Slides 10(Chapter 13)2Predatory conductWe.docx

Slides 10
(Chapter 13)
2
Predatory conduct
investment
3
Predation with asymmetric info

-cost incumbent have an incentive to
pretend to be low-cost to prevent entry? Such as
price like a low-cost firm?
4
An example of predation via
asymmetric information
t observes incumbent’s actions in period 1
-cost or low-cost
-cost
o specify payoffs in different situations
5

-cost firm acting as low-cost monopolist: 10
-cost firm acting as high-cost monopolist: 6
-cost adopting low-cost monopoly price: 4
nt profits in period 2
-cost incumbent: 5
-cost incumbent: 2
-cost incumbent: -2
-cost incumbent: 2
An example of predation via
asymmetric information
6
What does the structure tell us?
—i.e. entrant knows

whether incumbent is high cost or low cost?
If the incumbent has low costs, don’t enter
uncertainty?
uncertainty?
like an economist”
7
Game tree for our example
Nature
High-
Cost
Low-Cost
I
I

High Price
Low Price
E
E
Enter
Stay
Out
Incumbent: 6 + 2 = 8
Entrant: 2
Entrant: 0
Enter
Stay
Out
Entrant: 2
Entrant: 0

Low Price
Enter
Stay Out
Entrant: -2
Incumbent: 10 + 10 = 20
Entrant: 0
8
What if a high-cost incumbent
pretends to be low-cost?
-cost incumbent. It can
riod 1
-cost incumbent has incentives to pretend to
be low-cost if by so doing it can deter entry

incumbent price like a low-cost firm?
9
that the incumbent may try to deceive it
a low price knowing this may be a deception?
low-price means the incumbent is a low-cost firm
10
setting a
low-price in period 1, it cannot tell whether the
incumbent is high cost or low cost
probability that the incumbent is low-cost
-cost with probability
hich case entry will lead to a profit of –2
-cost with probability 1 -
in which case entry will lead to a profit of 2

- - -
11
- - -
cost is “sufficiently high”, an incumbent can deter
entry by setting a low price in period 1
12
More on predatory pricing

rice firms claim low price firms are predating
13
Classic case:
Matsushita vs Zenith (1986)
pricing against U.S. competitors
e goal was to drive U.S. firms out of the market
firms (especially relative to their prices in Japan)
and lost market share by U.S. firms
amages
14
Classic legal identification of

predatory pricing: P<AVC
-run “shut-down” price of profit-maximizing firm
difficult to measure
not predatory
15
Classic economic idea behind
predatory pricing
$/unit
Quantity
Demand
MR
QM

PM
AVC=MC
QP
ATCMonopoly
Profit
Firm needs to drive out competitors so it
can charge the monopoly price Pm
16
Classic economic idea behind
predatory pricing
$/unit
Quantity
Demand
MR
QM
PM
AVC=MC
PP

QP
ATC
Losses during predation
Monopoly
Profit
Charge price PP during predatory
phase. This is below your AVC and that
of your rivals. Rivals will have to exit.
17
What are some requirements for
successful predatory pricing?
two ways

make money
or low capacity costs to do this
18
Successful predatory pricing
means you must recover losses
nt losses with
the expectation of recouping monopoly profits later
less valuable because they come in the future
barriers to be large

19
Back to Matsushita vs Zenith
(1986)
is competitive, televisions should sell for
similar prices in different countries
of about 10 years)
iffs’ argument hold water?
20
The NPV of Predation:
Matsushita v. Zenith
Variable Level
Predatory price (% of “competitive” price) 62%

