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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

4 Class 4: Market Failure Definitions Public Policy Ethics Recap

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

Profits and Competition Recap

You have to learn the rules of the game. And then you have to play better than anyone else. – Albert Einstein

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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?

Markets are not perfect

Firms need to understand how this affects ethical and profit objectives

True leaders understand that ethics should never be compromised for profit

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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

Monopoly regulation - how it affects business decisions

Externalities - what they are and what to do about them

Understand market failures - consider how to turn them into opportunity

Create a simple set of ethics rules for yourself to use

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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

Market Failures

Discussion: Market failure is simply, markets failing to deliver the most good to the most people. (i.e. Pareto-optimal outcomes)

Markets only exist if rules that preserve property rights work

When markets work, no party is worse-off after a transaction

When markets fail, somebody gets the short end

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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

Market Failures

Discussion: Market failure is simply, markets failing to deliver the most good to the most people. (i.e. Pareto-optimal outcomes)

Markets only exist if rules that preserve property rights work

When markets work, no party is worse-off after a transaction

When markets fail, somebody gets the short end

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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

Market Failure Types

Time-Inconsistent Preferences Information Asymmetries

Monopoly Power Externalities

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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

Time-Inconsistent Preferences

Please indicate your choices on a card:

On your mortgate, would you pay a 5% interest rate?

Or 3% now, adjustable to 8% in three years?

...people are disproportionately attracted to immediately available rewards... (e.g., the pleasure of a cigarette now vs. the pleasure of good health in the future) – Stephen.H and G.Loewenstein(1991) Time Inconsistent Preferences and Consumer Self Control

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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

Time-Inconsistent Preferences

Please indicate your choices on a card:

On your mortgate, would you pay a 5% interest rate?

Or 3% now, adjustable to 8% in three years?

...people are disproportionately attracted to immediately available rewards... (e.g., the pleasure of a cigarette now vs. the pleasure of good health in the future) – Stephen.H and G.Loewenstein(1991) Time Inconsistent Preferences and Consumer Self Control

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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

Information Asymmetries

Somebody knows more than the other person - can the trade be fair? Who knew what was in the mortgage bonds

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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

Market Power-(Monopoly)

What if there was only one bank? What would ATM fees be?

businesses should be looking to create value

they should not be looking to corner rent

Let’s have a debate

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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

Externalities

Example 1: Your neighbor’s house is foreclosed.

What happens to the value of your home?

Example 2: You take risks that could cost the taxpayer bailout funds.

How much risk do you take?

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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

Externalities Recap

Externalities happen where:

Marginal Total Cost 6= Marginal Private Cost ORMarginal Total Benefit 6= Marginal Private Benefit

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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

Public Policy

Regulation

Definition: Market regulation is government action to address market failures: Operating limits and standards to address time-inconsistent preferences Reporting standards and contract regulation for information problems Antitrust actions to address abuses of monopoly power Taxes, permits and facilitated payments to address externalities

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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

Public Policy

Policy Response: Externalities

Remedies for externalities could be: government-managed or negotiated Public solutions include:

Taxes (Pollution taxes, Gasoline tax) Standards Permits (e.g. Lead limits in drinking water)

Negotiated or hybrid solutions include: Private Payments Cap and Trade

Governments’ role is to promote positive externalities:

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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

Public Policy

Zero Emission Credits

Two perspectives on Tesla: L.A. Times Bloomberg

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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

Public Policy

Coase’s Theorem

You can have economically efficient (Pareto-optimal) outcomes IF: trade in the externality is possible there are sufficiently low transaction costs all parties can bargain

the initial allocation of property does not matter

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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

Public Policy

Positive Externalities: Patents and Copyrights, R&D subsidy

Patents promote discovery:

R& D subsidies reduce the costs of discovery

Copyrights secure brands used to market discoveries

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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

Public Policy

Policy Response: Monopoly Power

Policy response include: Breaking up existing monopolies Breaking up cartels Blocking monopolistic practices (e.g. predatory pricing) Blocking mergers

Governments’ role is to encourage competition

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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

Public Policy

Policy Response: Information Asymmetries

Policy response include: Reporting standards Contract regulation

Governments’ role is to encourage full disclosure

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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

Ethics

The Ethical Question

Will markets fail if all parties were 100% ethical?

In context of market failure, what does leadership mean?

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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

Ethics

Notable Companies with Ethical Heuristic

Google: "Don’t be evil."

Patagonia: "1% for the planet"

Salesforce: all get six days off per year to do charitable work

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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

Ethics

Class Exercises

Work in groups: Come up with an ethics rule for your company. Try for 6 words or less Make your own Ethical Heuristic (i.e. Rules of Thumb)

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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

Ethics

Breakout: Team Project

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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: The Case for Public Policy Intervention

Markets often fail - i.e. they do not give the best outcomes to the most people Think TIME:

Externalities: having the right to incur costs for others may create issues Market power: rent-seeking hurts most to the benefit of a few Info asymmetries: Laws are needed to avoid cheating by the more knowledgeable Time-inconsistent market choices (short-termism) call for public intervention

Therefore, true business leaders must support reasonable regulation

...because markets exist only because of regulation, in the first place

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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 risk and uncertainty - which is really a problem of information

Read Chapter 12 carefully, there will be a quiz

Work hard on your projects, the finish line is in sight

Register for Class 6 simulation

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