ECN 337 (2).pdf - Chapter 1 Industry Any large scale business activity Industrial Organization Is concerned with the workings of markets and industries

ECN 337 (2).pdf - Chapter 1 Industry Any large scale...

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Unformatted text preview: Chapter​ ​1: ● Industry: ○ Any​ ​large​ ​scale​ ​business​ ​activity ● Industrial​ ​Organization: ○ Is​ ​concerned​ ​with​ ​the​ ​workings​ ​of​ ​markets​ ​and​ ​industries,​ ​in​ ​particular​ ​the​ ​way firms​ ​compete​ ​with​ ​each​ ​other. ■ Studies​ ​the​ ​economics​ ​of​ ​imperfect​ ​competition ● Market​ ​Power: ○ Ability​ ​to​ ​set​ ​prices​ ​above​ ​cost,​ ​specifically​ ​above​ ​incremental​ ​or​ ​marginal​ ​cost ○ As​ ​long​ ​as​ ​there’s​ ​free​ ​entry,​ ​expect​ ​insignificant​ ​levels​ ​of​ ​market​ ​power ■ Acquiring​ ​market​ ​power​ ​1:​ ​legal​ ​protection ● Ex:​ ​Xerox​ ​develops,​ ​patents​ ​plain-paper​ ​photocopying​ ​technology, then​ ​raises​ ​prices ■ Acquiring​ ​market​ ​power​ ​2:​ ​firm​ ​strategy: ● ex:​ ​BSkyp​ ​introduces​ ​aggressive​ ​digital​ ​TV​ ​package:​ ​free​ ​recover box,​ ​free​ ​internet​ ​40%​ ​discount​ ​on​ ​telephone​ ​charges ● ● ● Allocative​ ​inefficiency: ○ High​ ​airfares,​ ​for​ ​example,​ ​imply​ ​potential​ ​fliers​ ​refrain​ ​from​ ​buying​ ​a​ ​ticket​ ​even though​ ​there​ ​are​ ​empty​ ​seats Rent​ ​seeking: ○ Firms​ ​invest​ ​in​ ​unproductive​ ​resources​ ​in​ ​an​ ​attempt​ ​to​ ​influence​ ​policymakers Productive​ ​inefficiency: ○ Less​ ​competitive​ ​markets​ ​imply​ ​fewer​ ​incentives​ ​to​ ​be​ ​cost​ ​efficient,​ ​innovate ● Firm​ ​regulation:​ ​firm​ ​has​ ​monopoly,​ ​or​ ​near-monopoly​ ​power;​ ​its​ ​actions​ ​(ex.​ ​prices)​ ​are directly​ ​under​ ​regulator’s​ ​oversight ● Antitrust​ ​policy:​ ​prevents​ ​firms​ ​from​ ​taking​ ​actions​ ​that​ ​increase​ ​market​ ​power: Examples:​ ​Mars​ ​vs​ ​Unilever​ ​legal​ ​cases​ ​in​ ​Europe ● Third​ ​dimension:​ ​industrial​ ​policy:​ ​support​ ​specific​ ​firms​ ​or​ ​industries,​ ​namely​ ​with respect​ ​to​ ​foreign​ ​firms ○ Generally​ ​disliked​ ​by​ ​economists Chapter​ ​2 ● Demand​ ​curve ○ Quantity​ ​demanded​ ​at​ ​any​ ​given​ ​price ○ Usually​ ​downward​ ​sloping ○ Inverse​ ​demand:​ ​what​ ​would​ ​you​ ​be​ ​willing​ ​to​ ​pay​ ​for​ ​1​ ​apple,​ ​2nd​ ​apple,​ ​3rd apple,​ ​etc ● Law​ ​of​ ​demand ○ Quantity​ ​demanded​ ​falls​ ​as​ ​price​ ​rises ● ● ● ● ● ● ● ● ● ● ● ■ Availability​ ​of​ ​substitutes,​ ​limited​ ​budget Inverse​ ​demand​ ​curve: ○ Difference​ ​between​ ​price​ ​and​ ​willingness​ ​to​ ​pay Fixed​ ​cost​ ​(FC):​ ​the​ ​cost​ ​that​ ​does​ ​not​ ​depend​ ​on​ ​the​ ​output​ ​level,​ ​C​ ​(0) Variable​ ​cost​ ​(VC):​ ​that​ ​cost​ ​which​ ​would​ ​be​ ​zero​ ​if​ ​the​ ​output​ ​level​ ​were​ ​zero,​ ​C​ ​(q)​ ​−​ ​C (0) Average​ ​cost​ ​(AC)​ ​(a.k.a.