Years of predation 20
Growth in demand 5%
Japanese beginning mkt. share 0.05
Japanese ending mkt. share 0.42
Recoupment price (% of “competitive” price) 119-138%
20 years—U.S. firms had not exited
period is infinite!
21
From the Supreme Court
decision
“In order to recoup their losses, petitioners [Japanese]
must obtain enough market power to set higher than
competitive prices, and then must sustain those prices
long enough to earn in excess profits what they earlier
gave up in below-cost prices. Two decades after their
conspiracy is alleged to have commenced, petitioners

appear to be far from achieving this goal: the two largest
shares of the retail market in television sets are held by
RCA and respondent Zenith, not by any of petitioners.”
22
From the Supreme Court
decision
“The alleged conspiracy's failure to achieve its ends in
the two decades of its asserted operation is strong
evidence that the conspiracy does not in fact exist.
Since the losses in such a conspiracy accrue before
the gains, they must be "repaid" with interest. And
because the alleged losses have accrued over the
course of two decades, the conspirators could well
require a correspondingly long time to
recoup…petitioners would most likely have to sustain
their cartel for years simply to break even.”

23
Legal tests for predatory pricing
a legal finding of predatory pricing
1. Are prices below a reasonable measure of seller’s
costs?
2. Is there a reasonable chance that the seller will
recoup its investment?
allowing some predatory pricing than to condemn
some competitive pricing
ssful predation is rare (so that the likelihood
of false acquittals is low)
24
Another type of behavior that
looks like predation

console at around a third less than the price of its
components - and that is not counting the cost of
assembly, testing, distribution and marketing,
according to research firm supply
25
Other stories
games. Make a big margin on the games
-of-mouth demand: Set low
price initially so lot of people buy. Demand increases
later once people see that the Xbox is lots of fun
-by-doing: Cost of making an Xbox
decreases as you make more of them

Microsoft products
26
Why so many suits then?
defendants typically pay by the hour
hour)
defending against predation claims
that, with tripling, would have amounted to a $1.8
billion judgment in 1980 dollars
27
Why so many suits then?

trials
testimony well beyond their comprehension....”
--even at the margins--the
law,
the economics, or any other testimony related to the
allegations or defense."
notion of what oligopoly, market power, or average variable
cost meant, much less how they applied to the case....
Typical is the response I received when I asked a juror
whether he remembered average variable cost. The juror
replied, ‘Yes, explain it to me. I still don't know what it
means.’”
28
Suing to collude?
be used to help organize a tacit collusion scheme:

complaint detailing what is wrong with defendant's
price cuts and what reasonable prices would be
years) in which
documents,
senior executives testify about their pricing strategies, business
plans, productive capacity, costs, and many more pieces of
business information that will come very handy to both sides
when considering future pricing and output decisions
29
Suing to collude?
kes place, a judge
closely scrutinizes the parties' pricing behavior
defendants, prohibiting them from lowering their

prices until a final adjudication of the case
ssful
tacit collusion scheme
30
Suing to collude?
9, 1992, and other major carriers quickly matched or
beat American's price cut. Between April and June,
fares remained relatively flat. Then Continental filed
its predatory pricing lawsuit in early June of 1992
and Northwest filed its parallel suit a few days later
w days after filing suit, Northwest announced a
10 percent price increase

increases of their own
pricing case progressed, the major airlines reportedly raised
prices seven times
Slides 11
(Chapters 5 and 6)
2
Price discrimination
each consumer their willingness to pay
o DWL!!!
types of consumers, but can’t distinguish them
“block” pricing (selling multiple units of the good)

fy different groups
of consumers and charge them different prices
3
3rd degree price discrimination
4
3rd degree price discrimination
5
2nd degree price discrimination
it can find out whether its buyers are students or
faculty

-demand sector (students), and low-
demand sector (faculty)
6
2nd degree price discrimination
-linear pricing” to get the “types” of
consumers to sort themselves
-linear pricing” often involves charging
different consumers different prices based on the
quantity or quality purchased
7
Simple example of quantity discount:
two-part tariff
customer ---students

- 2Q
DMR
10
4
MC
8
two-part tariff
-student demand is P = 16 - 2Q; MC = 4
-part tariff? Charge a cover
charge F plus a per-drink price p
-drink price p?

D
16
4
6
MC
9
two-part tariff
-drink price p?
D

16
4
6
MC
10
two-part tariff
-drink price p?
D
16

4
6
MC
11
two-part tariff
-drink price p?
16

4
6
MC
12
two-part tariff
-drink price p?

