ECON 7950 Exam 1
deterred entry
entry is not blockaded
what do consumers do in indirect price discrimination?
"self select" the price they pay
What would you consider to be evidence of tit-for-tat pricing?
A telltale pattern is good evidence for tit for tat pricing
Identify a real-world example of indirect price discrimination, including the product, the different pricing options offered for consumers to "self select," and what prevents rivals from viewing the lower price options as the start of a price war.
Bed bath and beyond distributes "20% off" towards the purchase of one item in their stores. consumers self select to either use the coupon or not depending on their own price sensitivity. the more price sensitive the more likely to self select to use the coupon, while the less price sensitive the coupon may not matter. the coupon is not viewed as starting a price war because the prices labeled on the shelf are not reduced, not all shoppers use the coupon, it only applies to one item, and they are recognized as indirect rather than direct price discrimination
Suppose that you were trying to determine whether the leading firms in the automobile manufacturing industry are playing a tit-for-tat pricing game. What real-world data would you want to examine?
Circumstantial evidence like the advance annoucement of price changes or the use of commitments to meet the lowest available price. Hard evidence would hve to be detailed data on historical prices and firm profits in an attempt to discern pricing patterns that support above-average industry profitability.
The following are the approximate US market shares of different brands of soft drinks: Coke: 45%, Pepsi: 30%, Dr.-Pepper/7-Up: 15%, and All Other Brands: 10% Compute the Herfindahl for the soft-drink market (DO NOT INCLUDE ALL OTHER BRANDS"
Herfindahl Index = .45^2 + .30^2 + .15^2 = .2025+.09+.0225= 0.315
Firms operating at or near capacity are unlikely to instigate price wars. Explain why?
If a firm is at or near capacity, its ability to expand quantity sold is constrained and hence the firm cannot recover the forgone profits from selling each unit at a lower margin. The capacity-constrained firm has little incentive to initiate a price reduction
What is the strategic difference between a soft commitment and no commitment?
In a Cournot game with strategic substitutes, the soft commitment will cause the rival firm to increase its own output as a strategic response to harm its rivals. In a bertrand game with strategic complements, the soft commitment will cause the rival firm to raise its own prices as a strategic response to help its rivals
What is the difference between a soft commitment and no commitment?
In making no commitment, a firm has not taken an action or made an investment that alters its own and/or its rival's competitive responses. In contrast, a soft commitment is one that, no matter what its competitors do, the firm will behave less aggressively than if it had not made the commitment. In a
Why are the Cournot and Bertrand models considered static?
In the cournot and bertrand models of duopoly, each firm decides on the price and quantity choice once. In a dynamic model, there will be multiple periods and these choices will have to be made repeatedly in each period. In the dynamic model, a firm has to anticipate what rivals will do in the future, not just react to what it has done in the past.
what might a firm implement when using indirect price discrimination?
a "pay as you go" model or two-part pricing scheme to charge a higher price to high-usage buyers
focal point
a cooperation inducing strategy that is also a compelling choice
what does a conjoint analysis require?
a design and implementation of conjoint survey
what do commitments have on a firms' profitability
a direct effect and strategic effect
Suppose that two firms compete for sales of an identical good. There is a mix of captive customers served by each firm and comparison shoppers who are well-informed about prices and purchase from the firm that offers a lower price. How can using a distributional pricing strategy help the two firms avoid a price war?
a distributional pricing strategy is intended to be unpredictable to the rival firm, such that the rival firm's best response is to follow a similar strategy. The random temporary price reductions are intended to balance the profitability of exploiting captive customers and the potential additional sales to well-informed
what is a network
a good that has higher value the more customers that use it
what occurs in a perfectly contestable market
a monopolist sets the price at competitive levels
Suppose an industry is a duopoly. The two firms, Firm X and Firm Y, compete through Cournot quantity-setting competition. Each year, the demand curve for the industry is P = 120-Q, where Q is the total quantity produced per year by Firm X and Firm Y combined. Each has a marginal cost of $60 per unit and no fixed costs. If the two firms could successfully cooperate to limit their production to split the monopoly quantity (i.e., each firm produces half of the quantity that would maximize the profits of a combined monopolist), what is the monopoly price, the quantity produced by each firm, and the profit for each firm?
a monopolist would choose quantity to maximize its profits step 1: set marginal profit= 0 solve for profit based off monopoly quantity
what must an entrant do to challenge an existing incumbent's existing network?
a new entrant must enter at a massive scale
what occurs in a cost benefit analysis for entry
a potential entrant compares the sunk cost of entry with the present of the post-entry profit stream
what is the profit-maximizing response to competitor's price cut
a price cut same action because strategic complements
what has significant impact on rivals' choices of positioning?
