Chapter 12The Economics of InformationLearning Objecti

Chapter 12
The Economics of Information
Learning Objectives
© 2022 by McGraw-Hill Education. All Rights Reserved.
12-‹#›
Identify
Identify strategies to manage risk and uncertainty, including
diversification and optimal search strategies.
Calculate
Calculate the profit-maximizing output and price in an
environment of uncertainty.
Explain
Explain why asymmetric information about “hidden actions” or
“hidden characteristics” can lead to moral hazard and adverse
selection and identify strategies for mitigating these potential
problems.

Explain
Explain how differing auction rules and information structures
impact the incentives in auctions and determine the optimal
bidding strategies in a variety of auctions with independent or
correlated values.
A variable that measures the outcome of an uncertain event is
called a random variable.
Probabilities can be attached to different values of a random
variable that denote the chance that a value occurs.
Information about uncertain outcomes can be summarized by the
mean (or, expected value) and variance of a random variable.
Measuring Uncertain Outcomes
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3
The mean (or expected value) of a random variable is the sum of
the probabilities that different outcomes will occur multiplied
by the resulting payoffs.
If denote the possible outcomes of the random variable and the
corresponding probabilities of the outcomes, then the expected
value of is:
, where .
The mean does not provide information about the risk
associated with the random variable.

Measuring Uncertain Outcomes: Mean
12-‹#›
4
The variance of a random variable is the sum of the
probabilities that different outcomes will occur multiplied by
the squared deviation from the mean of the resulting payoffs.
If denote the possible outcomes of the random variable, their
corresponding probabilities are , and the expected value of is ,
then the variance of is:
The variance is a common measure of risk.
The standard deviation is the positive square root of the
variance: .
Measuring Uncertain Outcomes:
Variance and Standard Deviation
12-‹#›
5
Attitudes toward risk differ among consumers.
A risk-averse consumer prefers a sure amount of to a risky
prospect with an expected value of .
A risk-loving consumer prefers a risky prospect with an
expected value of to a sure amount of .

A risk-neutral consumer is indifferent between a risky prospect
with an expected value of and a sure amount of .
Risk Aversion
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6
Risk analysis can used to examine situations where consumers
are uncertain about product quality.
Consider a consumer who regularly uses Brand X. If a new
product enters the market, Brand Y, under what conditions will
the consumer be willing to try the new product?
Issues to overcome and consider:
Relative certainty about Brand X.
At equal prices among other things, a risk averse consumer will
continue to purchase Brand X, since a risk averse consumer
prefers the sure thing (Brand X) to a risky prospect (Brand Y).
Two tactics can be employed to induce a risk averse consumer
to try a new product:
Lower the price of Brand Y.
Try to convince consumer the new product’s quality is higher
than the old product.
Managerial Decisions with
Risk-Averse Consumers: Product Quality
12-‹#›

7
Chain stores: may be in a firm’s best interest to become part of
a chain store
Standardization, reputation, increased chance of survival
Online reviews: can help even the playing field between chains
and independent stores.
Insurance: the fact that consumers are risk averse implies they
are willing to pay to avoid risk.
Managerial Decisions with Risk- Averse Consumers
12-‹#›
To identify the low-price seller from among many firms selling
an identical product, consumers sometimes incur a cost, , to
obtain each price quote.
After observing each price quote, a consumer must weigh the
expected benefit from acquiring an additional price quote with
the additional cost.
Consumer Search
12-‹#›
9
Suppose that three-quarters of stores in a market charge and
one-quarter charge .
A consumer observing a price of should stop searching since

there is no price below .
What should a risk-neutral consumer do after observing a price
of , if search occurs with free recall and with replacement?
One-quarter of the time the consumer will save .
Three-quarters of the time the consumer will save nothing.
The expected benefit from an additional search is: .
A consumer should search for a lower price as long as the
expected benefits for an additional search are greater than the
cost of an additional search.
Consumer Search
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10
Optimal Search Strategy (Figure 12-1)
Price
Reservation price:
Price at which a consumer
is indifferent between
purchasing at that price and
searching for a lower price.
Expected
benefits
and costs
Acceptance Price

Rejection Price
8-11
12-‹#›
11
The optimal search rule is such that the consumer rejects prices
above the reservation price, , and accepts prices below the
reservation price. Stated differently, the optimal search strategy
is to search for a better price when the price charged by a firm
is above the reservation price and stop searching when a price
below the reservation price is found.
Consumer’s Search Rule
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12
Increasing Cost of Search (Figure 12-2)
Price
Expected
benefits
and costs

Due to increase in search costs.
12-‹#›
13
While managers must understand the impact of uncertainty on
consumer behavior, uncertainty also impacts the manager’s
input and output decisions.
Manager’s risk profiles:
Risk averse: a manager who prefers a risky project with a lower
expected value if the risk is lower than a project with a higher
expected value.
Risk loving: manager who prefers a risky project with higher
expected value and higher risk to one with lower expected value
and lower risk.
Risk neutral: manager interested in maximizing expected
profits; the variance of profits does not impact a risk-neutral
manager’s decisions.
Manager’s Risk Attitudes
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14
A risk-averse manager is considering two projects. The first
project involves expanding the market for bologna; the second
involves expanding the market for caviar. There is a 10 percent

chance of recession and a 90 percent chance of an economic
boom. The following table summarizes the profits under the
different scenarios. Which project should manager undertake,
and why?
a
Risk Aversion In Action: Problem
ProjectBoom
(90%)Recession (10%)MeanStandard DeviationBologna-
$10,000$12,000-$7,800$6,600Caviar20,000-
8,00017,2008,400Joint10,0004,0009,4001,800Safe (T-
Bill)3,0003,0003,0000
12-‹#›
15
Risk Aversion In Action: Answer
Managers should not invest in T-Bills
The joint project is assured of making at least $4,000, which is
greater than $3,000 under the T-Bill scenario.
Since the expected returns of the bologna project are negative,
neither a risk-neutral nor a risk-averse manager would choose to
undertake this project.

The manager should adopt either the caviar project or the joint
project. Which project will depend on his or her risk
preferences.
ProjectBoom
$10,000$12,000-$7,800$6,600Caviar20,000-
8,00017,2008,400Joint10,0004,0009,4001,800Safe (T-
Bill)3,0003,0003,0000
12-‹#›
16
Notice from the previous problem that by investing in multiple
projects, the manager may be able to reduce risk.
The process of potentially reducing risk by investing in multiple
projects is called diversification.
Whether it is optimal to diversify depends on a manager’s risk
preferences and the incentives provided to the manager to avoid
risk.
Manager’s Risk Attitudes and Diversification
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17
When producers are uncertain about the prices of inputs, an

optimizing firm will use optimal search strategies.
These strategies mimic consumer search previously developed.
Producer Search
12-‹#›
18
The basic principles of profit maximization can be modified to
deal with uncertainty.
If demand (hence, revenue) is uncertain and the manager is risk
neutral, then the manager will want to maximize expected
profits by producing the output where the expected marginal
revenue equals marginal cost:
Profit Maximization and Uncertainty
12-‹#›
19
Appleway Industries produces apple juice and sells it in a
competitive market. The firm’s manager must determine how
much juice to produce before he knows what the market
(competitive) price will be.
Economists estimate that there is a 30 percent chance the
market price will be $2 per gallon and a 70 percent chance it
will be $1 per gallon when the juice hits the market.

If the firm’s cost function is , how much juice should be
produced to maximize expected profits?
What are the expected profits of Appleway Industries?
In Action: Problem
12-‹#›
20
Appleway Industries’ profits are
Since price is uncertain, the firm’s revenues and profit are
uncertain. For competitive firms, MR=p; thus, MR is also
uncertain. To maximize expected profits, the manager equates
expected price with marginal cost.
The expected price is: .
Therefore, manager should produce output where:
gallons.
Therefore, expected profits are $645.
In Action: Answer
12-‹#›
21

Uncertainty can have a profound impact on the ability of
markets to efficiently allocate resources.
Some markets are characterized by individuals who have better
information than others.
Implication: Those individuals with the least information may
choose not to participate in a market.
A market with asymmetric information one in which some
people have better information than others. There are two
specific manifestations related to asymmetric information in
markets:
Adverse selection
Moral hazard
Asymmetric Information
12-‹#›
22
Adverse selection refers to situations where individuals have
hidden characteristics and in which a selection process results
in a pool of individuals with undesirable characteristics.
In this context, a hidden characteristic is something that one
party to a transaction knows about itself, but which is unknown
by the other party.
Asymmetric Information: Adverse Selection
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23
Moral hazard refers to a situation where one party to a contract
takes a hidden action that benefits his or her at the expense of
another party.
In this context, a hidden action is an action taken by one party
in a relationship that cannot be observed by the other party.
One way to mitigate the moral hazard problem is an incentive
contract.
Asymmetric Information: Moral Hazard
12-‹#›
24
Another way to mitigate the problem of moral hazard is
signaling, which is an attempt by an informed party to send an
observable indicator (or signal) of his or her hidden
characteristics to an uninformed party.
For signaling to be effective it must be:
observable by the uninformed party.
a reliable indicator of the unobservable characteristic(s) and
difficult for parties with other characteristics to easily mimic.
Signaling
12-‹#›