16
4
6
MC
13
With one “type” of consumer, two-part
tariff or “block tariff” are like 1st degree PD
-part tariff:
block tariff
ckage deal”
14
More interesting: two types of consumers

- 2Q
- 2Q
wice as many faculty as students
15
Suppose we can distinguish the two types
degree price discriminate
-tariff to each group
16
8
12
6
44 MC MC
64
$36
$16
StudentsFaculty

Low fixed price = $16
Per unit price = MC
High fixed price = $36
Per unit price = MC
16
More interesting: we can’t distinguish the
two types
-part tariffs
Students?
16
8
12
6
44 MC MC
64
$36
$16

StudentsFaculty
Low fixed price = $16
High fixed price = $36
Per unit price = MC
Per unit price = MC
17
More interesting: you can’t distinguish the
two types. Block pricing case.
still offer the same block tariffs
16
8
12
6
44 MC MC
64
$36
$16

StudentsFaculty
Block for faculty:
$32 for 4 tickets
Block for students:
$60 for 6 tickets
$16 $24
18
More interesting: you can’t distinguish the
two types. Block pricing case.
drinks is $48
12
6
4 MC
4
$16

Faculty
Block for faculty:
$32 for 4 tickets
16
8
4 MC
64
$48
Students
19
When you can’t distinguish types, can’t
perfectly discriminate anymore
students
pay the high cover
’t get as many drinks under block tariff

-part tariff for all customers
student tariff
20
Option 1: Charge a single cover price F
plus per-drink price p to everyone
adults. But won’t pay higher cover charge
-part tariff examples suggest that
setting p = MC = 4 is a good starting point
21
Single two-part tariff with two types
6
C =4
4
A =12

8
A =16
B B’
22
Option 2: Offer two entry / drink packages
choose, and a package that faculty (“low types”)
will choose
ll include a smaller number of
drinks, so that students won’t want it
23
First think about the low
demand types (faculty)
First package from before: costs $32
and includes four drinks
Producer surplus is:
$32-$16 = $16

12
6
4 MC
4
$16
$16
Recall where these numbers come from
Four drinks because that is what they
demand when P=MC
Then, add triangle ($16) and cost ($16)
24
High demand types (students)
16
8
4 MC
6

$36
$24
THIS WON’T WORK!
25
Students buying the faculty
package
16
8
4 MC
6
Package 1: $32
Includes: entry and 4 drinks
If a high demand consumer
buys package 1, the area under
demand is $48 and they pay $32.
So, they get $16 in surplus.
4

$48
Any package must bring high
demand consumers at least $16
in surplus.
High demand Can the firm do anything?
26
What is needed to make this work?
that they are indeed a high demand customer?
When it is in their interest to do so!
revealing that they are a high demand customer
package such that students will want to buy it
students will get more utility from this new
package

27
Constructing a package for the
high types
16
8
4
MC
6
Package 2: $????
Why should package have 6 drinks?
$60
28
high types
16
8
4

MC
6
Package 2: $????
demand is $60
$60
What is the most you can charge
them?
29
high types
16
8
4
MC

6
Package 2: $????
demand is $60
$60
What is the most you can charge
them?
$60-$16 = $44
Producer surplus is:
$44-24=$20
30
Recap so far: 2nd degree PD
with block pricing

can’t observe type, we must charge the
students less. Otherwise, they will take the faculty
package.
Profits = $36
31
Can we do even better?
Let’s think about what just happened…
package because we are worried the high
demand consumers will buy the low demand
package
amount of CS a high demand consumer would

get from buying the low demand package
high demand package and make more money?
32
Options for increasing the price of
the high demand package
1. We could increase the price of the low demand
package
low types
attractive to the high types?
2. We could “degrade” the quality of the low
demand package by offering fewer drinks
drinks, but lower cover charge…

33
Degrading the low demand
package…
drinks, but lower cover charge. What happens?
34
Recap of degrading the “low type”
package
drinks?
ect a bulk discount (one student
package is cheaper than two faculty packages)