​ ​“unit​ ​cost”):​ ​total​ ​cost​ ​divided​ ​by​ ​output​ ​level,​ ​C​ ​(q)/q Marginal​ ​cost​ ​(MC):​ ​the​ ​unit​ ​cost​ ​of​ ​a​ ​small​ ​increase​ ​in​ ​output​ ​ ​Definition:​ ​derivative​ ​of cost​ ​with​ ​respect​ ​to​ ​output,​ ​dC/dq​ ​ ​Approximated​ ​by​ ​C​ ​(q)​ ​−​ ​C​ ​(q−1) Perfect​ ​competition: ○ Homogeneous​ ​product​ ​and​ ​lots​ ​of​ ​competitors,​ ​none​ ​of​ ​them​ ​large​ ​enough​ ​to affect​ ​the​ ​market​ ​price​ ​on​ ​its​ ​own ○ Perfect​ ​information​ ​about​ ​price​ ​and​ ​quality ○ Free​ ​entry​ ​and​ ​free​ ​access​ ​to​ ​production​ ​methods Market​ ​equilibrium ○ If​ ​p​ ​>​ ​p∗,​ ​supply​ ​>​ ​demand​ ​and​ ​price​ ​will​ ​tend​ ​to​ ​fall ○ If​ ​p​ ​<​ ​p∗,​ ​supply​ ​<​ ​demand​ ​and​ ​price​ ​will​ ​tend​ ​to​ ​rise ○ Equilibrium:​ ​At​ ​p​ ​=​ ​p∗,​ ​supply​ ​=​ ​demand,​ ​and​ ​there​ ​are​ ​no​ ​forces​ ​pushing​ ​the price​ ​in​ ​either​ ​direction ○ The​ ​Law​ ​of​ ​Supply​ ​and​ ​Demand Short​ ​run:​ ​ ​The​ ​number​ ​of​ ​firms​ ​is​ ​fixed​ ​ ​Firms​ ​use​ ​min​ ​AVC​ ​as​ ​shut-down​ ​threshold Long​ ​run:​ ​ ​Firms​ ​can​ ​enter​ ​or​ ​exit​ ​the​ ​market​ ​ ​Firms​ ​use​ ​min​ ​AC​ ​as​ ​entry/exit​ ​threshold The​ ​Fundamental​ ​Theorem​ ​ ​Also​ ​known​ ​as​ ​Fundamental​ ​Theorem​ ​of​ ​Welfare Economics ○ Exchange​ ​generates​ ​surplus: ○ Sellers​ ​sell​ ​for​ ​more​ ​than​ ​marginal​ ​cost:​ ​producer​ ​surplus ○ Buyers​ ​pay​ ​less​ ​than​ ​willingness​ ​to​ ​pay:​ ​consumer​ ​surplus ○ If​ ​markets​ ​are​ ​competitive,​ ​then​ ​markets​ ​are​ ​efficient:​ ​total​ ​gains​ ​from​ ​trade (surplus)​ ​are​ ​maximized ■ The​ ​Fundamental​ ​Theorem​ ​(cont) ■ Consumers​ ​who​ ​have​ ​a​ ​valuation​ ​higher​ ​than​ ​price​ ​buy ■ Producer​ ​sells​ ​units​ ​with​ ​marginal​ ​cost​ ​lower​ ​than​ ​price ■ Hence,​ ​all​ ​trades​ ​such​ ​that​ ​willingness​ ​to​ ​pay​ ​is​ ​higher​ ​than​ ​marginal​ ​cost take​ ​place ■ Price​ ​indicates​ ​whether​ ​consumer​ ​should​ ​buy​ ​and​ ​whether​ ​producer should​ ​sell:​ ​the​ ​invisible​ ​hand What​ ​is​ ​regulation?​ ​ ​:​ ​Government​ ​intervention​ ​in​ ​economic​ ​activity​ ​using​ ​commands, controls,​ ​and​ ​incentives ○ State-imposed​ ​limitation​ ​on​ ​the​ ​discretion​ ​that​ ​may​ ​be​ ​exercised​ ​by​ ​individuals​ ​or organizations,​ ​which​ ​is​ ​supported​ ​by​ ​the​ ​threat​ ​of​ ​sanction ■ Types​ ​of​ ​regulation ● Market​ ​regulation ● ​ ​Entry​ ​regulation ● ● ● ● ● ● ● ● ● ● ● ● ● Firm​ ​regulation ● Social​ ​regulation Perfect​ ​price​ ​discrimination: ○ Each​ ​customer​ ​is​ ​charged​ ​a​ ​different​ ​price​ ​—​ ​exactly​ ​his/her​ ​willingness​ ​to​ ​pay (“from​ ​each,​ ​according​ ​to​ ​his/her​ ​willingness”) ■ Examples:​ ​plumber,​ ​lawyer,​ ​piano​ ​teacher;​ ​customer​ ​markets Informally,​ ​game​ ​theory​ ​reminds​ ​us​ ​to: ○ Understand​ ​our​ ​competitors:​ ​Our​ ​results​ ​depend​ ​not​ ​only​ ​on​ ​our​ ​own​ ​decisions but​ ​on​ ​our​ ​competitors’​ ​decisions​ ​as​ ​well ○ Look​ ​into​ ​the​ ​future:​ ​Decisions​ ​taken​ ​today​ ​may​ ​have​ ​an​ ​impact​ ​in​ ​future decisions,​ ​both​ ​by​ ​ourselves​ ​and​ ​by​ ​our​ ​competitors ○ Pay​ ​attention​ ​to​ ​information:​ ​Who​ ​knows​ ​what​ ​can​ ​make​ ​a​ ​difference ○ Look​ ​for​ ​win-win​ ​opportunities:​ ​Some​ ​situations​ ​are​ ​competitive,​ ​but​ ​others​ ​offer benefits​ ​to​ ​all Nash​ ​equilibrium: ○ Combination​ ​of​ ​moves​ ​in​ ​which​ ​no​ ​player​ ​would​ ​want​ ​to​ ​change​ ​her​ ​strategy unilaterally.​ ​Each​ ​chooses​ ​its​ ​best​ ​strategy​ ​given​ ​what​ ​the​ ​others​ ​are​ ​doing​ ​(or given​ ​the​ ​beliefs​ ​of​ ​what​ ​others​ ​are​ ​doing). Typical​ ​scenarios​ ​: ○ Agency​ ​problem:​ ​a​ ​principal​ ​(e.g.,​ ​employer)​ ​wants​ ​to​ ​contract​ ​with​ ​an​ ​agent,​ ​but the​ ​former​ ​cannot​ ​observe​ ​the​ ​latter’s​ ​actions​ ​(moral​ ​hazard) ○ Lemons​ ​problem​ ​(or​ ​adverse​ ​selection):​ ​one​ ​party​ ​(e.g.,​ ​car​ ​seller)​ ​has​ ​better information​ ​than​ ​the​ ​other ○ Signaling​ ​problem.​ ​A​ ​player​ ​chooses​ ​its​ ​actions​ ​strategically​ ​so​ ​as​ ​to​ ​influence others’​ ​beliefs​ ​(e.g.,​ ​reputation) 1.​ ​Market​ ​power​ ​The​ ​ability​ ​to​ ​price​ ​above​ ​marginal​ ​cost.​ ​Firms​ ​with​ ​market​ ​power​ ​face​ ​a downward​ ​sloping​ ​demand​ ​curve​ ​and​ ​choose​ ​price​ ​so​ ​as​ ​to​ ​maximize​ ​profit. 2.​ ​Oligopoly​ ​Market​ ​structure​ ​in​ ​which​ ​only​ ​a​ ​few​ ​(2+)​ ​firms​ ​supply​ ​the​ ​market.​ ​This​ ​can result​ ​in​ ​market​ ​power​ ​for​ ​those​ ​firms​ ​because​ ​of​ ​reduced​ ​competition. 3.​ ​Demand​ ​elasticity​ ​The​ ​percent​ ​change​ ​in​ ​demand​ ​due​ ​to​ ​a​ ​one​ ​percent​ ​change​ ​in price.​ ​If​ ​absolute​ ​value​ ​is​ ​larger​ ​than​ ​one,​ ​demand​ ​is​ ​said​ ​to​ ​be​ ​elastic,​ ​if​ ​less​ ​than​ ​one, inelastic,​ ​and​ ​if​ ​equal​ ​to​ ​one,​ ​unit​ ​elastic. 4.​ ​Dynamic​ ​efficiency​ ​Productive​ ​efficiency,​ ​or​ ​improvement,​ ​over​ ​time.​ ​The​ ​idea​ ​is​ ​that firms​ ​are​ ​making​ ​the​ ​investments​ ​to​ ​improve​ ​the​ ​production​ ​process​ ​and​ ​introduce​ ​new products. ​ ​5.​ ​Nash​ ​equilibrium​ ​Equilibrium​ ​concept​ ​in​ ​game​ ​theory​ ​that​ ​is​ ​described​ ​as​ ​a​ ​mutual best​ ​response​ ​so​ ​that​ ​no​ ​player​ ​can​ ​do​ ​better​ ​by​ ​unilaterally​ ​deviating. Price​ ​is​ ​equal​ ​to​ ​average​ ​cost​ ​but​ ​above​ ​marginal​ ​cost.​ ​Profits​ ​are​ ​equal​ ​to​ ​zero​ ​for​ ​all firms.​ ​_Monopolistic​ ​competition One​ ​firm​ ​supplies​ ​the​ ​entire​ ​market.​ ​Price​ ​is​ ​above​ ​marginal​ ​cost​ ​and​ ​there​ ​is deadweight​ ​loss.​ ​_Monopoly All​ ​products​ ​are​ ​the​ ​same,​ ​firms​ ​have​ ​the​ ​same​ ​cost​ ​structure,​ ​and​ ​there​ ​is​ ​free​ ​entry and​ ​exit.​ ​_Perfect​ ​competition ...
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