Managerial	  Economics	   California	  College	  of	  the	  Arts	          Amy	  Whitaker	            Residency	  2	  
Class	  Topics	                                    	  1.  Guest	  Speaker:	  Marney	  Morris	  2.  Review	  of	  Price	  E...
Marney	  Morris	      www.marney.com	     www.animatrix.com	  
 	  Interac2ve	  Design	  is	  Self	  Explanatory	  	  	  	  	  If	  a	  design	  is	  good,	  a	  user	  will	  immediate...
Review	  •  Supply	  and	  demand	  •  Price	  Elas2city	  •  Produc2on	  Func2ons	  
supply	  and	  demand	  	     P	                                                             S	  (Price)	                 ...
The	  law	  of	  demand	  	  P	                                                            D	                             ...
Diminishing	  marginal	  returns	                      ©	  Amy	  Whitaker	  -­‐	              a.whitaker@sothebysinsEtute....
The	  relaEonship	  of	  price	  and	  quanEty	     P	                 Change	  in	  price	                       S	  (Pri...
shortage	     P	                                                                S	  (Price)	                              ...
surplus	     P	        2:	  demand	                                                         S	  (Price)	     falls	       ...
shiYs	  in	  supply	  and	  demand	                       ©	  Amy	  Whitaker	  -­‐	               a.whitaker@sothebysinsEt...
cigare_e	  tax	                                          S2	     P	              2:	  like	                      adding	  ...
Airline	  fuel	  more	  expensive?	     P	                                                                   S	  (Price)	 ...
Airline	  fuel	  more	  expensive?	                                                               S2	     P	              ...
Your	  income	  goes	  up.	  .	  .	     P	                                                                  S	  (Price)	  ...
Your	  income	  goes	  up.	  .	  .	     P	                                                                  S	  (Price)	  ...
Consumer	  and	  Producer	  Surplus	     P	                                                              S	  (Price)	     ...
Price	  DiscriminaEon	     P	                                                            S	  (Price)	                     ...
producEon	  funcEons	        ©	  Amy	  Whitaker	  -­‐	  awhitaker@cca.edu	  
Eadweard	  Muybridge	  Time-­‐MoEon	  Studies	  
Frederick	  Taylor	  	  ScienEfic	  Management	  
Excess	  Capacity	  •  ZipCar	  •  AirBnB	  •  Kickstarter	  
Scalable	  Technology	  
Donuts!	  
How	  much	  does	  it	  cost	  to	  make	  a	  donut?	                        Premium	  donut	  -­‐	  $2	  -­‐	  $3.50	  ...
supply	  and	  demand	  	     P	                                                             S	  (Price)	                 ...
Perfect	  CompeEEon	  
All	  donuts	  are	  created	  equal	           Price	  =	  $9/dozen	  
Idea-­‐driven	  	  business	  Brand	  as	  idea	  or	  purpose	  	  For-­‐profit	  or	  non-­‐profit	  	  Big	  picture	  or...
Start	  making	  guesses.	  .	  .	     (“sketching	  in	  numbers”)	  	  
Inputs:	  Beer	  –	  fancy	  and	  cheap,	  Hot	  Dogs	  –	  buns,	  hot	  dogs,	  toppings	  	  	                        ...
Happy	  Dog	            Gordon	  Square	  Gets	  Musical	            Gordon	  Square	  Gets	  Literary	            Orchest...
Monopolis2c	  	  Compe22on	  CompeEEon	  on	  brand	  or	  other	  forms	  of	  market	  segmenta2on	                     ...
Strategy	  of	  MonopolisEc	  CompeEEon	  •    Non-­‐price	  compeEEon	  •    Influence	  over	  demand	  via	  adverEsing,...
How	  do	  people	  react	  to	  changes	  in	  price?	  
Price	  ElasEcity	  of	  Demand	                       %	  change	  in	  the	  quanEty	  ElasEcity	  =	                   ...
Determinants	  of	  Price	  ElasEcity	  •  Availability	  of	  subsEtutes	  •  ProporEon	  of	  your	  income	  •  Luxury	...
price	  elasEcity	  and	  total	  revenue	                                                             1     E	  <	  1,	  ...
CalculaEng	  elasEcity	                                       %	  change	  in	  the	  quanEty	                 ElasEcity	 ...
CalculaEng	  elasEcity	                                       %	  change	  in	  the	  quanEty	                 ElasEcity	 ...
Arc	  or	  Midpoint	  ElasEcity	                                                               Q1	  –	  Q2	               ...
CalculaEng	  elasEcity	                                                                           Q1	  –	  Q2	            ...
Problem	  Set:	  Pasta	  Bar	  Italia	  restaurant	  is	  famous	  in	  Boise	  for	  its	  spaghew	  dinner.	  	  Maria,	...
Example:	  Maple	  Bacon	  Donuts	       Say	  Dynamo	  increases	  the	  price	  from	       $3	  to	  $4.50	  for	  mapl...
Price	  ElasEcity	  of	  Donuts	                                                                                         Q...
