 28. Concentration Measures of Monopoly<br />Concentration Ratio – market share of top 4 firms >60% is considered oligopoly<br />2. Herfindahl-Hirschman Index – sum of squares of all the market concentrations<br />if merger creates an HHI > 1800: DOJ will challenge<br />if merger creates an HHI between 1000 – 1800: DOJ will challenge if merger if likely to increase HHI by 100 points or more<br />
    29. 29.
    30. 30. market failure<br />
    31. 31. Public Good<br />Consumption by one person does not interfere with consumption by another<br />Private good: donut<br />Public good: water, air<br />Free-rider problem<br />The market tends to overproduce private goods and underproduce public ones<br />
    32. 32. Public vs. Private Goods<br />Museums vs. individual paintings<br />Clean air vs donuts<br />A park vs. a backyard<br />Anything for which one person’s enjoyment does not interfere with another’s<br />
    33. 33. National Parks and Art Museums?<br />Nicholas Kristof, New York Times, course homepage under “Seminar Reading.”<br />
    34. 34. Natural Monopoly<br />Industry like a utility or the post office that is so vast only one firm can support the fixed cost structure<br />
    35. 35. Minimum Efficient Scale (MES)<br />
    36. 36. Externalities<br />Costs or benefits of production that are borne by a third party – Costs that don’t get added or subtracted<br /> + beekeeper who lives next to a flower grower<br /> - pollution, excessive noise, environmental damage<br />Positive externalities tend to get subsumed into business models, negative externalities are often regulated<br />
    37. 37. Positive Externality: the beekeeper and the flower grower<br />
    38. 38. Negative Externality: pollution<br />Key Issue – what’s good for one isn’t good for many<br />
    39. 39. Tragedy of the Commons<br />
    40. 40. What an externality looks like:<br />S2<br />S<br />(Supply)<br />P<br />(Price)<br />P2<br />Adding the cost of an externality to the supply curve<br />P1<br />D<br />(Demand)<br />Q<br />(Quantity)<br />An exclusion of a portion of the cost of a product<br />
    41. 41. Externalities: Environmental Case Study<br />Pollution and its effects: acid rain, bio-accumulation of mercury in food stocks, asthma due to airborne particulates, etc., emissions of CO2 and other contributors to climate change<br />
    42. 42. Costs of Pollution<br />Estimating the cost of environmental damage/ Tangible or specific costs can be calculated by:<br />Diminished life expectancies<br />Lost work days<br />Direct medical costs<br />Productivity losses<br />Cost of replacing, restoring, remediating environmental damage<br />
    43. 43. Direct and indirect costs<br />Diffuse and concentrated benefits and costs<br />
    44. 44. Payment for power includes infrastructure costs but not externalities like pollution<br />How can externalities be included?<br />
    45. 45. Regulation<br />Governments are generally best positioned to address the problem of externalities by altering the rules under which a particular market operates. <br />
    46. 46. Press / Public Knowledge<br />
    47. 47. Taxes <br />The additional cost is borne directly by the end user in the exact proportion to the quantity of product consumed. <br />
    48. 48. Including the externality as a cost:<br />S2<br />S<br />(Supply)<br />P<br />(Price)<br />P2<br />Adding the cost of an externality to the supply curve<br />P1<br />D<br />(Demand)<br />Q<br />(Quantity)<br />An exclusion of a portion of the cost of a product<br />
    49. 49. Cap and trade<br />Assigning property rights<br />
    50. 50. Coase Theorem<br />A resource allocation can be efficient as long as contracting costs are sufficiently low and property rights are assigned clearly, enforced well, and exchanged readily.<br />Ronald Coase, 1960<br />The free market is more powerful in producing efficient outcomes than previously thought<br />Pricing in externalities lets people trade them. Even if the price isn’t set right the first time, the market will correct it.<br />Assumes transaction costs and monitoring costs are low enough.<br />
    51. 51. Outright Prohibition<br />
    52. 52. Indirect Intervention:Incentives for Innovation<br />Focus on renewables<br />Supporting capital-intensive start-up costs<br />Making alternative energy cost-competitive <br />
    53. 53. 1: Renewable Portfolio Standards<br />Utilities agree to obtain a certain percentage of their power from renewable generators by a point in time. Aadopted by 28 states.<br />Creates two markets with two separate demand curves: a price for fossil fuels and a price for renewables.<br />