35
package…
profits because:
tion of quantity on the
margin. So don’t have to compensate the low type
too much for this
low type’s margin. Degrading the low-type
package makes it much less desirable to the high
type
Can charge more for the more attractive high-type
package
36
package is common

uncomfortable. Serve gross food
(may not be true today): no roof for
section of train with the cheapest tickets
its cheaper laser printers
Slides 12
(Chapter 7)
2
Multi-product Monopolies:
A bit of gray area…
r examples of 2nd degree price
discrimination can also be thought of as
differentiated products models
-class versus economy airfare

exists in these cases when:
by cost differences
3
Why is Microsoft “evil”?
near-monopoly in operating systems (MS
Windows)
exclusively focused on Windows. Other products of
Microsoft have always been central to the cases
t yet, but
multi-product issues will play a role
4
Multiple products changes
things…

le? price?)
of another
5
Two types of product differentiation:
vertical vs horizontal
which product has the highest quality
agrees which product is best

types of consumer
6
Product variety and “quality”
discrimination
EX, LX, XX, TX, etc…
-quality
version, others to buy low-quality
imilar to price discrimination
the good that was designed for him/her
7
Quality and price discrimination
ll consumer surplus from low quality good

and as much as possible from high quality good
demand customers buy high quality product
8
Monopoly with multiple horizontally
differentiated products
A return to Hotelling!
9
Example: Breakfast cereal
-to-eat” cereal industry
’s and General Mills are dominant
marginal cost)?

10
Some puzzles
margins. An exception is recent entry of
healthy brands, e.g., Kashi
k of entry, incumbent firms
frequently introduce new brands (there are at
least 12 types of Cheerios)
11
Does the world need this many
types of cheerios?
12
Entry puzzle in breakfast cereal: no
new firms, but lots of new brands
A. Lack of entry by other firms suggests

presence of barriers to entry
B. Incumbent firms introduce lots of new brands
Two potential stories as to why this might be:
1. High costs of advertising / promotion
2. All brands themselves are a barrier to entry
13
What about story 1: High up-front
advertising?
A. Lack of entry by other firms suggests presence
of barriers to entry
B. Incumbent firms introduce lots of new brands
How would an advertising story work given (A)
and (B) above?
firms don’t have to spend
as much on ads as an entrant
substantial brand recognition
-Cinnamon Cheerios in 1989

14
What about story 2: Brand
proliferation?
deterrence
have N brands of cereal ---we will model this!
d idea to introduce more
brands?
15
Idea behind entry deterrence via
brand proliferation
brands

enough” so that it makes positive profits
instead
product
still competing only with itself
16
We need a model to help us
answer some questions here
horizontally differentiated market?
differentiated product Bertrand competition
otelling line! Except now the products are
all owned by the same firm

monopolist?
number of brands?
17
Return to the Hotelling model of
horizontal differentiation
model to figure out what happens in
differentiated Bertrand competition
model differing preferences of consumers
people on other side like Coke

18
Return to the Hotelling model of
horizontal differentiation
on the Hotelling line
19
Applying the Hotelling line to a
multiproduct monopoly

20
Basic setup of the model is the
same as in multi-firm case
store located at y
– t|y – x| - py
21
What will the monopolist do?
consumers
to charge

number of brands?
many pictures! PRN 7.2 does a similar example,
though graph setup is different
PROBLEM SET 3
1. Read the April 2002 Wall Street Journal article: “How to
Beat Priceline: New Sites Post Secret
Bids—Bargain Hunters Can See Exactly What Winners Have
Paid for Cheap Trips” posted
under the “Problem Sets” section of the course website.
(a) An identical hotel room appears to sell for one price if
booked through the hotel and a
different, lower price if booked through Priceline. What may
account for the difference in
the two prices (more than one factor may be potentially
relevant)? Be as specific and

complete as possible.
(b) Describe any differences between the hotel and Priceline in
their incentives for preventing
customers from posting the price they paid on Priceline for a
room in a specific hotel.
2. Suppose Volvo can produce a new sedan with the cost
function:
C(Q) = 50000 + 15Q
These sedans are sold in the European and U.S. markets.
Demand is given by:
QE = 18000 – 400PE QU = 5500 – 100PU
where E denotes Europe and U denotes the U.S. All prices and
quantities are in thousands.
Assume that it costs Volvo the same amount to produce and
deliver a car for sale in the U.S.
as in Europe.
(a) Show that Volvo’s total demand, if the two markets are
treated as one, is given by:
Q = 0 if P ≥ 55
Q = 5500 – 100P if 45 ≤ P < 55