Revenue	  and	  Profits?	  Fixed	  cost	  =	  $75	  
Donuts!	  –	  Example	  2	                                                  P1	  =	  $3	                                  ...
Revenue	  and	  Profit?	  
Market	  Power	  and	  Structure	  
Perfect	  vs.	  Imperfect	  CompeEEon	  •  Efficiency	  vs.	  Power	  •  In	  perfect	  compeEEon,	  firms	  are	  powerless	...
Perfect	  CompeEEon	  •    Infinite	  Buyers/Infinite	  Sellers	  –	  Infinite	  consumers	  with	  the	  willingness	  and	 ...
monopoly	        •  Single	  seller	        •  High	  barriers	  to	  entry	        •  Price-­‐maker	  not	  price-­‐taker...
Monopsony	  vs.	  Monopoly	  (one	  buyer,	  many	  sellers	  vs.	  one	  seller,	  many	  buyers)	     WalMart,	  Gates	 ...
Demand	  Curves	                (market	  power	  means	  being	  able	  to	  set	  price)	  P	                           ...
The	  MonopolisEc	  Firm	  is	  the	  Market	       P	                                             D	                     ...
Monopolists	  are	  the	  whole	  market	  •  Firm	  demand	  curve	  =	  industry	  demand	  curve	  •  For	  compeEEve	 ...
What	  this	  looks	  like	     P	  (Price)	                                                    D	                        ...
Marginal	  Revenue	  for	  Monopolists	  Example:	  Perfect	  compeEEon:	  price	  =	  $5	  MR	  =	  $5	  no	  ma_er	  wha...
Bushels	  of	  Fish	  –	  p.	  199	  Marginal	  Revenue	  <	  Price	  for	  monopolist	  for	  every	  sale	  aYer	  the	 ...
Schiller,	  p.	  200	  monopolist	  always	  seek	  to	  produce	  so	  that	  MR	  =	  MC	  	  
Takeaways	  •  The	  decision	  of	  how	  much	  to	  produce	  is	  as	     criEcal	  for	  monopolists	  as	  compeEEve...
oligopolies	  Behave	  like	  a	  monopoly	  but	  made	  up	  of	  individual	  actors,	  so	  they	  face	  problems	  o...
OrganizaEon	  of	  Petroleum	  ExporEng	  Countries	  
Group	  of	  eyeglasses	  firms	  domina2ng	  the	  industry	  
cargo	  surcharge	  collusion	  21	  airlines	  arEficially	  inflated	  passenger	  and	  cargo	  fuel	  surcharges	  betwe...
Price	       Agreement	  •    19	  execuEves	  have	  been	  charged	       with	  wrongdoing	  –	  four	  have	  gone	  t...
Game	  Theory:	  	  Prisoner’s	  Dilemma	  
Oligopolist’s	  Payout	  
Some	  basic	  characterisEcs	  of	  games	  1.	  Simultaneous	  v.	  Sequen2al	  Whether	  it	  is	  played	  sequen*ally...
3.	  Dominant	  Strategy	  Whether	  there	  is	  one	  way	  to	  behave	  that	  always	  works	  best,	  or	  a	  domin...
Expected	  Value	                       “a	  good	  decision	  can	  have	  a	  bad	  outcome”	  If	  I	  play	  poker	  w...
Expected	  Value	  Example	  2:	  	  I	  am	  going	  to	  teach	  a	  class	  and	  charge	  $30.	  •  If	  I	  get	  gre...
Nash	  	    Equilibrium	    	  each	  player	  is	  assumed	  to	  know	  the	  equilibrium	  strategies	  of	  the	  othe...
Cournot	                                                               Companies	  compete	  on	  the	  amount	  of	  outp...
Demand	  Curve	  in	  Oligopoly	  •  Li_le	  consensus	  among	  economists	  on	  oligopoly	  price	  theory	  •  	  Kink...
Review	  cartels,	  pricing	  leadership,	  and	  predatory	  pricing	  
AnEtrust,	  regulaEon,	  natural	  monopoly	  No	  compeEEve	  pressure	  can	  create	  inefficiency	  
Natural	  Monopoly	  Industry	  like	  a	  uElity	  or	  the	  post	  office	  that	  is	  so	  vast	  only	  one	  firm	  ca...
Government	  RegulaEon	  of	  Natural	  Monopolies	  1.	  Regulate	  price	  	  •  P	  =	  MC:	  consistent	  with	  oppor...
AnEtrust	  
Market	      Power	  •  Consumer	     segmentaEon	     and	     discriminatory	     pricing	  •  Divide	  the	     market	...
Barriers	  to	  Entry	  patents;	  monopoly	  franchises;	  exclusive	  suppliers	  (control	  of	  key	  inputs)	  or	  o...
Some	  Determinants	  of	  Market	  Power	  •  ReputaEon	  (for	  toughness	  toward	  new	  entrants)	  •  Long-­‐term	  ...
Tests	  of	  Market	  Power	  •  Number	  of	  producer	  firms	  •  Size	  of	  each	  firm	  •  Barriers	  to	  entry	  • ...
Red	  Flags	  for	  AnEtrust	  •  Patents	  •  CompeEtors	  must	  establish	  alternate	  means	     of	  producing	  or	...
