Case Study 1 (due in 16 hours)
onomatopoeia
CaseStudy1Session.pptx
ECO 550 Managerial Economics
Week 6: Case Study 1: Auctions
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Eco 550 2018
Agenda: Table of Contents
Why Auctions?
What is the Assignment
What Is Expected
What Not To Do
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Case Study 1: Why Auctions?
Every thing we have done up to now has lead us to the subject of the first case study, auctions.
This is Dr William Vickery, Nobel Prize winner 1996. He asked a fundamental question we have not yet raised. What if we have a limited supply of something and/or there is no way to know the supply curve and therefore there is no marginal cost? What this means is there is or will be no new production. How can we efficiently allocate something that is scarce and be sure that the limited supply go to those who most value the items that are available?
We know how to find out who most values a painting by Van Gogh, but what if we want to know who most values a trip between points A and B of a congested highway corridor? His insight was that these two value problems are fundamentally the same problem.
In This Presentation We will look at what Role auctions serve in discovering value
To see the role of auctions, this presentation will look at the steps we have taken to find the optimal price to charge.
Auctions are also a search to find the price of something, but the goal of an auction is to search for the value. In that sense, auctions are much like the problem we examined in bundling, approximately first degree price discrimination. But what we will see is that if there is no cost and/or no supply curve there is no need to find as many buyers as possible.
The reason bundlers bundle, is to not only find optimal prices, but to sell as much as possible because of the high fixed cost and the need to achieve economies of scale.
In an auction where supply is limited, the need for scale is irrelevant. We need only to identity who most values the limited supply.
You may ask is this an important tool today? The answer is in an age when we have the ability to offer goods and services world-wide at virtually no cost, yes, auctions allow companies like eBay to assemble sufficient participants in what would otherwise be an impossible thin market into a market for valuing items. The internet is a place where we can even create a market to sell things that will never be produced, i.e. the Fantasy Football.
In the following we will take each step that brought us here so we can connect all the dots.
The Classic Picture of a Market
Now I want you to look at what the rule tells us. We determine the optimal quantity. When we look at market structure below remember that we are always going to determine the optimal quantity first. Then we will use the optimal quantity to determine the optimal price.
(Note: Cost is supply concept. Price is a demand concept.)
This is a world where we have full and complete information.
Determining the Rule for Max Profits: Classic Case of Perfect and Imperfect Competition
We Know Elasticity Is Important
Economists use elasticity in two ways.
We can talk about elasticity along a demand or supply curve.
Or we can talk about relatively elastic curves
We know the demand curve very well.
Deadweight Loss: Having our cake by breaking the Tyranny of the single price in a market
What If We Can Do Better
What if we could charge different prices to different customers for the same thing?
The customer thinks in terms of the value proposition
Price Discrimination Is a Method for Enhancing Revenue: In Some Classical Cases We Know Enough to Do It
The market demand curve is sum of all the individual demand curves. In other words we have lots of buyers, but what if while the all are willing as able to pay for a product, we can divide them up in group with different elasticity.
What if we can know our demand curve well enough to used the different degrees of preference to charge what the different groups are willing to pay.
Bundling as a Pricing Strategy
| Bundling wt negative correlation of taste | |||||
| Film 1 | Film 2 | Combined | |||
| Customer NE | $12,000 | $2,400 | $14,400 | ||
| Customer MW | $5,000 | $10,000 | $15,000 | ||
| High Price Strategy | Bundle @ $14,400 | ||||
| Sell Film 1 NE | $12,000 | Sell 2 | $28,800 | ||
| Sell Film 2 MW | $10,000 | Distribution Cost | |||
| Distribution Cost | Per Customer $20 | 40 | |||
| Per Customer $20 | $40 | Total Profit | $28,760 | ||
| Total Profit | $21,960 | ||||
| Low Price Strategy | |||||
| Sell 2 @ $2,400 | $4,800 | ||||
| Sell 2 @ $5,000 | $10,000 | ||||
| Distribution Cost | |||||
| Per Customer $20 | $40 | ||||
| Total Profit | $14,760 |
There are a large number of businesses in which MC is so small that to use the MC = MR rule does not help set the price. In this case we must look at how customers value the product.
What are some of these businesses: software is a great example, there are approximately zero costs associated with replicating software. The big cost is the development of the code. Once done it can be replicated and distributed for pennies. Education, once there is a curriculum and an instructor, the marginal cost of one more student is zero.
Because fixed cost is very very large we need to achieve economies of scale.
First degree price discrimination says, what if we could identify the highest price every customer will pay? It works in some markets but it can be costly where the market is large.
Bundling is the cost efficient way to approximate 1st degree price discrimination for general use.
Bundling is a process for evaluating the diversity of consumer willingness to pay and then, developing a strategy to drive a bundle price toward the mean.
Mixed bundling, offers freedom from the tyranny of one or two prices.
When There Is Only 0ne
There is only one and there will always be only one Starry Night. There is no supply curve and the cost of producing the item in no way informs us of its value.
How/to whom do we allocate this rare item?
If I wanted to own the painting, there is little incentive for me to volunteer any information about how much I am willing to pay.
If I am the owner of the painting, before I sell at what might be offered, I might ask who else might want the painting and how much are they willing to pay.
We cannot draw a demand curve. There is no way to get data points on price and quantity. There is only 1 quantity for which we are seeking the best price.
The Definition of a Thin Market
A thin market is one in which there are an insufficient number of bids and acceptances so that a demand curve cannot be derived. There is a wide divergence between ask and offers.