Q = 23500 – 500P if P < 45
(b) If Volvo must set a single price (i.e. the same price in both
the U.S. and Europe) for its new
sedans, what price should it set, what will be the quantity sold
in each market, and what
are Volvo’s profits and total consumer surplus?
(c) Now suppose that Volvo is able to restrict U.S. sales to
authorized Volvo dealers only, and
at the same time is successful in lobbying the European and
U.S. governments to make it
illegal for a consumer or dealer to ship Volvo sedans from
Europe to the U.S. What quantity
of sedans should Volvo sell in each market, and what will be the
price in each market?
What are total profits and consumer surplus? Why does this
differ from the optimal price
and quantity you found in (b)?
(d) Now suppose that Volvo’s lobbying power isn’t as strong as
in case (c), and that individual
consumers wishing to purchase a car in Europe, retrofit it to
meet U.S. regulations, and
ship it to the U.S. can do so and incur an additional cost of

about $2 thousand. Given this
possibility of costly arbitrage, what quantity of sedans should
Volvo sell in each market,
and what will be the price in each market? What are total
profits?
3. Consider a coffee shop that has two types of customers:
lawyers and doctors. The demand for
espresso by lawyers is given by QL = 18 – 3P, where P is
measured in dollars and Q is measured
in ounces. The demand for espresso by doctors is given by QD =
10 – 2P. There are equal
numbers of lawyers and doctors. The marginal cost of an ounce
of espresso is $2.
(a) Suppose that the coffee shop can identify which customer is
a doctor and which is a lawyer.
The shop will offer each type of customer a specific size cup of
espresso for some total
price. How many ounces of espresso will lawyers be offered,
and at what total price? How
many ounces of espresso will doctors be offered, and at what
total price? (HINT: you
should find that lawyers are offered a 12 ounce drink for $48,
and doctors are offered a 6

ounce drink for $21. Lawyers and doctors are both tired and
rich!)
(b) Suppose that the shop owner can no longer distinguish the
lawyers from the doctors (e.g.,
the doctors don’t put on their white coats before getting their
espresso). Suppose the shop
still offers the two options you found in part (a). That is, each
customer has the option of
paying $21 for 6 ounces or $48 for 12 ounces. How will the
customers respond?
(c) Keeping the drink sizes the same (6 ounces and 12 ounces),
how should the coffee shop
owner change the total prices of the two drinks so that lawyers
will buy the lawyer option
and doctors will buy the doctors option, and profits are
maximized?
(d) Describe qualitatively how the coffee shop owner should
change the drink sizes (and then
the prices) to increase profits even further, while still ensuring
that lawyers will buy the
lawyer option and doctors will buy the doctors option.
(e) Suppose that the coffee shop owner could only charge a

single, uniform two-part tariff to
all customers. That is, both lawyers and doctors pay the same
cover charge C and per-ounce
price p. Describe qualitatively what C and p should be if the
shop owner maximizes profits.
Can you put upper and / or lower bounds on C and / or p?
4. High Street in Columbus, Ohio is exactly 5 miles long. Urban
Meyer plans to sell Ohio State
Buckeyes 2014 National Champion t-shirts to customers on
High Street, and he has the right
to do so as a monopoly. There are 1,000 Ohio State football
fans spread out evenly on the
street, and each fan values the t-shirt at $5. It costs every fan $1
per mile he or she has to walk
to get to a shop selling the t-shirts. Each shirt costs $0.50 to
make, and each shop costs $40 to
set up. How many shops should Urban Meyer set up, and what
will be the price of a t-shirt at
each shop?

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