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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs

3 Class 3: Competition Definitions Determinants of Profitability: Porter’s 5 Forces Economic Competition Recap

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs

3 Class 3: Competition Definitions Determinants of Profitability: Porter’s 5 Forces Economic Competition Recap

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs

3 Class 3: Competition Definitions Determinants of Profitability: Porter’s 5 Forces Economic Competition Recap

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

42 / 125

Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs

3 Class 3: Competition Definitions Determinants of Profitability: Porter’s 5 Forces Economic Competition Recap

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

42 / 125

Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs

3 Class 3: Competition Definitions Determinants of Profitability: Porter’s 5 Forces Economic Competition Recap

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

42 / 125

Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs

3 Class 3: Competition Definitions Determinants of Profitability: Porter’s 5 Forces Economic Competition Recap

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

42 / 125

Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs

3 Class 3: Competition Definitions Determinants of Profitability: Porter’s 5 Forces Economic Competition Recap

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Quiz 2

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Why are we in class today?

You have a bright idea?... You are not the only one

Competitive environment shapes decisions about demand and costs

So, firms must understand competitive environment

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Key Learning Objectives

Porter’s 5-Forces Framework

Oligopoly - Industry Concentration

Prisoners’ Dilemmas - Games of ’I-don’t-know-what-you’d-do’

Price wars as a case of Prisoners’ Dilemma

Competition Rules: When to cut prices

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Definitions

Competition

In a perfect market:

There are no barriers to participating as a buyer or seller

So, large numbers of economic agents converge to transact

The transactions are standardized, for products with uniform traits

So that prices are uniform, and cannot be influenced by any one ...

Examples of a perfect market?

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Definitions

Definition: Monopoly

Monopoly: market with a single (dominant) seller

3 % of US GDP is transacted in markets like these

e.g. Concrete mix, utilities...

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Definitions

Definition: Oligopoly

Oligopoly: market with a few sellers and many buyers for a product that may or may not be homogeneous

There is no entry (maybe)

With few sellers, firms must act strategically, as profits are interdependent

i.e. each firm considers actions of competitors, and competitors’ reactions to own actions...

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Definitions

Definition: Cartels

Cartel: (In)formal association of firms or countries that explicitly agree to coordinate their activities [e.g. OPEC, DeBeers (at one time)]

They are inherently unstable

They are inherently illegal and unethical Sherman Act (1890), Section 1: Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade... is declared to be illegal. Every (violator) shall be punished by fine not exceeding $100 million... or by imprisonment not exceeding ten years, or by both...

European Union: Treaty of Rome (1957), Article 85, prohibits all agreements between undertakings, decisions by associations of undertakings and concerted practices...

"People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices." – Adam Smith (The Wealth of Nations)

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Determinants of Profitability: Porter’s 5 Forces

Porter’s 5 Forces

Provides framework for understanding the structure of industries:

Comprehensive and applicable to most industries

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Determinants of Profitability: Porter’s 5 Forces

Intra-Sector Competition

combines several factors like: resource constraints scope for differentation technical constraints

can be measured by concentration

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Determinants of Profitability: Porter’s 5 Forces

Oligopoly Concentration Ratios

- Industry concentration: usually defined as share of industry revenue for top 4 firms (or C4) - Exercise: Rank these industries in increasing order of concentration

Auto dealerships, Auto manufacturing, automobile parts manufacturing

Mobile/wireless phone service, cellphone handset manufacturing, handset retail

Cable television service, cable modem manufacturing, Entertainment and media

- Herfindahl-Hirschman Index = ∑

i S 2 i : (better measure of industry concentration)

-Concentration Ratio: US Census

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Determinants of Profitability: Porter’s 5 Forces

Ease of Entry

represents barrier to entry into industry common determinants of ease of entry:

increasing returns to scale control of scarce resources technological superiority government created barriers to entry

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Determinants of Profitability: Porter’s 5 Forces

Substitutes

represents elasticity of subsitution for related sectors

calls for thinking broadly (if necessary) about industry Coca-Cola: competing for share of all liquids people ingest

e.g. Are batteries and natural gas substitutes?

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Determinants of Profitability: Porter’s 5 Forces

Supplier Power

captures importance of costs: fixed, marginal, opportunity

... as well as whether the behavior of component costs is tech-driven or cost-driven

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Determinants of Profitability: Porter’s 5 Forces

Buyer Power

captures demand, elasticity of demand

... as well as potential effects of monopsony

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Determinants of Profitability: Porter’s 5 Forces

5 Forces Recap

Intra-industry competition

(The threat of) Entry

Substitute products

Suppliers (Monopolies)

Buyers (Monopsony)

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Economic Competition

Price Rigidity: Elasticity

Underlying all these models is the Law of Demand

...the principle that consumers’ demand curves are sensitive to prices

Economists usually represent this with a smooth demand curve

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Economic Competition

Kinked Demand Curves

Demand curves may be kinked for oligopolies

Therefore prices may be somewhat stable

...because price elasticity is high above current price and low below it

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Economic Competition

Price Wars

Discussion: Exercise

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Economic Competition

Prisoner’s Dilemma

Prisonner’s Dilemma: Simple game-theoretic framework for describing one category of non-cooperative systems of interaction

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Economic Competition

When to Cut Prices

Consider cutting prices:

if the market demand curve shifts to the left when your product is moving from early adopters to the mass market when you find your way up the learning curve when it is the industry fad when it can boost sales of complements

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Recap

Prisoner’s Dilemma

Group Project Review

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Recap

Recap: Competition

Most of the US economy is run by oligopolies - industries with few producers Producer pricing power is between monopoly and perfect competition Firm decisions are interdependent

the small numbers tempt firm to form illegal cartels

Industry concentration measured by C4 or HHI is high Porter’s 5 Forces framework describes these well

intra-sector competition; ease of entry Substitutes; Supplier power; Buyer power

Prices may be stable if kinked demand curve, or may reflect price wars

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Recap

Prep for Next Class

We will discuss market failure - when markets do not work

Read Chapter 11 pages 446-470 before class

Revise today’s material and previous classes, work as group to extend the team report

Take some time to breathe and relax, it will all be fine

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