SubsEtutes?	  
MicrosoY’s	  anEtrust	  defense:	  	  That	  prices	  hadn’t	  increased,	  as	  they	  would	  have	  under	  expected	  ...
Cross	  elasEcity	  as	  measure	  Cross	  elasEciEes	  help	  answer	  quesEon	  of	  market	  definiEon:	  •  	  %	  chan...
ConcentraEon	  Measures	  of	  Monopoly	  1.  ConcentraEon	  RaEo	  –	  market	  share	  of	  top	  4	          firms	  >60...
Cost	  Benefit	  of	  RegulaEon	  •  AdministraEve	  Costs	  (public	  sector	  costs)	  •  Compliance	  Costs	  (private	 ...
market	  failure	  
Public	  Good	  •  ConsumpEon	  by	  one	  person	  does	  not	     interfere	  with	  consumpEon	  by	  another	     –  P...
ExternaliEes	  •  Costs	  or	  benefits	  of	  producEon	  that	  are	  borne	                 by	  a	  third	  party	  –	 ...
Examples	  of	  ExternaliEes	  •    Costs	  of	  PolluEon	  •    EsEmaEng	  the	  cost	  of	  environmental	  damage	  •  ...
Remedies?	  •  Regulate	  (producEon	  or	  purchase)	  •  ShiY	  to	  consumers	  (consumer	  tax)	  •  Assign	  Property...
Coase	  Theorem	          A	  resource	  alloca*on	  can	  be	  efficient	  as	  long	  as	          contrac*ng	  costs	  ar...
CCA Whitaker Lecture Residency 2 2011
CCA Whitaker Lecture Residency 2 2011
CCA Whitaker Lecture Residency 2 2011
CCA Whitaker Lecture Residency 2 2011
CCA Whitaker Lecture Residency 2 2011
CCA Whitaker Lecture Residency 2 2011
CCA Whitaker Lecture Residency 2 2011
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CCA Whitaker Lecture Residency 2 2011

  1. 1. Managerial  Economics   California  College  of  the  Arts   Amy  Whitaker   Residency  2  
  2. 2. Class  Topics    1.  Guest  Speaker:  Marney  Morris  2.  Review  of  Price  ElasEcity  and  ProducEon   FuncEons  3.  Market  Power  and  Structure   Monopoly,  Oligopoly,  Duopoly  –  Game  Theory   MonopolisEc  CompeEEon  –  Brand  Power  4.  Market  Failure   ExternaliEes,  RegulaEon,  Environmental  Policy  5.  Guest  Speaker:  John  Bodt  
  3. 3. Marney  Morris   www.marney.com   www.animatrix.com  
  4. 4.    Interac2ve  Design  is  Self  Explanatory          If  a  design  is  good,  a  user  will  immediately  know  how  to  use  it.  To  make  a  design  self  explanatory  there  are  three  simple  rules:    01.  Present  a  minimal  amount  of  informaEon.      02.  Arrange  the  informaEon  so  there  is  an  obvious  starEng  point.      03.  Build  each  "next  step"  on  the  logic  of  the  step  before.      When  designing  for  screens,  here  a  couple  of  addiEonal  Eps:    Reduce  your  variables  so  the  choice  on  the  next  screen  is  obvious.  For  example,  when  you  use  the  same  font,  same  size  font,  same  color  font,  and  line  all  the  text  up,  any  text  that  is  different  (bold,  different  color,  or  different  locaEon)    is  easily  disEnguished.    Register  everything.  When  things  shiY  from  screen  to  screen  they  are  distracEng.  
  5. 5. Review  •  Supply  and  demand  •  Price  Elas2city  •  Produc2on  Func2ons  
  6. 6. supply  and  demand     P   S  (Price)   (Supply)   D   (Demand)   Q   (QuanEty)   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  7. 7. The  law  of  demand    P   D   Q   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  8. 8. Diminishing  marginal  returns   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  9. 9. The  relaEonship  of  price  and  quanEty   P   Change  in  price   S  (Price)   moves  you  along   (Supply)   the  curve.   Change  in  anything   else  shi$s  the   D   curve.   (Demand)   Q   (QuanEty)   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  10. 10. shortage   P   S  (Price)   (Supply)   1:  supply   constricts   2:  demand   increases   D   (Demand)   Q   (QuanEty)   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  11. 11. surplus   P   2:  demand   S  (Price)   falls   (Supply)   1:  supply   increases   D   (Demand)   Q   (QuanEty)   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  12. 12. shiYs  in  supply  and  demand   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  13. 13. cigare_e  tax   S2   P   2:  like   adding  $2   S  (Price)   to  cost   (Supply)   $8   1:  the  government   $6   adds  $2  to  every   pack   D   (Demand)   Q   (QuanEty)   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  14. 14. Airline  fuel  more  expensive?   P   S  (Price)   (Supply)   D   (Demand)   Q   (QuanEty)   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  15. 15. Airline  fuel  more  expensive?   S2   P   S  (Price)   (Supply)   $250   $240   D   (Demand)   Q   (QuanEty)   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  16. 16. Your  income  goes  up.  .  .   P   S  (Price)   (Supply)   D   (Demand)   Q   (QuanEty)   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  17. 17. Your  income  goes  up.  .  .   P   S  (Price)   (Supply)   D2   D   (Demand)   Q   (QuanEty)   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  18. 18. Consumer  and  Producer  Surplus   P   S  (Price)   (Supply)   D   (Demand)   Q   (QuanEty)   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  19. 19. Price  DiscriminaEon   P   S  (Price)   (Supply)   D   (Demand)   Q   (QuanEty)   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  20. 20. producEon  funcEons   ©  Amy  Whitaker  -­‐  awhitaker@cca.edu  
  21. 21. Eadweard  Muybridge  Time-­‐MoEon  Studies  
  22. 22. Frederick  Taylor    ScienEfic  Management  
  23. 23. Excess  Capacity  •  ZipCar  •  AirBnB  •  Kickstarter  
  24. 24. Scalable  Technology  
  25. 25. Donuts!  
