2. 2014 Managerial Economics Stefan Markowski Managerial Economics Stefan Markowski How? When? What? The economics of competitive advantage Why? Where? Who? Market structures and conduct Competition and contestability

3. Detailed course schedule Day no TopicTextbook ch. 1 (24 Nov; 3 hrs) 1. Introduction. Decision making process and its elements. The scope of economic decision making. Application of marginal analysis Chs. 1-2 2 (25 Nov; 3 hrs) 2. Demand analysis and demand elasticitiesCh. 3 3 (26 Nov; 3 hrs) 3. Buyer product valuation and choices. Consumer surplus. Buyer pricing decisions Ch. 4 4 (27 Nov; 2 hrs) 4. Production/transformation process. Production technologies and input-output structure Ch. 5 5 (28 Nov; 2 hrs) 5. Cost structure and cost drivers of producer pricing strategies. Production scale and scope. Chs. 5 and 7 6 (1 Dec; 3 hrs) 6. Structure-conduct-performance. Market structures: competition and contestability. Pricing strategies of buyers and sellers Ch. 8 7 (2 Dec; 3 hrs) 7. Market structures: monopoly/monopsony, monopolistic competition and oligopoly. Pricing strategies and strategic behaviour Chs. 9-10 8 (3 Dec; 3 hrs) 8. Input sourcing and investment. Pricing and market powerChs. 6 and 11 9 (4 Dec; 2 hrs) 9. Decision making under conditions of uncertainty. Informational asymmetries and risk management Ch. 12 10 (5 Dec; 2 hrs) 10. Market research and market analysis. Auction and rings. Strategic behaviour Ch. 13 11 (8 Dec; 2 hrs ) 11. Public sector perspectiveCh. 14 12 (9 Dec; 2 hrs) 12. Revision 13. Examination 13 (11 Dec; 2 hrs) Examination

4. Topic 6: Structure-conduct-performance Market structures: competition and monopoly/monopsony Pricing strategies of buyers and sellers Topic Contents 6.1 Managerial perspective 6.2 Market exchange - supply and demand model 6.3 Competitive market and efficient market exchange 6.4Distorted market exchange 6.5 Make or buy decision - Vertical integration 6.6 Alternatives to vertical integration 6.7 Transfer pricing 6.8Competition and contestability 6.9 Further reading

5. 6.1 Managerial Perspective Market multilateral forms of exchangeMarket - any collection of buyers and sellers trading outputs produced for sale and inputs purchased for use in production. Markets facilitate multilateral forms of exchange The firm market powerThe firm is an organisation in which centralised management replaces the decentralised, impersonal forces of the market. A crucial issue is whether firms have market power Price makers have a degree of market power and make use of it strategicallyMany firms act strategically to increase their market power by trying to change the environment in which they and their rivals are competing

6. 6.1Managerial Perspective market structuresDifferent market structures are a stylised way of framing the mechanics of market interactions between buyers and sellers market powerWhat is emphasised here is the distribution of market power between buyers and sellers, which drives their business conduct and outcomes/preformance activeMarket power should not be confused with the number of active market participants The benchmark of economic efficiency is the competitive market structure where neither buyers nor sellers can exercise market power to influence the market price

7. 6.3 Market exchange: Supply and demand model supply-demandmodelThe supply-demand model is perhaps the most powerful of all tools/models used by economists (equilibrium) price- quantity excess demandexcess supplyThe interaction between the demand and supply curves determines a unique (equilibrium) price- quantity combination at which there is neither excess demand nor excess supply

8. 6.3 Market exchange: Supply and demand model Price Market Demand Market DemandMarket Supply Excess Supply P(high) P(equilibrium) P(low) Excess Demand Q(eq)Quantity

9. 6.3 Market exchange: Supply and demand model Predictions of price-quantity adjustments Shift in demand Price Market Demand Market DemandMarket Supply Pb Pa Qa Qb Quantity

10. 6.3 Market exchange: Supply and demand model Predictions of price-quantity adjustments Shift in supply Price Market Demand Market DemandMarket Supply Pa Pb Qa Qb Quantity