25
A final way to mitigate the moral hazard problem is by
screening, which is an attempt by an uninformed party to sort
individuals according to their characteristics.
Screening may be achieved through a self-selection device.
A self-selection device is a mechanism in which informed
parties are presented with a set of options, and the options they
choose reveal their hidden characteristics to an uninformed
party.
Screening
12-‹#›
26
An auction is a mechanism where potential buyers compete for
the right to own a good, service, or, more generally, anything of
value.
Sellers participating in an auction offer an item for sale and
wish to obtain the highest price.
Buyers participating in an auction seek to obtain the item at the
lowest possible price.
Bidders’ risk preferences can affect bidding strategies and the
expected revenue a seller receives.
Types of Auctions
12-‹#›

27
There are Four basic types of auction:
English (ascending-bid)
First-price, sealed-bid
Second-price, sealed-bid
Dutch (descending-bid)
These auctions differ with respect to:
The timing of bidder decisions (simultaneously or sequentially)
The amount the winner is required to pay.
Differences Among Auctions Types
12-‹#›
28
An English auction is an ascending sequential-bid auction in
which bidders observe the bids of others and decide whether or
not to increase the bid. The auction ends when a single bidder
remains; this bidder obtains the item and pays the auctioneer the
amount of the bid.
Bidders continually obtain information about one another’s
bids.
Bidder who values the item the most will win.
English Auction
12-‹#›

29
A first-price, sealed-bid auction is a simultaneous-move auction
in which bidders simultaneously submit bids to an auctioneer.
The auctioneer awards the item to the highest bidder, who pays
the amount bid.
Bidders obtain no information about one another’s bids.
First-Price, Sealed-Bid Auction
12-‹#›
30
A second-price, sealed-bid auction is a simultaneous-move
auction in which bidders simultaneously submit bids to an
auctioneer. The auctioneer awards the item to the highest
bidder, who pays the amount bid by the second-highest bidder.
Bidder who values the item the most will win but pays the
second-highest bid.
Second-Price, Sealed-Bid Auction
12-‹#›
31
A Dutch auction is a descending sequential-bid auction in which
the auctioneer beings with a high asking price and gradually

reduces the asking price until one bidder announces a
willingness to pay that price for the item.
Bidders obtain no information about one another’s bids
throughout the auction process.
Bidder who values the item the most will win and pay the
amount of his or her bid.
Dutch Auction
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32
The Dutch and first-price, sealed-bid auctions are strategically
equivalent; that is, the optimal bids by participants are identical
for both types of auctions.
Strategic Equivalence of Dutch
and First-Price Auctions
12-‹#›
33
While the four auction types differ with respect to the
information bidders have about the bids of other bidders,
bidders also have different information structures regarding
their own valuation of the item being auctioned.
Perfect information (this is rare)
Independent private values (determined by bidder’s individual
tastes)
Affiliated (or correlated) value estimates

Special case: common-value auctions
Information Structures
12-‹#›
34
Optimal Bidding Strategies
for Risk-Neutral Bidders
12-‹#›
35
An optimal bidding strategy for risk-neutral bidders is a
strategy that maximizes a bidder’s expected profit.
Optimal bids depend on the
1. type of auction
2. information available to bidders at the time of bidding
With independent private values, bidders know their own values
prior to the auction start.

English auction
Remain active until the price exceeds his or her own valuation
of the object.
Second-price, sealed-bid auction
Bid his or her own valuation of the item. This is a dominant
strategy.
First-price, sealed-bid auction (strategically equivalent to the
Dutch auction)
Bid less than his or her valuation of the item. If there are
bidders who all perceive valuations to be evenly (or uniformly)
distributed between a lowest and highest possible valuation,
and , respectively, then the optimal bid, , for a player whose
own valuation is is:
Strategies for Independent
Private Value Auctions
12-‹#›
36
Consider an auction where bidders have independent private
values. Each bidder perceives that valuations are evenly
distributed between and . Sam knows his own valuation is .
Determine Sam’s optimal bidding strategy in:
A first-price, sealed-bid auction with two bidders.
A Dutch auction with three bidders.
A second-price, sealed-bid auction with 20 bidders.
Private Value Auctions In Action: Problem

12-‹#›
37
Sam’s optimal bid in a first-price, sealed-bid auction with two
bidders is .
Sam’s optimal bid in a Dutch auction with three bidders is .
Sam’s optimal bid in a second-price, sealed-bid auction with 20
bidders is to bid his true valuation, which is .
Private Value Auctions In Action: Answer
12-‹#›
38
Bidders do not know their own valuations for an item, nor
others’ valuations.
Implication: makes bidders vulnerable to the winner’s curse,
which is the “bad news” conveyed to the winner that his or her
estimate of the item’s value exceeds the estimates of all other
bidders.
A bidder should revise downward her private estimate of the
item’s value to account for the fact that her estimate of the
item’s value may exceed the item’s value estimates of other
bidders (the winner’s curse).

The auction process may reveal information about how much the
other bidders value the object.
The winner’s curse is most pronounced in sealed-bid auctions
since bidders don’t learn about other player’s valuation.
English auction, in contrast, provides bidders with information.
Therefore, bidders may have to revise up their initial bids.
Strategies for Correlated Values Auctions
12-‹#›
39
Comparison of expected revenue in auctions with risk-neutral
bidders
Expected Revenues in
Alternative Types of Auctions
Information structureExpected revenuesIndependent private
valuesEnglish=Second-price = First-Price = DutchAffiliated
value estimatesEnglish > Second-price > First-price = Dutch
12-‹#›
40
Chapter 12
The Economics of Information

Learning Objectives
12-‹#›
Identify
Identify strategies to manage risk and uncertainty, including
diversification and optimal search strategies.
Calculate
Calculate the profit-maximizing output and price in an
environment of uncertainty.
Explain
Explain why asymmetric information about “hidden actions” or
“hidden characteristics” can lead to moral hazard and adverse
selection and identify strategies for mitigating these potential
problems.
Explain
Explain how differing auction rules and information structures
impact the incentives in auctions and determine the optimal
bidding strategies in a variety of auctions with independent or
correlated values.

A variable that measures the outcome of an uncertain event is
called a random variable.
Probabilities can be attached to different values of a random
variable that denote the chance that a value occurs.
Information about uncertain outcomes can be summarized by the
mean (or, expected value) and variance of a random variable.
Measuring Uncertain Outcomes
12-‹#›
3
The mean (or expected value) of a random variable is the sum of
the probabilities that different outcomes will occur multiplied
by the resulting payoffs.
If denote the possible outcomes of the random variable and the
corresponding probabilities of the outcomes, then the expected
value of is:
, where .
The mean does not provide information about the risk
associated with the random variable.
Measuring Uncertain Outcomes: Mean
12-‹#›

4
The variance of a random variable is the sum of the
probabilities that different outcomes will occur multiplied by
the squared deviation from the mean of the resulting payoffs.
If denote the possible outcomes of the random variable, their
corresponding probabilities are , and the expected value of is ,
then the variance of is:
The variance is a common measure of risk.
The standard deviation is the positive square root of the
variance: .
Measuring Uncertain Outcomes:
Variance and Standard Deviation
12-‹#›
5
Attitudes toward risk differ among consumers.
A risk-averse consumer prefers a sure amount of to a risky
prospect with an expected value of .
A risk-loving consumer prefers a risky prospect with an
expected value of to a sure amount of .
A risk-neutral consumer is indifferent between a risky prospect
with an expected value of and a sure amount of .
Risk Aversion
12-‹#›

6
Risk analysis can used to examine situations where consumers
are uncertain about product quality.
Consider a consumer who regularly uses Brand X. If a new
product enters the market, Brand Y, under what conditions will
the consumer be willing to try the new product?
Issues to overcome and consider:
Relative certainty about Brand X.
At equal prices among other things, a risk averse consumer will
continue to purchase Brand X, since a risk averse consumer
prefers the sure thing (Brand X) to a risky prospect (Brand Y).
Two tactics can be employed to induce a risk averse consumer
to try a new product:
Lower the price of Brand Y.
Try to convince consumer the new product’s quality is higher
than the old product.
Managerial Decisions with
Risk-Averse Consumers: Product Quality
12-‹#›
7
Chain stores: may be in a firm’s best interest to become part of
a chain store
Standardization, reputation, increased chance of survival
Online reviews: can help even the playing field between chains

and independent stores.
Insurance: the fact that consumers are risk averse implies they
are willing to pay to avoid risk.
Managerial Decisions with Risk- Averse Consumers
12-‹#›
To identify the low-price seller from among many firms selling
an identical product, consumers sometimes incur a cost, , to
obtain each price quote.
After observing each price quote, a consumer must weigh the
expected benefit from acquiring an additional price quote with
the additional cost.
Consumer Search
12-‹#›
9
Suppose that three-quarters of stores in a market charge and
one-quarter charge .
A consumer observing a price of should stop searching since
there is no price below .
What should a risk-neutral consumer do after observing a price
of , if search occurs with free recall and with replacement?
One-quarter of the time the consumer will save .
Three-quarters of the time the consumer will save nothing.
The expected benefit from an additional search is: .
A consumer should search for a lower price as long as the

expected benefits for an additional search are greater than the
cost of an additional search.
Consumer Search
12-‹#›
10
Optimal Search Strategy (Figure 12-1)
Price
Reservation price:
Price at which a consumer
is indifferent between
purchasing at that price and
searching for a lower price.
Expected
benefits
and costs
Acceptance Price
Rejection Price
8-11
12-‹#›