  26. 26. How  much  does  it  cost  to  make  a  donut?   Premium  donut  -­‐  $2  -­‐  $3.50  price   Basic  donut  -­‐  $0.80  -­‐  $1   Inputs:  Flour,  Sugar,  Oil,  Labor,  Overhead  
  27. 27. supply  and  demand     P   S  (Price)   (Supply)   D   (Demand)   Q   (QuanEty)   ©  Amy  Whitaker  -­‐   a.whitaker@sothebysinsEtute.com  
  28. 28. Perfect  CompeEEon  
  29. 29. All  donuts  are  created  equal   Price  =  $9/dozen  
  30. 30. Idea-­‐driven    business  Brand  as  idea  or  purpose    For-­‐profit  or  non-­‐profit    Big  picture  or  everyday  
  31. 31. Start  making  guesses.  .  .   (“sketching  in  numbers”)    
  32. 32. Inputs:  Beer  –  fancy  and  cheap,  Hot  Dogs  –  buns,  hot  dogs,  toppings       ©  Amy  Whitaker  -­‐  awhitaker@cca.edu  
  33. 33. Happy  Dog   Gordon  Square  Gets  Musical   Gordon  Square  Gets  Literary   Orchestral  Manoeuvres  at  the  Dog   Musicians  who  are  dishwashers   Ticket  sales  that  go  straight  to  the  band   ©  Amy  Whitaker  -­‐  awhitaker@cca.edu  
  34. 34. Monopolis2c    Compe22on  CompeEEon  on  brand  or  other  forms  of  market  segmenta2on   You     Are  The  determinaEon  has  to  do  with   Here.  whether  there  are  subsEtutes  –  perfect,  imperfect,  improvised  or  otherwise  
  35. 35. Strategy  of  MonopolisEc  CompeEEon  •  Non-­‐price  compeEEon  •  Influence  over  demand  via  adverEsing,  branding  •  Increase  switching  costs  •  Bolster  number  of  complements  •  Extended  service  agreements,  frequent  upgrades  •  Network  externaliEes  •  Technical  standards  (Blue  Ray  v.  HD  DVD)  
  36. 36. How  do  people  react  to  changes  in  price?  
  37. 37. Price  ElasEcity  of  Demand   %  change  in  the  quanEty  ElasEcity  =   %  change  in  the  price  
  38. 38. Determinants  of  Price  ElasEcity  •  Availability  of  subsEtutes  •  ProporEon  of  your  income  •  Luxury  vs.  necessity  •  Time  horizon   ©  Amy  Whitaker  -­‐  awhitaker@cca.edu  
  39. 39. price  elasEcity  and  total  revenue   1 E  <  1,  inelasEc   E  >  1,  elasEc   Unit  elasEc   (unitary  elasEc)   ©  Amy  Whitaker  -­‐  awhitaker@cca.edu  
  40. 40. CalculaEng  elasEcity   %  change  in  the  quanEty   ElasEcity  =   %  change  in  the  price     (30-­‐20)  /  30   1/3   ElasEcity  =    =    =   4/3  =  1.3   (5-­‐4)/4   1/4  1.  The  price  of  a  la_e  goes  up  from  $4  to  $5.    30   people  buy  at  $4,  and  20  people  buy  at  $5.       ©  Amy  Whitaker  -­‐  awhitaker@cca.edu  
  41. 41. CalculaEng  elasEcity   %  change  in  the  quanEty   ElasEcity  =   %  change  in  the  price     1/2   (30-­‐20)  /  20   ElasEcity  =    =    =   5/2  =  2.5   (5-­‐4)/5   1/5  2.  The  price  of  a  la_e  goes  down  from  $5  to  $4.       ©  Amy  Whitaker  -­‐  awhitaker@cca.edu  
  42. 42. Arc  or  Midpoint  ElasEcity   Q1  –  Q2   Q1  +  Q2   2  Elas2city  =   P1  –  P2   P1  +  P2   2   ©  Amy  Whitaker  -­‐  awhitaker@cca.edu  
  43. 43. CalculaEng  elasEcity   Q1  –  Q2   Elas2city  =   Q1  +  Q2   2   P1  –  P2   P1  +  P2     2   (30-­‐20)  /  (20  +  30)/2   10/25   ElasEcity  =    =    =   0.4  /  0.22  =   (5-­‐4)/(5  +4)/2   1  /  4.5   1.81         ©  Amy  Whitaker  -­‐  awhitaker@cca.edu  
  44. 44. Problem  Set:  Pasta  Bar  Italia  restaurant  is  famous  in  Boise  for  its  spaghew  dinner.    Maria,  the  chef,  may  be  the  only  purveyor  of  fiYh  generaEon  Tuscan  recipes  in  the  state  of  Idaho.    Maria  prices  the  dish  at  $12,  and  100  people  order  it  each  night.    Every  Tuesday,  she  hosts  ‘student  night’  and  the  dish  is  $8.    On  Tuesdays,  200  people  order  it.  What  is  the  price  elasEcity  of  demand  for  Maria’s  spaghew?     ©  Amy  Whitaker  -­‐  awhitaker@cca.edu  
  45. 45. Example:  Maple  Bacon  Donuts   Say  Dynamo  increases  the  price  from   $3  to  $4.50  for  maple  bacon  donut.     They  were  selling  100  a  day.    Now   they  sell  75.   What  is  the  PED?    Revenue?  If  $2  per   donut  and  $75  overhead,  what  is  their   profit?    