a product's positioning
telltale pattern
a punishment strategy where all firms lower price to "punish" a firm that deviates and reduces its price unilaterally, then after a period, all firms raise their price back to the previous, higher level.
what is the profit-maximizing response to a competitor's quantity reduction
a quantity increase the opposite action because strategic substitute
what is a hedonic regression
a regression of price on variables that capture product characteristics
what do antitrust agencies define a market as
a set of competitors that, if they were to merge (creating a "hypothetical monopolist"), could increase profits through a "small but significant nontransitory increase in price"
what occurs in a conjoint analysis
a survey is presented to participants with many "choice tasks"
what must hedonic regression data exhibit?
a variation in attributes of interest
what can predatory pricing degenerate into
a war of attrition
How are opportunity costs (i.e., economic costs) different from accounting costs?
accounting costs generally represent historical costs while economic costs is the cost of deploying resources in a particular activity is the value of the best foregone alternative use of those resources
How is economic profit different from accounting profit?
accounting profit is revenue minus accounting costs while economic profit is revenue minus economic costs
coordination problem
achieving desirable equilibrium out of many possible equilibria
how do advance announcements work as a strategy for cooperative pricing
advance announcements reduce the uncertainty of whether the rival will undercut the price
The Besanko textbook states: "The best competition is for all the firms to lock in their own customers. This reduces price competition." and "Offer bonuses to your best customers, not to your competitors' best customers. That way, neither company competes vigorously over important customers, and all companies earn profits." Identify examples of companies or markets where existing customers (or locked in customers) get more access to products, discounts, or other benefits.
airline reward programs, credit card companies that offer points that are increasingly valuable when redeemed, grocery store loyalty cards, starbucks reward programs
peak-load pricing
allocates the costs of capacity to the relevant demand which is demand during peak-load times
most favored customer clauses
allow the buyer to pay the lowest price charged by the seller
what happens with a firms capacity in an economic downturn?
an economic downturn in demand may leave firms in an industry with excess capacity for non-strategic reasons
limit pricing strategy
an incumbent sets the price sufficiently low to discourage entrants
what is a bertrand price competition with horizontally differentiated products like?
an oligopolistic market in which products are close but not perfect substitutes
what is a conjoint analysis
analyzes survey responses to estimate differences in willingness to pay associated with differences in product attributes, all else equal
entry conditions for markets can be characterized by whether:
any existing barriers to entry are structural or strategic and if entry deterring strategies are feasible
what are random "sales" intended to do?
balance the profitability of exploiting captive customers and potential additional sales to informed shoppers
why is price competition viewed as a dynamic process
because decisions by a firm today will affect it's behavior as well as it's competitors' in the future
why is ownership of a network valuable?
because entry against an established incumbent is difficult
Suppose a market consists of two firms with horizontally differentiated products who compete through Bertrand price-setting competition. Their demand curves are: Qx = 120-3Px + 2Py and Qy = 120-3Py+2Px Each firm has a marginal cost of $20 per unit and no fixed costs. If the equilibrium price is higher than the marginal cost, why are the firms able to generate profits in this market even when competing on price?
because of product differentiation, a firm lowers its price will only steal some of its rival's customers. this product differentiation softens price competition such that the firms are able to maintain prices above marginal cost and generate profits
why do diversifying firms pose a great threat
because they tend to build bigger plants than other entrants
what are the three possible entry conditions of a market
blockaded entry, accommodated entry, and deterred entry
what type of markets do firms compete in
both input and output markets
what is the purpose of comparing part worths
by comparing part worths for pricing levels to part worths for other attributes, the value of each attribute can be translated into dollars
how does a firm exit a market
by fully dissolving, discontinuing a particular product or product group, or leaving a particular geographic market segment
how can firms facilitate cooperative pricing
by price leadership advance announcement of price changes most favored customer clauses
how does entry threaten incumbents
by reducing incumbent's market share and intensifying price competition
how can an incumbent exploit its brand umbrella more to introduce new products more easily than new entrants?
by using brand recognition by its customers using its established relationships with its supplies, distributors, and retailers
commitment-flexibility tradeoff
by waiting a firm preserves it option values and may allow it's competitors to make preemptive investments
what do new firms need for growth?
capital because survival and growth are related
direct price discrimination
charging customers different prices based on observable characteristics of the customer
price discrimination
charging different customers different prices for the same good
variety/horizontal differentiation
color, shape, appearance, location
what two consumer groups does a firm's single price on an item serve
comparison shoppers and captive customers
what are strategies to avoid spending profits to win a price war?