11
The optimal search rule is such that the consumer rejects prices
above the reservation price, , and accepts prices below the
reservation price. Stated differently, the optimal search strategy
is to search for a better price when the price charged by a firm
is above the reservation price and stop searching when a price
below the reservation price is found.
Consumer’s Search Rule
12-‹#›
12
Increasing Cost of Search (Figure 12-2)
Price
Expected
benefits
and costs
Due to increase in search costs.
12-‹#›

13
While managers must understand the impact of uncertainty on
consumer behavior, uncertainty also impacts the manager’s
input and output decisions.
Manager’s risk profiles:
Risk averse: a manager who prefers a risky project with a lower
expected value if the risk is lower than a project with a higher
expected value.
Risk loving: manager who prefers a risky project with higher
expected value and higher risk to one with lower expected value
and lower risk.
Risk neutral: manager interested in maximizing expected
profits; the variance of profits does not impact a risk-neutral
manager’s decisions.
Manager’s Risk Attitudes
12-‹#›
14
A risk-averse manager is considering two projects. The first
project involves expanding the market for bologna; the second
involves expanding the market for caviar. There is a 10 percent
chance of recession and a 90 percent chance of an economic
boom. The following table summarizes the profits under the
different scenarios. Which project should manager undertake,
and why?

a
Risk Aversion In Action: Problem
ProjectBoom
$10,000$12,000-$7,800$6,600Caviar20,000-
8,00017,2008,400Joint10,0004,0009,4001,800Safe (T-
Bill)3,0003,0003,0000
12-‹#›
15
Risk Aversion In Action: Answer
Managers should not invest in T-Bills
The joint project is assured of making at least $4,000, which is
greater than $3,000 under the T-Bill scenario.
Since the expected returns of the bologna project are negative,
neither a risk-neutral nor a risk-averse manager would choose to
undertake this project.
The manager should adopt either the caviar project or the joint
project. Which project will depend on his or her risk
preferences.
ProjectBoom

$10,000$12,000-$7,800$6,600Caviar20,000-
8,00017,2008,400Joint10,0004,0009,4001,800Safe (T-
Bill)3,0003,0003,0000
12-‹#›
16
Notice from the previous problem that by investing in multiple
projects, the manager may be able to reduce risk.
The process of potentially reducing risk by investing in multiple
projects is called diversification.
Whether it is optimal to diversify depends on a manager’s risk
preferences and the incentives provided to the manager to avoid
risk.
Manager’s Risk Attitudes and Diversification
12-‹#›
17
When producers are uncertain about the prices of inputs, an
optimizing firm will use optimal search strategies.
These strategies mimic consumer search previously developed.
Producer Search

12-‹#›
18
The basic principles of profit maximization can be modified to
deal with uncertainty.
If demand (hence, revenue) is uncertain and the manager is risk
neutral, then the manager will want to maximize expected
profits by producing the output where the expected marginal
revenue equals marginal cost:
12-‹#›
19
Appleway Industries produces apple juice and sells it in a
competitive market. The firm’s manager must determine how
much juice to produce before he knows what the market
(competitive) price will be.
Economists estimate that there is a 30 percent chance the
market price will be $2 per gallon and a 70 percent chance it
will be $1 per gallon when the juice hits the market.
If the firm’s cost function is , how much juice should be
produced to maximize expected profits?
What are the expected profits of Appleway Industries?
In Action: Problem

12-‹#›
20
Appleway Industries’ profits are
Since price is uncertain, the firm’s revenues and profit are
uncertain. For competitive firms, MR=p; thus, MR is also
uncertain. To maximize expected profits, the manager equates
expected price with marginal cost.
The expected price is: .
Therefore, manager should produce output where:
gallons.
Therefore, expected profits are $645.
In Action: Answer
12-‹#›
21
Uncertainty can have a profound impact on the ability of
markets to efficiently allocate resources.
Some markets are characterized by individuals who have better
information than others.
Implication: Those individuals with the least information may

choose not to participate in a market.
A market with asymmetric information one in which some
people have better information than others. There are two
specific manifestations related to asymmetric information in
markets:
Adverse selection
Moral hazard
Asymmetric Information
12-‹#›
22
Adverse selection refers to situations where individuals have
hidden characteristics and in which a selection process results
in a pool of individuals with undesirable characteristics.
In this context, a hidden characteristic is something that one
party to a transaction knows about itself, but which is unknown
by the other party.
Asymmetric Information: Adverse Selection
12-‹#›
23
Moral hazard refers to a situation where one party to a contract
takes a hidden action that benefits his or her at the expense of
another party.
In this context, a hidden action is an action taken by one party

in a relationship that cannot be observed by the other party.
One way to mitigate the moral hazard problem is an incentive
contract.
Asymmetric Information: Moral Hazard
12-‹#›
24
Another way to mitigate the problem of moral hazard is
signaling, which is an attempt by an informed party to send an
observable indicator (or signal) of his or her hidden
characteristics to an uninformed party.
For signaling to be effective it must be:
observable by the uninformed party.
a reliable indicator of the unobservable characteristic(s) and
difficult for parties with other characteristics to easily mimic.
Signaling
12-‹#›
25
A final way to mitigate the moral hazard problem is by
screening, which is an attempt by an uninformed party to sort
individuals according to their characteristics.
Screening may be achieved through a self-selection device.

A self-selection device is a mechanism in which informed
parties are presented with a set of options, and the options they
choose reveal their hidden characteristics to an uninformed
party.
Screening
12-‹#›
26
An auction is a mechanism where potential buyers compete for
the right to own a good, service, or, more generally, anything of
value.
Sellers participating in an auction offer an item for sale and
wish to obtain the highest price.
Buyers participating in an auction seek to obtain the item at the
lowest possible price.
Bidders’ risk preferences can affect bidding strategies and the
expected revenue a seller receives.
Types of Auctions
12-‹#›
27
There are Four basic types of auction:
English (ascending-bid)
First-price, sealed-bid

Second-price, sealed-bid
Dutch (descending-bid)
These auctions differ with respect to:
The timing of bidder decisions (simultaneously or sequentially)
The amount the winner is required to pay.
Differences Among Auctions Types
12-‹#›
28
An English auction is an ascending sequential-bid auction in
which bidders observe the bids of others and decide whether or
not to increase the bid. The auction ends when a single bidder
remains; this bidder obtains the item and pays the auctioneer the
amount of the bid.
Bidders continually obtain information about one another’s
bids.
English Auction
12-‹#›
29
A first-price, sealed-bid auction is a simultaneous-move auction
in which bidders simultaneously submit bids to an auctioneer.
The auctioneer awards the item to the highest bidder, who pays
the amount bid.

First-Price, Sealed-Bid Auction
12-‹#›
30
A second-price, sealed-bid auction is a simultaneous-move
auction in which bidders simultaneously submit bids to an
auctioneer. The auctioneer awards the item to the highest
bidder, who pays the amount bid by the second-highest bidder.
Bidder who values the item the most will win but pays the
second-highest bid.
Second-Price, Sealed-Bid Auction
12-‹#›
31
A Dutch auction is a descending sequential-bid auction in which
the auctioneer beings with a high asking price and gradually
reduces the asking price until one bidder announces a
willingness to pay that price for the item.
Bidders obtain no information about one another’s bids
throughout the auction process.
Bidder who values the item the most will win and pay the
amount of his or her bid.

Dutch Auction
12-‹#›
32
The Dutch and first-price, sealed-bid auctions are strategically
equivalent; that is, the optimal bids by participants are identical
for both types of auctions.
Strategic Equivalence of Dutch
and First-Price Auctions
12-‹#›
33
While the four auction types differ with respect to the
information bidders have about the bids of other bidders,
bidders also have different information structures regarding
their own valuation of the item being auctioned.
Perfect information (this is rare)
Independent private values (determined by bidder’s individual
tastes)
Affiliated (or correlated) value estimates
Special case: common-value auctions
Information Structures
12-‹#›

34
Optimal Bidding Strategies
for Risk-Neutral Bidders
12-‹#›
35
An optimal bidding strategy for risk-neutral bidders is a
strategy that maximizes a bidder’s expected profit.
Optimal bids depend on the
1. type of auction
2. information available to bidders at the time of bidding
With independent private values, bidders know their own values
prior to the auction start.
English auction
Remain active until the price exceeds his or her own valuation
of the object.
Second-price, sealed-bid auction
Bid his or her own valuation of the item. This is a dominant
strategy.