  46. 46. Price  ElasEcity  of  Donuts   Q1  –  Q2  P1  =  $3   Elas2city  =   Q1  +  Q2  P2  =  $4.50     2     P1  –  P2  Q1  =  100   P1  +  P2  Q2  =  75     2   (100-­‐75)  /  (100  +  75)/2   25/87.5   ElasEcity  =    =    =   0.286  /  0.4  =   (3-­‐4.5)/(3  +4.5)/2   1.5  /  3.75   0.714         ©  Amy  Whitaker  -­‐  awhitaker@cca.edu  
  47. 47. Revenue  and  Profits?  Fixed  cost  =  $75  
  48. 48. Donuts!  –  Example  2   P1  =  $3   P2  =  $4.50     Q1  =  100   Q2  =  50   (100-­‐50)  /  (100  +  50)/2   50/75  ElasEcity  =    =    =   0.66  /  0.4  =   (3-­‐4.5)/(3  +4.5)/2   1.5  /  3.75   1.67  
  49. 49. Revenue  and  Profit?  
  50. 50. Market  Power  and  Structure  
  51. 51. Perfect  vs.  Imperfect  CompeEEon  •  Efficiency  vs.  Power  •  In  perfect  compeEEon,  firms  are  powerless   –  They  do  not  set  price.    They  can  only   respond.  •  Economists  believe  perfect  compeEEon   creates  efficiency  which  allocates  resources   effecEvely  –  “allocaEve  efficiency.  
  52. 52. Perfect  CompeEEon  •  Infinite  Buyers/Infinite  Sellers  –  Infinite  consumers  with  the  willingness  and  ability   to  buy  the  product  at  a  certain  price,  Infinite  producers  with  the  willingness  and   ability  to  supply  the  product  at  a  certain  price.  •  Zero  Entry/Exit  Barriers  –  It  is  relaEvely  easy  for  a  business  to  enter  or  exit  in  a   perfectly  compeEEve  market.  •  Perfect  Factor  Mobility  -­‐  In  the  long  run  factors  of  producEon  are  perfectly  mobile   allowing  free  long  term  adjustments  to  changing  market  condiEons.  •  Perfect  Informa2on  -­‐  Prices  and  quality  of  products  are  assumed  to  be  known  to   all  consumers  and  producers.  •  Zero  Transac2on  Costs  -­‐  Buyers  and  sellers  incur  no  costs  in  making  an  exchange   [Perfect  mobility].  •  Profit  Maximiza2on  -­‐  Firms  aim  to  sell  where  marginal  costs  meet  marginal   revenue,  where  they  generate  the  most  profit.  •  Homogeneous  Products  –  The  characterisEcs  of  any  given  market  good  or  service   do  not  vary  across  suppliers.  •  Constant  Returns  to  Scale  -­‐  Constant  returns  to  scale  insure  that  there  are   sufficient  firms  in  the  industry.    
  53. 53. monopoly   •  Single  seller   •  High  barriers  to  entry   •  Price-­‐maker  not  price-­‐taker   •  No  subsEtutes  (pure   monopoly),  or  power  in   proporEon  to  availability  of   subsEtutes   •  If  more  subsEtute  products   are  available,  demand   elasEcity  will  be  greater   and  mark-­‐up  will  be  lower  
  54. 54. Monopsony  vs.  Monopoly  (one  buyer,  many  sellers  vs.  one  seller,  many  buyers)   WalMart,  Gates  Founda2on,  Warren  Buffeg.  .  .    