When there is lack of consensus about value, assets become very illiquid.
There are many instances of thin markets including: financial markets; art; finding Mr(Ms) right, acquiring a corporation, mineral rights on public lands, bandwidths, satellite orbits, public goods, ad space at a specific time, place and to a specific demographic.
Back to Vickery
Here was the problem about the value of a trip between a and b as explained by Vickery “It turned out that for each additional car making a daily trip that contributes to the dominant flow, during the peak hour, an additional investment of $23,000 was projected. In other words, a man who bought a $3,000 car for the purpose of driving downtown to work every day would be asking the community, in effect, to match his $3,000 investment with $23,000 from general highway funds.” (Vickrey 1963, p. 456) “Pricing in Urban and Suburban Transport.” American Economic Review 52, no. 2: 452–465.
As something of a futurist, Vickery suggested that cars could come with an electronic device that could record usage, sending a bill for use to the owner every month.,
But let’s look at how an auction could determine the optimal allocation of highway use. Now like the Van Gogh painting, it is unlikely that anyone will volunteer what they are willing to pay, but we know the trip at rush hour has higher value to some than others. In fact what we would like to know is the schedule of times and amounts people are willing to pay for those times. (Similar to airline pricing and very like the ad spot problem on the internet.)
What if we could auction off times for travel? If we could discover what toll each user is willing to pay for a given time for unimpeded travel, the use of the road would be optimized by allocating the limited resource to those with the most intense preference or highest value.
You can read more about William Vickery and Auctions at https://www.econlib.org/library/Enc/bios/Vickrey.html
Case Study 1: Auction
The goal of case study one is to investigate, why we have auctions, what are the different types of auctions and which auctions work best at uncovering value in which circumstances.
Be sure to view the video, the link is on the assignment, Auctions as price discovery mechanisms https://www.youtube.com/watch?v=4kWuxfVbIaU
Now Let’s Look at the Assignment
The following video describes auctions as price discovery mechanisms https://www.youtube.com/watch?v=4kWuxfVbIaU
Use the video on auctions and at least 3 academic and/or high-quality business publications, see definitions below, to answer the following questions in 5-7 pages:
1. There are many types of auctions each with strengths and weakness at uncovering the real price/value of an item. Compare and contrast:
a) the English and Dutch auctions; and,
b) the sealed bid first price auction and the Vickery Auction.
2. After many months of offers and counter offers for Sky PLC, the UK’s The Takeover Panel (http://www.thetakeoverpanel.org.uk/) required that Sky PLC be acquired via an auction. What type of auction was the Sky auction, who were the bidders and who won? Given that there had been multiple public offers revealed by the bidders, was the auction type selected the best type of auction for the Sky acquisition?
3. Auctions are widely used in finance, e-commerce and in e-games. Identify 3 applications of auctions used in finance, e-commerce and/or e-games. Explain the:
a) need for an auction in the product/service; and
b) what type of auction is used and why that type of auction is appropriate for the product/service.
4. Auctions are also widely used to generate revenue for not-for-profit organizations. What are the advantages/disadvantages of auctions as revenue generators for not-for-profit organizations?
5. Suggest ways in which the company you work for, or the company which you aspire to work for, can use auctions to better uncover value and increase revenue.
What is the Biggest Mistake we see
The most common problem we see, and I see this in the discussions as well, you research and write without answering the question. Make sure you address the question asked. If you are asked to draw a conclusion, make it your conclusion. The analysis should lead you to an answer.
If you are told to define and explain a concept, give a definition but make it in your own words and then make the example your own. The best way to explain a concepts is to always work from the definition and then make an illustration.
Research Requirements and Expectation
The definition of a high-quality professional business publication is one which is primarily a publication directed to reporting and/or analysis of the workings of business. Examples are: Wall Street Journal, Bloomberg, Reuters…etc. Avoid general news publications such as USA Today, Washington Post, NY Times.
PLEASE DO NOT RELY ON WIKIPEDIA, INVESTOPEDIA OR ANY OTHER PEDIA AS A REFERENCE AT ANYTIME IN THIS COURSE.
Format, presentation and citation
Must be typed, double spaced, using Times New Roman font (size 12) with one-inch margins on all sides; citations and references must follow APA format.
Include a cover page containing the title of the assignment, the student’s name, the professor’s name, the course title and the date. The cover page and the reference page are not included in the required assignment length.
AVOID GRAPHIC DECORATION ON THE COVER PAGE, SAFEASSIGN CANNOT PROCESS THESE AND THEY ARE NOT APA ACCEPTABLE.
Citation and plagiarism
Put your research into you own words. That means read, digest and summarize. You must avoid paraphrasing, a process whereby you to keep the majority of someone else’s structure of explanation. Think about how to explain the core of the idea to a friend who may not be very interested. The is the heart of the thinking. Then go back and expand around the core to fill-in important points. Make it your own.
When in doubt, cite in the text, the source. The reader should never be in doubt of the source of the material presented.
To pre-check you paper for possible plagiarism, use Grammerly. You will find Grammerly under the tutoring link. Grammerly is fast and gives you feedback for changes grammar, spelling, punctuation, and possible plagiarism. Once you get the document back, go through and complete the editing, read and change the work.
OTHER TIPS
Avoid direct quotes, they will raise your plagiarism score
Don’t use the questions as section head and make your own title to the paper
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ECO 550
Questions & Answers
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