First-price, sealed-bid auction (strategically equivalent to the
Dutch auction)
Bid less than his or her valuation of the item. If there are
bidders who all perceive valuations to be evenly (or uniformly)
distributed between a lowest and highest possible valuation,
and , respectively, then the optimal bid, , for a player whose
own valuation is is:
Private Value Auctions
12-‹#›
36
Consider an auction where bidders have independent private
values. Each bidder perceives that valuations are evenly
distributed between and . Sam knows his own valuation is .
Determine Sam’s optimal bidding strategy in:
A first-price, sealed-bid auction with two bidders.
A Dutch auction with three bidders.
A second-price, sealed-bid auction with 20 bidders.
Private Value Auctions In Action: Problem
12-‹#›
37

Sam’s optimal bid in a first-price, sealed-bid auction with two
bidders is .
Sam’s optimal bid in a Dutch auction with three bidders is .
Sam’s optimal bid in a second-price, sealed-bid auction with 20
bidders is to bid his true valuation, which is .
Private Value Auctions In Action: Answer
12-‹#›
38
Bidders do not know their own valuations for an item, nor
others’ valuations.
Implication: makes bidders vulnerable to the winner’s curse,
which is the “bad news” conveyed to the winner that his or her
estimate of the item’s value exceeds the estimates of all other
bidders.
A bidder should revise downward her private estimate of the
item’s value to account for the fact that her estimate of the
item’s value may exceed the item’s value estimates of other
bidders (the winner’s curse).
The auction process may reveal information about how much the
other bidders value the object.
The winner’s curse is most pronounced in sealed-bid auctions
since bidders don’t learn about other player’s valuation.
English auction, in contrast, provides bidders with information.
Therefore, bidders may have to revise up their initial bids.

Strategies for Correlated Values Auctions
12-‹#›
39
Comparison of expected revenue in auctions with risk-neutral
bidders
Expected Revenues in
Alternative Types of Auctions
Information structureExpected revenuesIndependent private
valuesEnglish=Second-price = First-Price = DutchAffiliated
value estimatesEnglish > Second-price > First-price = Dutch
12-‹#›
40
Module Group A
Strategies to Change the Business Environment
MA-‹#›
MODULE 1
ENTRY PREVENTION

MA-‹#›
LEARNING OBJECTIVES:
Explain the economic basis for limit pricing and identify the
conditions under which a firm can profit from such a strategy.
Successful businesses often spawn entry of new competitors
into the market, and adversely affect the profits of existing
firms.
Faced with that threat, a manager may consider limit pricing,
which is a strategy where an incumbent maintains a price below
the monopoly level in order to prevent entry.
Limit Pricing to Prevent Entry
MA-‹#›
3
Monopoly Pricing (Figure M1-1)
Price
Quantity
Demand
MR
MC

ATC
)
Profits
MA-‹#›
4
Limit Pricing and Residual Demand (Figure M1-2)
Price
Quantity
Demand
Entrant’s residual
demand curve
AC
MA-‹#›
5
Under limit pricing, the entrant was assumed to have complete
information about the incumbent’s demand and costs.

The strategy did not “hide” information about the profitability
of the incumbent’s business.
The low price charged by the incumbent did not prevent entry;
the entrant stayed out because it believed the incumbent would
produce at least , if it entered.
A revised strategy is to set the monopoly price, , and produce
the monopoly output, , and threaten to expand output to , if
entry occurs.
This, however, is not a credible threat; so, a rational entrant
would find it profitable to enter if the incumbent sets price,
Limit Pricing May Fail to Deter Entry
MA-‹#›
6
For limit pricing to effectively prevent entry by rational
competitors, the preentry price must be linked to the postentry
profits of potential entrants.
Effective Limit Pricing
MA-‹#›
7
Commitment mechanisms – incumbent can commit to not
reducing output in the face of entry.
Learning curve effects – when a firm enjoys lower costs due to
knowledge gained from its past production decisions.

Incomplete information – can delay or eliminate entry.
Reputation effects – being “tough” on new entrants may
discourage entry.
Linking Preentry Price to Postentry Profits
MA-‹#›
8
The Value of Commitment (Figure M1-3)
E
E
I
Commit to
Enter
Enter
Don’t enter
Don’t enter
Don’t Commit
I=Incumbent
E=Potential entrant
MA-‹#›

9
Even if the incumbent can link preentry price to post-entry
profits to prevent entry, it may be more profitable to permit
entry.
The present value of maintaining monopoly status is:
Entry reduces profit from the monopoly to duopoly level:
Since , entry will harm the incumbent.
Dynamic Considerations
MA-‹#›
10
Profits under effective limit pricing:
Limit pricing is profitable when:
MA-‹#›
The conditions under which limit pricing is attractive include:
Low interest rate environments

Monopoly and limit-price profits are close
Duopoly profits are significantly lower than limit-price profits.
Conditions for Dynamic Considerations
MA-‹#›
12
Baker Enterprises operates a midsized company that specializes
in the production of a unique type of memory chip. It is
currently the only firm in the market, and it earns million per
year by charging the monopoly price of per chip.
Baker is concerned that a new firm might soon attempt to clone
its product. If successful, this would reduce Baker’s profit to
million per year. Estimates indicate that, if Baker increases its
output to units (which would lower its price to per chip), the
entrant will stay out of the market and Baker will earn profits of
million per year for the indefinite future.
What must Baker do to credibly deter entry by limit pricing?
Does it make sense for Baker to limit price if the interest rate is
10 percent?
Dynamic Considerations In Action: Problem
MA-‹#›
13

Baker must “tie its hands” to prevent itself from cutting output
below units if entry occurs, and this commitment must be
observable to potential entrants before they make their decision
to enter or not enter.
10 percent?
Limit pricing is profitable if .
Therefore, limit pricing is profitable.
Dynamic Considerations In Action: Answer
MA-‹#›
14
MODULE 2
LESSENING COMPETITION
MA-‹#›
Explain the economic basis for predatory pricing.
Show how a manager can profitably lessen competition by
raising rivals’ costs.
Identify some of the adverse legal ramifications of business
strategies designed to lessen competition.

Predatory pricing is a strategy where a firm temporarily prices
below its marginal cost to drive existing competitors out of the
market.
Involves a trade-off between current and future profits, so it is
profitable only when the present value of the higher future
profits offsets the losses required to drive rivals out of the
market.
A firm engaging in predatory pricing must have “deeper
pockets” (greater financial resources) than the prey in order to
outlast it.
Predatory Pricing to Lessen Competition
MA-‹#›
16
To significantly reduce the profitability of predatory pricing,
the prey may:
Stop production entirely and cause the predator to lose more
money each period.
Purchase the product from the predator and stockpile it to sell
when predatory pricing ceases.
Predatory Pricing Counterstrategies
MA-‹#›

17
Engaging is predatory pricing is vulnerable to prosecution under
the Sherman Antitrust Act; however, it is often difficult to
prove in court.
Some legitimate business practices/scenarios might be deemed
“predatory” under legal definitions.
Fierce competition with substantial fixed cost may lead to the
departure of the weakest firm.
Firms attempting to penetrate a market with a new product often
find it advantageous to sell the product at a low price or give it
away for free initially.
Legality of Predatory Pricing
MA-‹#›
18
in the production of a unique type of memory chip. If Baker
were a monopolist, it could earn million per year for an
indefinite period by charging the monopoly price of per chip.
While Baker could have thwarted the entry of potential rivals by
limit pricing, it opted against doing so, and it is now in a
duopoly situation, earning annual profits of million per year for
the foreseeable future.
Predatory Pricing In Action: Problem
MA-‹#›

19
If Baker drops its price to per chip and holds it there for one
year, it will be able to drive the other firm out of the market and
retain its monopoly position indefinitely. Over the year in
which it engages in predatory pricing, however, Baker will lose
million. Ignoring legal considerations, is predatory pricing a
profitable strategy? Assume the interest rate is 10 percent and,
for simplicity, that any current period profits or losses occur
immediately (at the beginning of the year).
MA-‹#›
If Baker does not engage in predatory pricing, the present value
of its earnings (including its current million in earnings) will
be
If Baker uses predatory pricing, the present value of its current
and future profits will be
Profits are lower under predatory pricing.
Predatory Pricing In Action: Answer
MA-‹#›
21

Raising rivals’ costs is a strategy in which a firm gains an
advantage over competitors by increasing their costs.
Strategies involving marginal cost.
Strategies involving fixed cost.
Strategies for vertically integrated firms.
Raising Rival’s Costs to Lessen Competition
MA-‹#›
22
Raising a Rival’s Marginal Cost (Figure M2-1)
Quantity2
Quantity1
A
B
MA-‹#›
23
A vertically integrated firm with market power in the upstream