  55. 55. Demand  Curves   (market  power  means  being  able  to  set  price)  P   P   Q   Q   The  market  overall   Facing  the  individual   firm  
  56. 56. The  MonopolisEc  Firm  is  the  Market   P   D   Q  
  57. 57. Monopolists  are  the  whole  market  •  Firm  demand  curve  =  industry  demand  curve  •  For  compeEEve  firm:  MR  =  MC  =  P  because  P  is   “taken.”    •  If  you  tried  to  raise  price,  you  would  lose  all  sales.    •  For  monopolist,  MR  ≠  P;  rather...  •  MR  is  always  less  than  P  so  long  as  demand  curve   is  downward  sloping  
  58. 58. What  this  looks  like   P  (Price)   D   (Demand)   Q   MR   (QuanEty)  
  59. 59. Marginal  Revenue  for  Monopolists  Example:  Perfect  compeEEon:  price  =  $5  MR  =  $5  no  ma_er  what    Monopoly:  To  sell  more  units,  you  have  to  lower  price:  At  price  of  $5,  you  sell  20.    TR  =  100.  At  price  of  $4,  you  sell  30.  TR  =  120.    MR  =  Change  in  total  revenue  divided  by  change  in  output  =  (120-­‐100)/(20-­‐30)  =  20/10  =  2  
  60. 60. Bushels  of  Fish  –  p.  199  Marginal  Revenue  <  Price  for  monopolist  for  every  sale  aYer  the  theoreEcal  first    
  61. 61. Schiller,  p.  200  monopolist  always  seek  to  produce  so  that  MR  =  MC    
  62. 62. Takeaways  •  The  decision  of  how  much  to  produce  is  as   criEcal  for  monopolists  as  compeEEve  firms   but  in  a  different  way    •  Over-­‐producEon  raises  costs  above  the  point   where  MR  =  MC,  and  profits  would  not  be   maximized  •  Even  monopolists  can’t  charge  the  highest   possible  rate  if  they  want  to  be  profit-­‐ maximizing  
  63. 63. oligopolies  Behave  like  a  monopoly  but  made  up  of  individual  actors,  so  they  face  problems  of  coordinaEon  and  game  theory    Examples:  oil  cartel  (OPEC),  airlines,  eyeglasses  pre-­‐Warby  Parker  
  64. 64. OrganizaEon  of  Petroleum  ExporEng  Countries  
  65. 65. Group  of  eyeglasses  firms  domina2ng  the  industry  
  66. 66. cargo  surcharge  collusion  21  airlines  arEficially  inflated  passenger  and  cargo  fuel  surcharges  between  2000  and  2006  to  make  up  for  lost  profits.    In  July  2005,  LuYhansa  told  the  JusEce  Department  about  airlines  conspiring  to  set  cargo  surcharges.  By  ValenEnes  Day  2006,  FBI  agents  and  their  counterparts  in  Europe  made  the  invesEgaEon  public  by  raiding  airline  offices.    AYer  those  raids,  BriEsh-­‐based  Virgin  AtlanEc  came  forward  about  its  role  in  a  similar  scheme  to  set  fuel  surcharges  for  passengers.  
  67. 67. Price   Agreement  •  19  execuEves  have  been  charged   with  wrongdoing  –  four  have  gone  to   prison      •  21  airlines  have  paid  more  than  $1.7   billion  in  fines  in  one  of  the  largest   criminal  anEtrust  invesEgaEons  in   U.S.  history.  •  The  court  cases  reveal  a  complex  web   of  schemes  between  mostly   internaEonal  carriers  willing  to  fix   fees  in  lockstep  with  compeEtors  for   flights  to  and  from  the  United  States.  •  Convicted  airlines  include  BriEsh   Airways,  Korean  Air,  and  Air  France-­‐ KLM.  No  major  U.S.  carriers  have   been  charged.  •  The  price-­‐fixing  unraveled  largely   because  two  airlines  decided  to  come   clean  and  turn  in  their  co-­‐ conspirators.  
  68. 68. Game  Theory:    Prisoner’s  Dilemma  
  69. 69. Oligopolist’s  Payout  
  70. 70. Some  basic  characterisEcs  of  games  1.  Simultaneous  v.  Sequen2al  Whether  it  is  played  sequen*ally  (one  player  chooses,  then  the  other  like  Ec-­‐tac-­‐toe  or  chess)  or  simultaneously  (both  choose  at  the  same  Eme  like  two  magazines  choosing  newspaper  headlines).    The  Prisoner’s  Dilemma  is  a  simultaneous  game  because  they  are  quesEoned  at  the  same  Eme.    Simultaneous  games  tend  to  be  modelled  in  tables,  sequenEal  games  in  trees  (see  later).      2.  Backward  Induc2on  Look  forward,  reason  back.    In  a  simultaneous  game,  this  means  to  imagine  your  way  into  your  rival’s  shoes,  see  what  their  best  strategy  is  and  assume  they  will  be  doing  the  same  to  you  (ad  infinitum),  and  reason  back  to  what  to  do  accordingly.    In  a  sequenEal  game,  it  means  follow  your  move  through  a  few  steps  and  if  you  would  fail  on  step  three  or  four  of  forty,  then  don’t  undertake  step  one.    (In  chess,  if  you  see  a  checkmate  five  moves  away,  you  don’t  move  your  pawn  out  on  move  1.)        
