Chapter 1. What is “Markets and Strategies”? Part I. Getting started Chapter 1. What is “Markets and Strategies”? © Cambridge University Press 2009

© Cambridge University Press 2009 Introduction to Part I Markets Play a central role in the allocation of goods Affect production decisions Goal of “Markets and Strategies” Present the role of imperfectly competitive markets for private and social decisions Issues related to markets and strategies Extremely large array! Firms take thousands of strategic decisions .... reacting to particular market conditions .... and affecting the well-being of market participants. © Cambridge University Press 2009

Product differentiation Introduction to Part I Product differentiation Horizontal merger Pricing strategies Entry deterrence © Cambridge University Press 2009

© Cambridge University Press 2009 Introduction to Part I Organization of Part I Chapter 1 Roadmap Markets & strategies Chapter 2 Players in markets: firms & consumers Profit maximization, utility maximization Market interaction © Cambridge University Press 2009

© Cambridge University Press 2009 Chapter 1 - Markets Markets Allow buyers and sellers to exchange goods and services in return for a monetary payment. Myriad of different varieties Our main focus A small number of sellers set price, quantity and other variables strategically. A large number of buyers react non-strategically to supply conditions. Usually, buyers = final consumers (B2C) In some instances, buyers = other firms (B2B) © Cambridge University Press 2009

© Cambridge University Press 2009 Chapter 1 - Market power Market power How do markets operate? Perfectly competitive paradigm: both sides of the market are price-takers OK for industries with small entry barriers and large number of small firms. Our focus: markets in which firms have market power An incremental price increase does not lead to a loss of all of the demand. Applies to large firms, but also to small ones. Market power and its sources are at the core of this course. © Cambridge University Press 2009

Chapter 1 - Number of firms Number of firms in an industry Natural oligopoly Supply and demand conditions are such that only a limited number of firms can enjoy positive profits. Positive profits are not competed away. Government-sponsored oligopolies Goal of competition policy: avoid monopolization But, governments sometimes restrict entry. Why? Avoid socially wasteful duplication of certain investments Regulated monopolies Spectrum auctions for mobile telephony Patent protection to foster innovation (see Part VII) Creation of national champions © Cambridge University Press 2009

Chapter 1 - Number of firms (2) Case. Alcoa’s natural monopoly 1886: process of smelting aluminium is patented A small number of firms use the patent and start to dominate the industry. Most successful: Alcoa (ALuminum COmpany of America) How? Large economies of scale  Alcoa develops markets for its growing output (intermediate and final aluminium products) Production intensive in energy  in 1893, Alcoa signs in advance for hydroelectric power produced at Niagara Falls Production intensive in bauxite  Alcoa stakes out all the best sources of North American bauxite for itself. Efficiency gains  Entry more difficult, even after expiration of patents Other factors  Public policy, tariff protection, limited antitrust check before 1914. © Cambridge University Press 2009

© Cambridge University Press 2009 Chapter 1 - Strategies Strategies Decision theory vs. Game theory Decision theory  isolated choices  monopoly Game theory  strategic interaction  oligopoly Nash equilibrium Prediction of market outcome when firms interact strategically Main concepts used in this course Best-response function Pure-, mixed-strategy Nash equilibrium Subgame perfect Nash equilibrium Bayesian Nash equilibrium Perfect Bayesian Nash equilibrium © Cambridge University Press 2009

© Cambridge University Press 2009 Chapter 1 - Contents Contents Part I. Getting started Chapter 1. What is “Markets and Strategies”? Chapter 2. Firms, consumers and the market Part II. Market power Chapter 3. Static imperfect competition Chapter 4. Dynamic aspects of imperfect competition Part III. Sources of market power Chapter 5. Product differentiation Chapter 6. Advertising Chapter 7. Consumer inertia Part IV. Pricing and market segmentation Chapter 8. Group and personalized pricing Chapter 9. Menu pricing Chapter 10. Intertemporal price discrimination Chapter 11. Bundling and tying © Cambridge University Press 2009

© Cambridge University Press 2009 Chapter 1 - Contents (2) Contents (cont’d) Part V. Product quality and information Chapter 12. Asymmetric information and signaling Chapter 13. Marketing tools for experience goods Part VI. Theory of competition policy Chapter 14. Cartels and collusion Chapter 15. Horizontal mergers Chapter 16. Strategic incumbents Chapter 17. Vertically related markets, vertical restraints and mergers Part VII. R&D and intellectual property Chapter 18. Innovation and R&D Chapter 19. Intellectual property © Cambridge University Press 2009

Chapter 1. What is “Markets and Strategies” Contents (cont’d) Part VIII. Networks, standards and systems Chapter 20. Markets with network goods Chapter 21. Strategies for network goods Part IX. Market intermediation Chapter 22. Markets with intermediated goods Chapter 23. Information and reputation in intermediated product markets © Cambridge University Press 2009