(input) market may be able to exploit this power to raise rivals’
costs in downstream markets.
Vertical foreclosure
Strategy wherein a vertically integrated firm charges
downstream rivals a prohibitive price for an essential input,
thus forcing rivals to use more costly substitutes or go out of
business.
Price-cost squeeze
Tactic used by a vertically integrated firm to squeeze the
margins of its competitors.
Raising Rivals’ Costs:
Vertically Integrated Firms
MA-‹#›
24
Raising a Rival’s Fixed Cost (Figure M2-2)
E
E
I
$90 License
Enter
Enter
Don’t enter
Don’t enter
No license

I=Incumbent
E=Potential entrant
MA-‹#›
25
MODULE 3
RESTRUCTURING GAME TIMING
MA-‹#›
Assess whether a firm’s profits can be enhanced by changing
the timing of decisions or the order of strategic moves, and
whether doing so creates first- or second-mover advantages.
A first-mover advantage permits a firm to earn a higher payoff
by committing to a decision before its rivals get a chance to
commit to their decisions.
Changing the timing of a game to move from a simultaneous-
move to sequential-move game can yield one player a first-
mover advantage.
First-Mover Advantages
MA-‹#›

27
Simultaneous-Move Production Game (Table M3-1)
Firm AFirm BStrategyLow outputHigh outputLow output$30,
$10$10, $15High output$20 , $5$1, $2
Firm A has a dominant strategy: Low output
Nash equilibrium: Firm A produces Low output; Firm B
produces High output.Firm AFirm BStrategyLow outputHigh
outputLow output$30, $10$10, $15High output$20 , $5$1, $2
MA-‹#›
28
Sequential-Move Production Game (Figure M3-1)
B
B
A
Low output
Low output
Low output
High output
High output
High output
Changing the timing of the game,
Firm A gets to move first.
Unique, subgame perfect
equilibrium is:

Firm A: produce High output
Firm B:
produce Low output, if Firm A produces High output
produce High output, if Firm A produces Low output
First-mover
advantage
permits
Firm A to
earn $20
Instead of
$10.
MA-‹#›
29
A second-mover advantage can permit a firm to earn a higher
payoff by free-riding on the investments made by the first
mover and produce at lower costs.
Second-Mover Advantages
MA-‹#›
30
MODULE 4
OVERCOMING NETWORK EFFECTS
MA-‹#›

Identify examples of networks and network externalities and
determine the number of connections possible in a star network
with n users.
Explain why networks often lead to first-mover advantages and
how to use strategies such as penetration pricing to favorably
change the strategic environment.
A network consists of links that connect different points (called
nodes) in geographic or economic space.
One-way networks - services flow in only one direction (ex.
residential water)
Key feature is that its value to each user does not directly
depend on how many other people use the new network
Two-way networks (ex. telephone systems, e-mail, etc.)
In contrast to one-way networks, the value to each user depends
directly on how many other people use the network.
Star networks – an example of a two-way network with a central
“hub”
What is a Network?
MA-‹#›
32

Two-Way, Star Network (Figure M4-1)
MA-‹#›
33
Two-way networks that link users exhibit positive externalities
called direct network externalities.
The direct value enjoyed by the user of a network because
others also use the network.
Principle: Direct network externalities
A two-way network linking users provides potential
connection services. If one new user joins the network, all the
existing users directly benefit because the new user adds
potential connection services to the network.
Direct Network Externalities
MA-‹#›
34
An indirect network externality (network complementarities) is

the indirect value enjoyed by the user of a network because of
complementarities between the size of a network and the
availability of complementary products or services.
Indirect Network Externalities
MA-‹#›
35
Negative network externalities exist when an additional user to
the network decreases the value per user of the services.
Congestion
Bottlenecks
Negative Network Externalities
MA-‹#›
36
The presence of network externalities often makes it difficult
for new networks to replace or compete with existing networks;
even a technologically superior network.
Existing networks likely have an installed user base and
complementary services compared to a new network.
Network externalities can create consumer lock-in: a scenario in
which consumers are stuck in a situation (equilibrium) where
they are using an inferior network.
Due to Consumer Lock-In

MA-‹#›
37
A Network Game (Table M4-1)
$10$10, $15High output$20 , $5$1, $2
Both users initially use Provider H1 and receive $10 each in
value.
Neither has an incentive to change to H2 even though if they
both did simultaneously, they would be better off and receive
$20 each in value.
Network externalities create a consumer lock-in.User 1User
2Network ProviderH1H2H1$10, $10$0, $0H2$0, $0$20, $20
MA-‹#›
38
Consumer lock-in resulting from an existing network might be
easily resolved by communication between two users; however,
communication is not feasible with potentially hundreds of
millions of users because of transaction costs.
What hope does a firm have of establishing its new network?
One strategy, penetration pricing, involves charging a low price
initially to penetrate a market and gain a critical mass of
customers; useful when strong network effects are present.
Using Penetration Pricing to “Change the Game”

MA-‹#›
39
A Network Game with Penetration Pricing (Table M4-2)
$10$10, $15High output$20 , $5$1, $2
During the trial period, users pay only $1.
The value to each user of having access to both networks is at
least as large as the value of using either network individually.
Consumers have an incentive to “try” the new network since the
choice H1, H2 is the dominant strategy for each user.
Once they try the service and determine it is superior, they will
quit using H1.
User 1User 2Network ProviderH1H1, H2H1$10, $10$10,
$11H1, H2
$11, $10$21, $21
MA-‹#›
40
Homework 2
For this discussion, please find one journal article that describes
a current economic topic covered in either Chapter 12 or 13.
Summarize the article and explain how it relates to your chosen
topicBefore you begin your summary, please state which
chapter and topic your selected article addresses (post this at
the beginning of the page).
Your summary should be 500-1000 words. You MUST include

the citation for your article. If your article can not be located
using your citation, you will receive a zero for the assignment,
so please verify that it works before you submit your post. You
do NOT have to upload the article.
You need write 2 page
The chapter 12 and chapter 13, I give you the ppt, you can see
the ppt what we learn.
ASEE 2014 Zone I Conference, April 3-5, 2014, University of
Bridgeport, Bridgpeort, CT, USA.
Organizational Change: Case Study of General
Motors
Muhammad Aliuddin Khan
Department of Economics,
University of Peshawar
Peshawar Pakistan
[email protected]
Muhammad Hashim
Department of Business
Preston University
Islamabad Pakistan
[email protected]
Abstract— The main purpose of this article was to elaborate
and bring to light the core concept of the organization change,
how it works, diverse factors which moves organization to

change, steps for change, resistance for change, change forces,
change management approaches and last an example of General
Motor (GM) has given that how change was taken place in the
organization and what was the strategies for change
management. Recommendations and conclusion forms the last
part of the paper.
Keywords - Organization change, Factors, Resistance, GM.
I. ORGANIZATIONAL CHANGE: A BRIEF
INTRODUCTION
The business world to day is going very fast and new
technology new methods of production and new taste of
customers and new market trends as well as new strategies for
best control of the organizations and motivation of employees
are emerging and taking place from old to new methods,
because the customers are the emperor of market and most of
the company now spending billions of amount on research and
development in the organization, by keeping in view all these
things the managers and experts of the today businesses now
compel to decide about the change management in the
organizations, because business activities now are globalize,
and every organization strive to sustained the loyal customers,
trained the employees, introduce and adopt new methods of
production and best control the activities of the organization,
so from here the concept of change management or
organization change starts. When the company feel that the
activities which they are doing, the management, the way of
administration, the use of technology, the human resource
policies, the culture of the organization, the liking and
disliking the contents and context of the organization by the
employees, organization structure, group concept ,the product
quality are continuously destroying the image and reputation

of the organization the question arises that how will change
the organization in present scenario, so when the expert
specialist decides about all the situation and preparing for
changing the organization it leads to the concept of
organizational change or change management[1] . In the word
of coetsee he said that it is the ability of the management that
how they can get maximum benefits and support form change
which reduces resistant from the side of employees and
encourage appreciate acceptance and support. The process of
changing the activities of the organization as well as the
implementation of the procedures and technologies to achieve
the desire objective of the organization, in simple words to
change the environment of the business organization and to
achieve a high profit from that change, usually change
management includes different aspects such as control change,
adaptation change and effecting change. The final goal of the
change management is the long term sustainability of the
organization. organizational change simply means to change
the activities of the organization concern it may includes to
change the culture of the organization, technology, business
process, change of employees, rules and procedures,
recruitment and selection, design of jobs, method of appraisal,
and human resource techniques, physical environment of the
organization, methods of training and development, job skill
and knowledge etc. when the change of the concern
organization is fundamental it is called organization
transformations. Change management means when all the
needed actions are taken to improve the present situation for
future to implement the change strategies to get the maximum
advantages and also see that the objectives of the organization
is achieving or not[2]
A. Factors Behind The Organization Change