  71. 71. 3.  Dominant  Strategy  Whether  there  is  one  way  to  behave  that  always  works  best,  or  a  dominated  strategy  in  which  case  it  is  always  the  worst  outcome—or  neither.  The  way  to  figure  out  whether  you  have  a  dominant  strategy  is  mentally  to  picture  a  row  of  the  table  and  to  superimpose  it  on  the  other  rows.  If  it  is  always  higher  for  every  box,  it  is  dominant.      4.  Credibility  and  Commitment:  Threats  and  Promises  Many  games  –  eg,  nuclear  disarmament,  poliEcs,  parenthood  –  rest  on  the  credibility  of  threats  and  promises.    An  incenEve  has  to  be  believable,  and  a  threat  has  to  be  plausible  and  in  proporEon  to  the  offense.    Commitment,  as  in  the  game  of  chicken  (cars  driving  head  on)  is  a  form  of  threat  or  promise.          5.  Repeat  or  Single  Game?  Be  more  fierce  in  a  single  game  and  more  cooperaEve  in  a  repeated  game.        6.  Predictability  It  is  always  strategically  be_er  to  be  unpredictable,  as  in  a  sport  like  football.  
  72. 72. Expected  Value   “a  good  decision  can  have  a  bad  outcome”  If  I  play  poker  with  Bob  and  Anne,  these  three  things  could  happen:    •  A  50%  chance  of  making  $20  •  A  30%  chance  of  losing  $20  •  A  20%  chance  of  breaking  even       Expected  value  =  the  probability  x    the  value  of  the  outcome    What  is  the  expected  value  of  each  outcome?  50%  chance  of  $20  =  .5  x  $20  =  +$10  30%  chance  of  $20  =  .3  x  -­‐$20  =  -­‐$6  20%  chance  of  zero  =  .2  x  $0  =  0  
  73. 73. Expected  Value  Example  2:    I  am  going  to  teach  a  class  and  charge  $30.  •  If  I  get  great  a_endance,  100  people  will   come.    ($30  x  100  people  =  $3,000)    •  If  I  get  poor  a_endance,  20  people  will   come.      ($30  x  20  people  =  $600)    At  50/50  odds,  that  is  $1500  +  $300  =  $1800  At  20/80  odds,  that  is  $600  +  480  =  $1080    
  74. 74. Nash     Equilibrium    each  player  is  assumed  to  know  the  equilibrium  strategies  of  the  other  players,  and  no  player  has  anything  to  gain  by  changing  only  his  or  her  own  strategy  unilaterally  
  75. 75. Cournot   Companies  compete  on  the  amount  of  output   they  will  produce,  which  they  decide  on   independently  of  each  other  and  at  the  same   Eme  Firm  treats  the  output  level  of  its  compe&tors  as  fixed  and  decides  how  much  it  should  produce.  Cournot  Equilibrium:  each  firms  output  maximizes  its  profits  given  the  output  of  the  other  firms    
  76. 76. Demand  Curve  in  Oligopoly  •  Li_le  consensus  among  economists  on  oligopoly  price  theory  •   Kinked  demand  curve  is  a  fudge:  really  economists’  way  of  saying   “we  don’t  know  how  rivals  are  going  to  respond  to  an  oligopolist’s   change  in  price,  so  here  are  the  major  opEons”    •  If  rivals  match  price  reduc*ons  but  not  increases,  kink  results  •  Unmatched  price  decrease  leads  to  increased  sales  and  market   share  at  lower  prices:  unlikely  outcome  •  Unmatched  price  increase  leads  to  reduced  sales  at  higher  price  •  Matched  price  decrease  leads  to  growth  in  total  quan*ty   demanded,  but  revenue  falls  •   Pricing  behavior  cannot  be  precisely  formulated  for  oligopoly,   because  it  is  highly  dependent  upon  assumpEons  used  
  77. 77. Review  cartels,  pricing  leadership,  and  predatory  pricing  
  78. 78. AnEtrust,  regulaEon,  natural  monopoly  No  compeEEve  pressure  can  create  inefficiency  
  79. 79. Natural  Monopoly  Industry  like  a  uElity  or  the  post  office  that  is  so  vast  only  one  firm  can  support  the  fixed  cost  structure  
  80. 80. Government  RegulaEon  of  Natural  Monopolies  1.  Regulate  price    •  P  =  MC:  consistent  with  opportunity  cost  •  because  MC  is  always  less  than  ATC,  would  cause  a  loss  on  every  unit  produced      2.  Provide  Subsidy:  •   P  =  MC  +  subsidy  3.  Regulate  Profit:  •  P=ATC  •  Doesn’t  regulate  cost  4.  Regulate  output:  •  Require  minimum  level  of  output  •  Doesn’t  specify  quality  
  81. 81. AnEtrust  
  82. 82. Market   Power  •  Consumer   segmentaEon   and   discriminatory   pricing  •  Divide  the   market   according  to   willingness  to   pay,  and   charge   different  prices  
  83. 83. Barriers  to  Entry  patents;  monopoly  franchises;  exclusive  suppliers  (control  of  key  inputs)  or  outlets;  predatory  liEgaEon  (large  firms  have  resources  to  liEgate);  acquisiEon  of  compeEtors;  scale  economies,  brand  (to  an  extent)  
  84. 84. Some  Determinants  of  Market  Power  •  ReputaEon  (for  toughness  toward  new  entrants)  •  Long-­‐term  contracts  with  key  suppliers  (that   make  entry  hard)  •  Licenses/patents  •  Learning  curve  effects  (first  mover  advantage)  •  Brand  advantage  (strong  for  “experience  goods”)  •  High  exit  costs  (deters  risk  of  entry)  
  85. 85. Tests  of  Market  Power  •  Number  of  producer  firms  •  Size  of  each  firm  •  Barriers  to  entry  •  Availability  of  subsEtute  goods    In  essence,  is  the  market  contestable?    