    54. 54. 2: Federal Tax Subsidies for renewable energy producers<br />Tax incentives rather than direct support<br />Takes the form of accelerated depreciation and Production Tax Credits (PTCs). <br />PTCs are tax credits approximately equal to 20 cents for each kWh produced by the facility for the first 10 years of its life. <br />An alternative to a PTC is an Investment Tax Credit (ITC) – 30% of construction cost on completion<br />
    55. 55. 3: 2009 Stimulus Package Cash Grants and Federal Debt Guarantees<br />
    56. 56. Pros and Cons<br />Pros<br />Better than no policy support<br /> <br />Cons<br />Hazards associated with the government attempting to pick winners High transaction costs<br />Uncertainty stemming from short vs long-term incentives<br />Competing and conflicting govt. subsidies. Tax credits for renewables made less effective by subsidies for natural gas production. <br />
    57. 57. Externalities in the Arts?<br />Education<br />Public Goods<br />Positive effects on test scores or innovation<br />Others?<br />
    58. 58. Labor Economics<br />
    59. 59. Some Labor Stats<br />The top 500 companies employ 20% of the workforce<br />Walmart employs 0.8% of the workforce<br />Most jobs in the economy are held in small firms.<br />There are approximately 26 million small businesses, of which 19 million are sole proprietorships.<br />Small businesses employ over half of private sector workers and create 60-80% of new jobs. (See Kauffman Foundation for more information)<br />
    60. 60. Determinants of Supply of Labor<br />Tastes<br />Income and Wealth<br />Expectations (for income and wealth)<br />Prices (of consumer goods)<br />Taxes<br />Local markets, skills, barriers to entry and exit<br />
    61. 61. Daniel Pink on Motivation<br />The human question <br />under the economic one:<br />What motivates <br />people to work?<br />purpose, autonomy, <br />money . . .<br /><br />
    62. 62. Steven Levitt Ted Talk<br />The Market for Crack Dealers<br /><br />
    63. 63. Motivation according to Economists<br />Work in order to have leisure time<br />Trading off intrinsic satisfaction and a paycheck<br />Income effect: raising wages makes people work less. Reduce hours without losing income. Opportunity cost of leisure is higher because leisure is more scarce.<br />Substitution effect: raising wages makes people work more. They substitute work for leisure.<br />Income effect<br />substitution effect<br />
    64. 64. Shapes of Supply Curves<br />Investment Banker?<br />
    65. 65. Shapes of Supply Curves<br />Famous Actor?<br />
    66. 66. Shapes of Supply Curves<br />Freelancer?<br />
    67. 67. Monopsony vs. Monopoly(one buyer, many sellersvs. one seller, many buyers)<br />WalMart, Gates Foundation, Warren Buffett. . . <br />
    68. 68. Work vs. Leisure<br />Iain Duncan Smith <br />and the case of <br />benefit reform <br />in England<br />(House of Commons video)<br /><br />
    69. 69. Opportunity Cost of not Working<br />Approximately 55 million people<br />Benefits: 28% of public expenditure (£193bn in payments and tax credits)<br />Up to £26,000 in benefits<br />As of April 2010, £20.30 per week was paid for the first child (including the eldest of a multiple birth) and £13.40 per week was paid for each additional child.<br />
    70. 70. Economics in Everyday Life: “James”<br />
    71. 71. James is a investment analyst and a new dad. Would he rather spend his time at work or at home?<br />
    72. 72. Both. . . (but not assembling Ikea furniture)<br />
    73. 73. Comparative Advantage<br />David Ricardo David Ricardo’s 1817 book On the Principles of Political Economy and Taxation<br />It always makes sense to produce the thing you are best at, even if you are good at other things. <br />Consider two men who live on an island. If they can each either fish or pick coconuts. Both pick coconuts at the same rate (10 per day) but one fishes faster than the other (12 fish instead of 6), then the one who is good at fishing should specialize in that and the other should pick coconuts. This maximizes the total number of fish and coconuts. <br />James has comparative advantage in work and in childrearing. Other people are far better at cribs, and he is willing to pay more than they charge.<br />
    74. 74. (wearing “the economists” hat. . .)<br />From the perspective of society, James specializes in investments.<br />From the perspective of himself and society, he also specializes in parenthood.<br />From his perspective re the crib, it’s all about opportunity cost of his time.<br />
    75. 75. Demand for LaborMalcolm Gladwell<br />Industry norms<br />Concentrated costs, diffuse benefits or vice versa<br />Noneconomic thinking<br />Value-based pay vs. market-based pay<br />
    76. 76. Museum Workers<br />
    77. 77. Links<br />AAMD<br />Guidestar<br />Bureau of Labor Statistics<br />
    78. 78. Economics in <br />Everyday Life (or, the power of non-economics in everyday life):<br />Charmingly kind retirees offering maps<br />