As we have mentioned before that organization change occurs
due to some factors that may be external or internal, such
factors may also bring change in the activities of he
organization and may also create problems to harder the
change process, as every know that change creates resistance,
and this resistance may creates huge problems, resistance to
change is also from the old employees or middle level
managers or people as they always appose to the change
strategies due to their own way of thinking and perception
regarding the change concept, this may be due to lake of
knowledge about the situation or due to the self interest of the
old employees but what ever may be the reasons but it is fact
that change always bring resistance, now it is up to mangers
that how they reduce the intensity of the resistance and
implement the whole change strategic business model in the
organization. [3].
B. Change Forces
The following are the main forces which bring change in the
organization. These are as under but it may depend on the
organization environment and the context of the organization.
Change in new government policies and legislation, Change
and development in new materials, Social and culture value
change, Change in national and global economic condition
and trade policies and regulation, Technology development,
Change in customer taste and requirements, Development and
innovation in manufacturing process, New products and
services design innovation, New ideas about the products that
how to deliver customers value and satisfaction, Office and
factory relocation closer to customers, suppliers, and market,
nature of the workforce, technology , economic shocks,

completion, social trends, and world politics[4].
C. Resistance to Change
Change creates resistance to change in every organization; it is
the react response from the side of the old employees. When
change strategies have implemented in the organization the
employees quickly respond by voicing complaints, engaging
in work slowdown, threatening to go on strike, etc. but care
should be taken by the change management expert to
overcome the resistance +
Major force for resistance to change: resistance to change
forces categorize into two main heading, 1) individual sources
and 2) organizational sources
1). Individual Source Resistance To Change Includes The
Following.
Habit, security, selective information processing, economic
factors, fear of the unknown.
2). Organizational Sources for Resistance to Change Include
the Following.
Limited focus on change, organization structural inertia, threat
to expertise, threat to established power relationship, group
inertia, threat to established resource allocation.
3). Overcoming to Resistance to Change.
Overcoming to resistance to change means to use the tactics to
reduce the intensity of the resistance to change, the change
agents have the ability to use these tactics. are as under.

a) Implementing change fairly.
b) Selection people who accept change
c) Education and communication
d) Participation
e) Building support and commitment
f) Manipulation and cooptation
D. Organizational Change Managing Approaches
When change management taken place in the organization,
now the question is how best one can manage change. There
are four approaches to change management. Lewins classi c
three step model of change process, kotters eight step plan,
action research, and organizational development.
According to the lewins model the organization must follow
three steps for successful change management, which are.
Unfreezing: the status quo, changing to overcome the pressure
of both individual resistance and group conformity.
Movement; desire end state, a change process that transforms
the organization from the status quo to a desired end state.
And refreezing the new change to make it permanent,
stabilizing a change intervention by balancing driving and
restraining forces. [4]
Lewins three steps change model.
Unfreezing Movement Refreezing

(Source Stephen, 2005)
1). Kotters Eight Step Plan.
To more elaborate the lewins model kotters have develop
eight steps which can be adopted to implement change. These
are
1) Establish a sense of urgency that why a change is
needed.
2) Form enough power to lead the change
3) Create a new vision to direct the change and
strategies for achieving the vision
4) Vision communication in organization
5) Empower others to act on vision by removing
barriers
6) Plan for, create short term reward to move the
organization toward the new vision
7) Continues improvement and make necessary
adjustment in new programs.
8) Reinforce the change by demonstrating the
relationship between new behaviors.
(Source Stephen, 2005)
2) Action Research

Action research is also a change management approach in
which systematically data collected and than change is taken
according that data indication.
3) Organizational Development
Organizational development plays an important role in the
change management no change be best implemented with out
organizational development, it can be define as a collection of
planned change interventions, built on humanistic democratic
values, that seek to improve the organizational effectiveness
and employees work performance and well being.[4]
4) Organizational Development Techniques
The change agent considers the following technique to bring
organizational development. Sensitivity training, team
building, process consultation, survey feed back, appreciative
inquiry and inter group development. These are the important
technique which should adopt by change specialist to bring
effective development in the organization, because
organizational development is vital for organizational change.
[5]
5) Change Management at General Motor
(Gm)
General motor established in 1908. that
time the company was the sole carmaker
dealer in the region, e.g. Michigan, first it
was a holding Buick company, till 1920 it
was becoming the world largest motor manufacturing
company, the company got a tremendous success in time of
Alfred salon, due to his leadership the company was
producing new style and design car every year, and he had

given such concept to the company. The other brand of the
company is Chevrolet, Pontiac, Buick, and Cadillac. These
were the different brand cars which were producing by
company that time, and this way there were no other
competitors to compete in the company different cars. But
with emerging of the japans automakers the company felt
threatened, specially the emerging of Toyota Japan, who with
great extent disturbed the profitability of the GM, especially in
the North American market. In 2001 the sale graph of the GM
was in declined trend, because the Toyota had captured the
market, this way the GM received loan form American
government and Canadian government to support the
company in that crises period. During 2009 the company had
faced a bankruptcy and had closed several brand and sold out
to china based company. Now the company again got his
position in market by restructuring and making change in the
company. Now the company is again operating business in the
core brands in America such as Chevrolet, GMC, Buick, and
Cadillac. [6]
II. REASON AND FORCES FOR CHANGE OF GM
In this section we will highlight the reason and forces behind
the change in general motor
1) Forces For Change.
The following are the main forces which affected the general
motor.
2) External Forces.
In external forces the GM which was greatly affected by the
japans based company Toyota was the emerged competitors in
that time, the north America is still the biggest market place
for GM where the company sold out in recent year round

about 2.9 million and the nearest competitor is Toyota and
china based companies, these competitors with great extent
disturbed the total profitability of the general motor, and the
second external forces which the company faced a huge
problem was financial crises which with great extent collapsed
the cash flows of the company.
3) Internal Forces.
The another force for change to GM was the high wages cost
to employees as the company was paying $74 per hour as
compared to Toyota $44 per hour, because GM was an
agreement with trade union. And the GM was compelled to
run the plant with minimum 80% capacity whether it was
needed or not, these things play an important role in the
bankruptcy of the company.
A. Types of Changes
By keeping in view the above discussion the company
ultimate decided to bring or make change in the company, so
the company decided to bring changes on some areas of the
business, these were included, structural change, cost
change, process change and cultural change
B. Steps in the Change Management Process of General
Motor.
While going on change management the GM, the company
took some steps to adopt change these are the most recent
change which the company had taken.
1) Cost Cutting.
The first steps which was taken by the GM is about cost
cutting, the company has reduced its cost of some brands to

maintain the profit level, such as the Saturn and hammer, by
keeping the other company cost. Similarly the company also
cut pay of employees which was the major problem to
company. The company has achieved the target of cost cutting
up to 15 billion in recent year.
2) Cultural Change
The general motor also changed the culture of the company,
the GM removed it automotive product board, and automotive
strategy up to 8 men board decision making team which were
responsible to report directly to CEO. The main objective of
such change is to speed up the day to day decision making
process. The GM also changed the culture to improve the
efficiency of the employees and make accountable and
responsible one.
C. Problems to Change Process
In change management process the GM faced a variety of
problems
1) Problems in Cultural Change
The cultural plan was based on top down approach, which
ignored totally the involvement of the employees as compared
to other companies , some suggested that the company has not
down top approach, in which employees feel satisfaction, so
this regard the company empowered the employees by
introducing in tailoring the down top approach. Rather than
merely telling to employees what they do.
2) Problem with Cost Cutting

As the cost cutting has an important place in the change
management but it was faced great problem from the
agreement of trade union, as the company was an agreement
with not lowering the pay of the employees and maintain the
capacity level.
D. Results of the Change Process
As we have discussed that the GM had adopted changed
previously also but these changes are recently those changes
which adopted by the company in the year 2009. The results
of he changes are as under.
1) Result of Cost Cutting
The result of cost cutting of GM seems from its employment
figure of 98 to 2009, it was reduced from 226000 to 101000
workers, and now the company is concentrating on sale rather
than to further cut off, and also the company is deciding to
reduce the worked force of the factory from 6oooo to 4oooo.
And it will certainly lead to cost saving to the company. [7]
2) Result of Cultural Change
The general motor had also achieved good result from cultural
change, and the employees now becoming aware about the
responsibility and accountability, as well as the company also
empowered the employees to give better productivity.
E. Effectiveness of the Change Strategies
As we have discussed above that the general motor adopted
tow main strategies for change management, recently one was
cost cutting strategy for change management and other was
cultural change management strategy, the company adopted
two other change strategies but these are the most recent, by

developing such strategies the company has achieved its
market shares in north America again, as the company was
threatened by the emerging of competitors in the automakers
industry but the company decided to bring changes and now
the company again in better position and he again maintained
the brand of core products, beside of these the company also
achieved the cost benefits by implementing these change
strategies in the company[8]
III. RECOMMENDATIONS
we have seen that how the GM has made changes in the
company for smooth running the company and increased in
sale volume and maintained market shares around the world
but it is not enough changes which was brought by the general
motor, the company needed more attention and adopt several
others changes to cope with the situation and to maintain the
position of the business and compete in the international
market. The following are the some suggested
recommendation for the general motor that it can pursue GM
might be reached the turnaround goals and can increase in sale
and market shares.
A. Production of the Right and Fuel Efficient
Automobiles/Poor Product Lineup
As it was the criticism in the brand of the GM product or cars
that these are not fuel inefficient automobiles. The company
was in top sale in 1990 when the oil was at cheap price but
when the price roused in the international market the company
brand had lost it reputation in the general market, the company
must produce such automobiles which have fuel efficient; the
company must also focus on the battery volt cars and hybrid
one. So it will maintain the company sale increasing as well as
the loyalty of the customer and market shares.