  86. 86. Red  Flags  for  AnEtrust  •  Patents  •  CompeEtors  must  establish  alternate  means   of  producing  or  license  process  from  patent   holder  •  Supply  &  DistribuEon  Control  •  Control  distribuEon  outlets  •  Also:  control  essenEal  supplies,  resources  •  Mergers  and  acquisiEons  
  87. 87. SubsEtutes?  
  88. 88. MicrosoY’s  anEtrust  defense:    That  prices  hadn’t  increased,  as  they  would  have  under  expected  monopoly  condiEons  of  restricEng  supply      Also,  that  significant  anEtrust  acEon  would  sEfle  innovaEon      The  reality  is  that  prices  didn’t  need  to  be  super  high,  only  for  MR  =  MC    Court  found  that  MicrosoY  had  behaved  illegally  to  maintain  its  monopoly  posiEon  and  to  take  advantage  of  the  fact  that  suppliers  and  consumers  had  limited  alternaEves  given  network  effects,  etc.  
  89. 89. Cross  elasEcity  as  measure  Cross  elasEciEes  help  answer  quesEon  of  market  definiEon:  •   %  change  in  QuanEty  demanded  of  X  divided  by   %  change  in  price  of  Y.  Analysis  of  cross-­‐elasEcity   shows  the  strength  of  subsEtuEon  •  If  cross-­‐elasEciEes  are  strongly  posiEve  –  if   increase  in  price  of  product  being  examined   causes  significant  increase  in  quanEty  demanded   of  another  product  =  effecEve  subsEtutes  
  90. 90. ConcentraEon  Measures  of  Monopoly  1.  ConcentraEon  RaEo  –  market  share  of  top  4   firms  >60%  is  considered  oligopoly    2.  Herfindahl-­‐Hirschman  Index  –  sum  of  squares  of  all  the  market  concentraEons   –  if  merger  creates  an  HHI  >  1800:  DOJ  will  challenge   –  if  merger  creates  an  HHI  between  1000  –  1800:  DOJ   will  challenge  if  merger  if  likely  to  increase  HHI  by  100   points  or  more    
  91. 91. Cost  Benefit  of  RegulaEon  •  AdministraEve  Costs  (public  sector  costs)  •  Compliance  Costs  (private  sector  reports)  •  Efficiency  costs  (opportunity  costs)  
  92. 92. market  failure  
  93. 93. Public  Good  •  ConsumpEon  by  one  person  does  not   interfere  with  consumpEon  by  another   –  Private  good:  donut   –  Public  good:  water,  air  •  Free-­‐rider  problem  •  The  market  tends  to  overproduce  private   goods  and  underproduce  public  ones  
  94. 94. ExternaliEes  •  Costs  or  benefits  of  producEon  that  are  borne   by  a  third  party  –  Costs  that  don’t  get  added   or  subtracted          +  beekeeper  who  lives  next  to  a  flower  grower          -­‐  polluEon,  excessive  noise,  environmental   damage  •  PosiEve  externaliEes  tend  to  get  subsumed   into  business  models,  negaEve  externaliEes   are  oYen  regulated    
  95. 95. Examples  of  ExternaliEes  •  Costs  of  PolluEon  •  EsEmaEng  the  cost  of  environmental  damage  •  Tangible  or  specific  costs  can  be  calculated  by:  •  Diminished  life  expectancies  •  Lost  work  days  •  Direct  medical  costs  •  ProducEvity  losses  •  Cost  of  replacing,  restoring,  remediaEng   environmental  damage  
  96. 96. Remedies?  •  Regulate  (producEon  or  purchase)  •  ShiY  to  consumers  (consumer  tax)  •  Assign  Property  Rights  (Coase  Theorem)  
  97. 97. Coase  Theorem   A  resource  alloca*on  can  be  efficient  as  long  as   contrac*ng  costs  are  sufficiently  low  and  property   rights  are  assigned  clearly,  enforced  well,  and   exchanged  readily.  •  Ronald  Coase,  1960  •  The  free  market  is  more  powerful  in  producing  efficient   outcomes  than  previously  thought  •  Pricing  in  externaliEes  lets  people  trade  them.    Even  if  the   price  isn’t  set  right  the  first  Eme,  the  market  will  correct  it.  

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