11. 6.3 Market exchange: Supply and demand model Market fluctuations Price Market Demand Market DemandMarket Supply Pb Pa Qa Quantity

12. 6.3 Market exchange: Supply and demand model stabilising speculation Market fluctuations and stabilising speculation Price stabilisation scheme (also Price stabilisation scheme) Price Market Demand Market Demand Market Supply P H b P S P L a Q L Q H Quantity In the absence of speculation quantities supplied fluctuate between Q L and Q H and market prices between P H and P L. Speculator buys low (a) sells high (b). This lowers the amplitude of price fluctuations if it is profitable

13. 6.4 Competitive market and efficient market exchange efficient market exchange maximises the sum of consumer and producer surplusesAn efficient market exchange is one that maximises the sum of consumer and producer surpluses invisible hand of impersonal market forcesThis is achieved in highly competitive markets through trade (the invisible hand of impersonal market forces) so that goods and services are: –allocated to buyers who value them most highly –allocated to buyers who value them most highly (as shown by their willingness to pay) –produced by/sourced from the least cost sellers –produced by/sourced from the least cost sellers (as indicated by the size of producer surplus0

14. 6.5 Distorted market exchange Impediments to free market exchangeImpediments to free market exchange prevent buyers and sellers from realising the full potential of market interaction Examples: –producer subsidy –tariffs –government price regulation

15. 6.5 Distorted market exchange Producer Subsidy Price Home supply before subsidy Home Market DemandHome supply with subsidy Cost home Subsidy P world World Supply Imports Qa Qb Quantity World price paid at home by consumers but subsidized producers produce more and replace imports of more efficiently produced world products. Net loss of national resources

16. 6.5 Distorted market exchange Tariff Price Home Market Demand Home Market DemandHome Supply P home Tariff P world World Supply Imports Qa Qb Qc Quantity

17. 6.5 Distorted market exchange Price regulation: Price Ceiling Price Market Demand Market DemandMarket Supply Free market price Price ceiling Excess demand Qs Qeq Qd Quantity

18. 6.6 Make or buy decision: Vertical integration Vertical integration value adding chainVertical integration - the consolidation of the production process/value adding chain under the control of a single corporate entity Firms integrate vertically because –they seek more market power in input and/or output markets –or the cost of in-house production is less than that of sourcing similar inputs/components from suppliers foreclosing the marketFirms may increase their market power by foreclosing the market through merger (a barrier to entry for competitors) Vertical integration may transaction cost –reduce their transaction cost of doing business with suppliers opportunistic behaviour –or reduce the scope for opportunistic behaviour by suppliers Quasi-vertical integration:Quasi-vertical integration: contractual arrangements but no formal merger

19. 6.7 Alternatives to vertical integration Alternatives to vertical integration: –exclusive territories –exclusive territories (may be combined with price ceilings and quotas) –exclusive dealerships –exclusive dealerships (may be reinforced by warranties or after-sale support) –retail price maintenance –retail price maintenance (often illegal) –franchising

20. 6.8 Transfer pricing A vertically-integrated firm may adopt rules for internal resource allocation Transfer pricingTransfer pricing involves setting prices (in transfers between cost centres) for products which a firm produces for in-house use Transfer pricing decisions where: –there is an external, competitive market for the in- house traded product –there is a market but it is not competitive –there is no external market for the product

21. 6.9 Competition and contestability Competitive marketCompetitive market is a market where there are many atomistic buyers and sellers and none of these has market power to influence the market price or the volume of products traded Perfectly competitive marketPerfectly competitive market - very large numbers of atomistic buyers and sellers, each buyer/seller operating as a utility/profit maximising price taker contestable marketA contestable market is a market where there are no significant barriers to entry and exit (no significant sunk costs) so that newcomers may enter and incumbents exit at a low cost MR = AR = P = MC s.t AC < ARDecision rule MR = AR = P = MC s.t AC < AR

22. 6.9 Competition and contestability Perfect Competition Representative Seller in the Long Run Price/Cost MC AC MR=AR=P PMR=AR=P QQuantity

23. 6.10 Further reading Baye (2010): chs. 7-8 and 11