B. Public Perception Improving
The general motor must improve the product quality and
customer services. Because the public perception is most
important thing, if the company improves the public
perception than the public will certainly believe that the
money of their not going in the wrong way, and they will great
full in the eyes of the public.
IV. CONCLUSION
After facing the intense competition and bankruptcy the
general motor now improved again the company activities,
and still the world largest car manufacturing company, the
company has gotten a change recently which has also
improved the working condition of the company, but the
company will must see the weakness and public perception to
increase the sale and market shares. Before formulating any
type of strategy the GM should make SWOT analysis to gain
competitive advantages in the market place.
REFERENCES
[1] David decenzo 2005. Human resource management, 8th
edition, Wiley
[2]David Buchanan and Andrzej Hcuzynski (2005),
organizational behavior,
3rd edition, prentice Hall.
[3]Bechard, R, 1969. Organization development:
strategies and

models, Addison Wesley.
[4]Stephen p. Robbins, judge, seema sanghi, 2005.
Organizational behavior,
13th edition, prentice Hall
[5]French, W.L. and Bell, C. H., 1995. Organization
development: Behavioral
science interventions for organizational improvement, 5th
edition,
Prentice Hall International.
[6] Muoio, A, 2007. G M has new model for change, online
retrieved, 15
December 2009 from fastcompany.com/magazine/41/gmhtm.
[7]General Motor taking swift cost cutting action 2008. Online
retrieved 15
December 2009 from
dailymarkets.com/stock/2008/11/24/General –
motor-taking swift –cost- action –cutting..
[8]Driving change at General Motor, 2005, online retrieved 15
December
2009, www.cioleadershipnotes.com/p/gm/htm
Homework 1
Read the attached case study outlining changes at General
Motors and answer the following questions in a 4 page paper
(following APA format)
According to your book, what are the four main factors that
influence the success of organizational change interventions?

Why is each of the factors so important when change is at
stake?
How do each of these factors apply to the Case Study?
Provide support for your answers using the text book and the
case study provided.
You can see the pdf, all information in pdf
You only need to write 4 page.
Module Group A
Strategies to Change the Business Environment
MA-‹#›
MODULE 1
ENTRY PREVENTION
MA-‹#›
Explain the economic basis for limit pricing and identify the
conditions under which a firm can profit from such a strategy.
Successful businesses often spawn entry of new competitors
into the market, and adversely affect the profits of existing
firms.
Faced with that threat, a manager may consider limit pricing,

which is a strategy where an incumbent maintains a price below
the monopoly level in order to prevent entry.
Limit Pricing to Prevent Entry
MA-‹#›
3
Monopoly Pricing (Figure M1-1)
Price
Quantity
Demand
MR
MC
ATC
)
Profits
MA-‹#›
4
Limit Pricing and Residual Demand (Figure M1-2)

Price
Quantity
Demand
Entrant’s residual
demand curve
AC
MA-‹#›
5
Under limit pricing, the entrant was assumed to have complete
information about the incumbent’s demand and costs.
The strategy did not “hide” information about the profitability
of the incumbent’s business.
The low price charged by the incumbent did not prevent entry;
the entrant stayed out because it believed the incumbent would
produce at least , if it entered.
A revised strategy is to set the monopoly price, , and produce
the monopoly output, , and threaten to expand output to , if
entry occurs.
This, however, is not a credible threat; so, a rational entrant
would find it profitable to enter if the incumbent sets price,
Limit Pricing May Fail to Deter Entry
MA-‹#›

6
For limit pricing to effectively prevent entry by rational
competitors, the preentry price must be linked to the postentry
profits of potential entrants.
Effective Limit Pricing
MA-‹#›
7
Commitment mechanisms – incumbent can commit to not
reducing output in the face of entry.
Learning curve effects – when a firm enjoys lower costs due to
knowledge gained from its past production decisions.
Incomplete information – can delay or eliminate entry.
Reputation effects – being “tough” on new entrants may
discourage entry.
Linking Preentry Price to Postentry Profits
MA-‹#›
8

The Value of Commitment (Figure M1-3)
E
E
I
Commit to
Enter
Enter
Don’t enter
Don’t enter
Don’t Commit
I=Incumbent
E=Potential entrant
MA-‹#›
9
Even if the incumbent can link preentry price to post-entry
profits to prevent entry, it may be more profitable to permit
entry.
The present value of maintaining monopoly status is:
Entry reduces profit from the monopoly to duopoly level:
Since , entry will harm the incumbent.

MA-‹#›
10
Profits under effective limit pricing:
Limit pricing is profitable when:
MA-‹#›
The conditions under which limit pricing is attractive include:
Low interest rate environments
Monopoly and limit-price profits are close
Duopoly profits are significantly lower than limit-price profits.
Conditions for Dynamic Considerations
MA-‹#›
12
in the production of a unique type of memory chip. It is
currently the only firm in the market, and it earns million per
year by charging the monopoly price of per chip.

Baker is concerned that a new firm might soon attempt to clone
its product. If successful, this would reduce Baker’s profit to
million per year. Estimates indicate that, if Baker increases its
output to units (which would lower its price to per chip), the
entrant will stay out of the market and Baker will earn profits of
million per year for the indefinite future.
10 percent?
Dynamic Considerations In Action: Problem
MA-‹#›
13
Baker must “tie its hands” to prevent itself from cutting output
below units if entry occurs, and this commitment must be
observable to potential entrants before they make their decision
to enter or not enter.
10 percent?
Limit pricing is profitable if .
Therefore, limit pricing is profitable.
Dynamic Considerations In Action: Answer
MA-‹#›

14
MODULE 2
LESSENING COMPETITION
MA-‹#›
Explain the economic basis for predatory pricing.
Show how a manager can profitably lessen competition by
raising rivals’ costs.
Identify some of the adverse legal ramifications of busines s
strategies designed to lessen competition.
Predatory pricing is a strategy where a firm temporarily prices
below its marginal cost to drive existing competitors out of the
market.
Involves a trade-off between current and future profits, so it is
profitable only when the present value of the higher future
profits offsets the losses required to drive rivals out of the
market.
A firm engaging in predatory pricing must have “deeper
pockets” (greater financial resources) than the prey in order to
outlast it.

Predatory Pricing to Lessen Competition
MA-‹#›
16
To significantly reduce the profitability of predatory pricing,
the prey may:
Stop production entirely and cause the predator to lose more
money each period.
Purchase the product from the predator and stockpile it to sell
when predatory pricing ceases.
Predatory Pricing Counterstrategies
MA-‹#›
17
Engaging is predatory pricing is vulnerable to prosecution under
the Sherman Antitrust Act; however, it is often difficult to
prove in court.
Some legitimate business practices/scenarios might be deemed
“predatory” under legal definitions.
Fierce competition with substantial fixed cost may lead to the
departure of the weakest firm.
Firms attempting to penetrate a market with a new product often
find it advantageous to sell the product at a low price or give it
away for free initially.
Legality of Predatory Pricing

MA-‹#›
18
in the production of a unique type of memory chip. If Baker
were a monopolist, it could earn million per year for an
indefinite period by charging the monopoly price of per chip.
While Baker could have thwarted the entry of potential rivals by
limit pricing, it opted against doing so, and it is now in a
duopoly situation, earning annual profits of million per year for
the foreseeable future.
MA-‹#›
19
If Baker drops its price to per chip and holds it there for one
year, it will be able to drive the other firm out of the market and
retain its monopoly position indefinitely. Over the year in
which it engages in predatory pricing, however, Baker will lose
million. Ignoring legal considerations, is predatory pricing a
profitable strategy? Assume the interest rate is 10 percent and,
for simplicity, that any current period profits or losses occur
immediately (at the beginning of the year).

MA-‹#›
If Baker does not engage in predatory pricing, the present value
of its earnings (including its current million in earnings) will
be
If Baker uses predatory pricing, the present value of its current
and future profits will be
Profits are lower under predatory pricing.
Predatory Pricing In Action: Answer
MA-‹#›
21
Raising rivals’ costs is a strategy in which a firm gains an
advantage over competitors by increasing their costs.
Strategies involving marginal cost.
Strategies involving fixed cost.
Strategies for vertically integrated firms.
Raising Rival’s Costs to Lessen Competition
MA-‹#›
22

Raising a Rival’s Marginal Cost (Figure M2-1)
Quantity2
Quantity1
A
B
MA-‹#›
23
A vertically integrated firm with market power in the upstream
(input) market may be able to exploit this power to raise rivals’
costs in downstream markets.
Vertical foreclosure
Strategy wherein a vertically integrated firm charges
downstream rivals a prohibitive price for an essential input,
thus forcing rivals to use more costly substitutes or go out of
business.
Price-cost squeeze
Tactic used by a vertically integrated firm to squeeze the
margins of its competitors.
Raising Rivals’ Costs:
Vertically Integrated Firms

MA-‹#›
24
Raising a Rival’s Fixed Cost (Figure M2-2)
E
E
I
$90 License
Enter
Enter
Don’t enter
Don’t enter
No license
I=Incumbent
E=Potential entrant
MA-‹#›
25
MODULE 3
RESTRUCTURING GAME TIMING
MA-‹#›

Assess whether a firm’s profits can be enhanced by changing
the timing of decisions or the order of strategic moves, and
whether doing so creates first- or second-mover advantages.
A first-mover advantage permits a firm to earn a higher payoff
by committing to a decision before its rivals get a chance to
commit to their decisions.
Changing the timing of a game to move from a simultaneous-
move to sequential-move game can yield one player a first-
mover advantage.
MA-‹#›
27
Simultaneous-Move Production Game (Table M3-1)
$10$10, $15High output$20 , $5$1, $2
Firm A has a dominant strategy: Low output
Nash equilibrium: Firm A produces Low output; Firm B
produces High output.Firm AFirm BStrategyLow outputHigh
outputLow output$30, $10$10, $15High output$20 , $5$1, $2
MA-‹#›
28

Sequential-Move Production Game (Figure M3-1)
B
B
A
Low output
Low output
Low output
High output
High output
High output
Changing the timing of the game,
Firm A gets to move first.
Unique, subgame perfect
equilibrium is:
Firm A: produce High output
Firm B:
produce Low output, if Firm A produces High output
produce High output, if Firm A produces Low output
First-mover
advantage
permits
Firm A to
earn $20
Instead of
$10.
MA-‹#›

29
A second-mover advantage can permit a firm to earn a higher
payoff by free-riding on the investments made by the first
mover and produce at lower costs.
Second-Mover Advantages
MA-‹#›
30
MODULE 4
OVERCOMING NETWORK EFFECTS
MA-‹#›
Identify examples of networks and network externalities and
determine the number of connections possible in a star network
with n users.
Explain why networks often lead to first-mover advantages and
how to use strategies such as penetration pricing to favorably
change the strategic environment.
A network consists of links that connect different points (called

nodes) in geographic or economic space.
One-way networks - services flow in only one direction (ex.
residential water)
Key feature is that its value to each user does not directly
depend on how many other people use the new network
Two-way networks (ex. telephone systems, e-mail, etc.)
In contrast to one-way networks, the value to each user depends
directly on how many other people use the network.
Star networks – an example of a two-way network with a central
“hub”
What is a Network?
MA-‹#›
32
Two-Way, Star Network (Figure M4-1)
MA-‹#›
33

Two-way networks that link users exhibit positive externalities
called direct network externalities.
The direct value enjoyed by the user of a network because
others also use the network.
Principle: Direct network externalities
A two-way network linking users provides potential
connection services. If one new user joins the network, all the
existing users directly benefit because the new user adds
potential connection services to the network.
Direct Network Externalities
MA-‹#›
34
An indirect network externality (network complementarities) is
the indirect value enjoyed by the user of a network because of
complementarities between the size of a network and the
availability of complementary products or services.
Indirect Network Externalities
MA-‹#›
35
Negative network externalities exist when an additional user to
the network decreases the value per user of the services.
Congestion

Bottlenecks
Negative Network Externalities
MA-‹#›
36
The presence of network externalities often makes it difficult
for new networks to replace or compete with existing netw orks;
even a technologically superior network.
Existing networks likely have an installed user base and
complementary services compared to a new network.
Network externalities can create consumer lock-in: a scenario in
which consumers are stuck in a situation (equilibrium) where
they are using an inferior network.
Due to Consumer Lock-In
MA-‹#›
37
A Network Game (Table M4-1)
$10$10, $15High output$20 , $5$1, $2
Both users initially use Provider H1 and receive $10 each in
value.
Neither has an incentive to change to H2 even though if they
both did simultaneously, they would be better off and receive

$20 each in value.
Network externalities create a consumer lock-in.User 1User
2Network ProviderH1H2H1$10, $10$0, $0H2$0, $0$20, $20
MA-‹#›
38
Consumer lock-in resulting from an existing network might be
easily resolved by communication between two users; however,
communication is not feasible with potentially hundreds of
millions of users because of transaction costs.
What hope does a firm have of establishing its new network?
One strategy, penetration pricing, involves charging a low price
initially to penetrate a market and gain a critical mass of
customers; useful when strong network effects are present.
Using Penetration Pricing to “Change the Game”
MA-‹#›
39
A Network Game with Penetration Pricing (Table M4-2)
$10$10, $15High output$20 , $5$1, $2
During the trial period, users pay only $1.
The value to each user of having access to both networks is at
least as large as the value of using either network individually.
Consumers have an incentive to “try” the new network since the
choice H1, H2 is the dominant strategy for each user.
Once they try the service and determine it is superior, they will

quit using H1.
User 1User 2Network ProviderH1H1, H2H1$10, $10$10,
$11H1, H2
$11, $10$21, $21
MA-‹#›
40
Homework 2
For this discussion, please find one journal article that describes
a current economic topic covered in either Chapter 12 or 13.
Summarize the article and explain how it relates to your chosen
topicBefore you begin your summary, please state which
chapter and topic your selected article addresses (post this at
the beginning of the page).
Your summary should be 500-1000 words. You MUST include
the citation for your article. If your article can not be located
using your citation, you will receive a zero for the assignment,
so please verify that it works before you submit your post. You
do NOT have to upload the article.
You need write 2 page
The chapter 12 and chapter 13, I give you the ppt, you can see
the ppt what we learn.
ASEE 2014 Zone I Conference, April 3-5, 2014, University of
Bridgeport, Bridgpeort, CT, USA.
Organizational Change: Case Study of General

Motors
Muhammad Aliuddin Khan
Department of Economics,
University of Peshawar
Peshawar Pakistan
[email protected]
Muhammad Hashim
Department of Business
Preston University
Islamabad Pakistan
[email protected]
Abstract— The main purpose of this article was to elaborate
and bring to light the core concept of the organization change,
how it works, diverse factors which moves organization to
change, steps for change, resistance for change, change forces,
change management approaches and last an example of General
Motor (GM) has given that how change was taken place in the
organization and what was the strategies for change
management. Recommendations and conclusion forms the last
part of the paper.
Keywords - Organization change, Factors, Resistance, GM.
I. ORGANIZATIONAL CHANGE: A BRIEF
INTRODUCTION
The business world to day is going very fast and new

technology new methods of production and new taste of
customers and new market trends as well as new strategies for
best control of the organizations and motivation of employees
are emerging and taking place from old to new methods,
because the customers are the emperor of market and most of
the company now spending billions of amount on research and
development in the organization, by keeping in view all these
things the managers and experts of the today businesses now
compel to decide about the change management in the
organizations, because business activities now are globalize,
and every organization strive to sustained the loyal customers,
trained the employees, introduce and adopt new methods of
production and best control the activities of the organization,
so from here the concept of change management or
organization change starts. When the company feel that the
activities which they are doing, the management, the way of
administration, the use of technology, the human resource
policies, the culture of the organization, the liking and
disliking the contents and context of the organization by the
employees, organization structure, group concept ,the product
quality are continuously destroying the image and reputation
of the organization the question arises that how will change
the organization in present scenario, so when the expert
specialist decides about all the situation and preparing for
changing the organization it leads to the concept of
organizational change or change management[1] . In the word
of coetsee he said that it is the ability of the management that
how they can get maximum benefits and support form change
which reduces resistant from the side of employees and
encourage appreciate acceptance and support. The process of
changing the activities of the organization as well as the
implementation of the procedures and technologies to achieve
the desire objective of the organization, in simple words to
change the environment of the business organization and to
achieve a high profit from that change, usually change

management includes different aspects such as control change,
adaptation change and effecting change. The final goal of the
change management is the long term sustainability of the
organization. organizational change simply means to change
the activities of the organization concern it may includes to
change the culture of the organization, technology, business
process, change of employees, rules and procedures,
recruitment and selection, design of jobs, method of appraisal,
and human resource techniques, physical environment of the
organization, methods of training and development, job skill
and knowledge etc. when the change of the concern
organization is fundamental it is called organization
transformations. Change management means when all the
needed actions are taken to improve the present situation for
future to implement the change strategies to get the maximum
advantages and also see that the objectives of the organization
is achieving or not[2]
A. Factors Behind The Organization Change
As we have mentioned before that organization change occurs
due to some factors that may be external or internal, such
factors may also bring change in the activities of he
organization and may also create problems to harder the
change process, as every know that change creates resistance,
and this resistance may creates huge problems, resistance to
change is also from the old employees or middle level
managers or people as they always appose to the change
strategies due to their own way of thinking and perception
regarding the change concept, this may be due to lake of
knowledge about the situation or due to the self interest of the
old employees but what ever may be the reasons but it is fact

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