compete on features, not prices "free to join"/"free to play" free usage for one side of a two-sided network
what do distributional strategies arise from
competition over a part of the market
when trying to achieve cooperative pricing what type of market structure conditions may it depend on?
concentration conditions that affect reaction speeds and detection lags asymmetries among firms price sensitivity of buyers
what can commitments sacrifice
the value of the options
three types of structural barriers
control of essential resources by the incumbent economies of scale and scope marketing advantage of incumbency
captive customers
customers poorly informed about rivals' prices
what do post-entry profits depend on
demand and cost conditions as well as post-entry competition
what is the key strategy in reducing rivalry?
differentation
what are ways to soften price competition
do not use price discrimination to offer your rival's customers lower prices create loyalty of existing customers rather than attempting to attract competitors' customers reward your sales force based on revenue or profits, not quantity sold offer non-price incentives rather than price cuts reduce quality to justify lower-priced options create complex, difficult to compare, pricing
what type of demand curve does a monopolist face
downward sloping
when do economies of scope in marketing exist
due to the upfront cost of achieving brand awareness by entrants
what are the characteristics of bertrand price competition?
each firm selects a price and stands ready to meet all the demand for its product at that price each firm selects a price to maximize its own profits given the price it believes the other firm will select rivalry between two firms results in the perfectly competitive outcome if not differentiated
what occurs with prices in bertrand price competition
each firm selects a price and stands ready to meet all the demand for its product at that price and a price to maximize its own profits given the price it believes the other firm will select
how does an incumbent appear 'tough' by cutting prices
either due to low costs irrational desire for market share or because there is other competition the entrant is unaware of
what is an example of peak-load pricing?
electricity generation: allocating costs of capacity to peak hours because peak hours determine the necessary capacity
deterred entry is the only condition for incumbents to do what
engage in entry-deterring strategies or predatory acts
who is predatory pricing directed at
entrants who have already entered while limit pricing is directed at potential entrants
what will still occur if a firm as excess capacity?
entry deterrence even if the entrant is as well-informed as the incumbent
explain why an incumbent would prefer blockaded entry to deterrable entry?
entry is blockaded if the incumbent need not undertake any entry-deterring strategies to deter entry. if entry is deterred rather than blockaded, the incumbent must actively engage in predatory acts to discourage entry. The incumbent might prefer to be passive rather than active about discouraging entry, blockaded entry, would be preferable to deterrable entry
what is hedonic regression?
estimates average differences in market prices associated with differences in product attributes, all else equal
A network is a good that has higher value the more customers that use it. Identify recent examples of new entrants (which may be new firms or diversifying firms) that attempted to offer network goods, including at least one that has been successful and one that has not. To what do you attribute the difference in success?
example, facebook and myspace are examples of entrants in the social media market facebook was successful compared to myspace who ultimately failed. facebook was first to offer an app, features that myspace did not offer, and was more intentional and successful with obtaining business relationships with advertisers
Identify an example of a product with multiple attributes that have quality complementarities. What specific attributes of the product have quality complementarities and why?
example, smartphone a better mobile network connection may enhance the value of a faster processor, better camera and other feature however, quality complementarities do not exist between all features for example, it is unlikely that a better mobile network connection would enhance the value of having more local storage space
Identify a real-world example of direct price discrimination, including the product, the observable characteristic of the customer used to distinguish between groups of customers, and what prevents arbitrage between those groups
example: senior citizen discounts at movie theaters, age is the observable characteristic a clearly defined age cutoff and the requirement of a photo ID to purchase and use the discounted movie ticket will prevent arbitrage
The Besanko textbook states: "The best competition is for all the firms to lock in their own customers. This reduces price competition." and "Offer bonuses to your best customers, not to your competitors' best customers. That way, neither company competes vigorously over important customers, and all companies earn profits." Identify examples of companies that offer more discounts or other benefits to new customers (or rivals' customers). What might explain these companies' tendencies to do so (rather than focus on locking in existing customers)?
examples: t-mobile, sprint, hulu in a nascent market, market with increasing demand, or when a firm is a new entrant in an existing market, it may be focused on growing market share by attracting new customers and/or rivals' customers, rather than exploiting a relatively small number of already locked-in customers
what can incumbent do with excess capacity
expand output at a low cost
what do static models not do
explain how firms can maintain price above competitive levels without formal collusion
what are barriers to entry
factors that allow incumbents to earn economic profit while making it unprofitable for the new firms to enter the industry
quality/vertical differentiation
features, performance, reliability, and durability
what are the characteristics of oligopolies?
few sellers with barriers to entry products can be homogeneous or differentiated pricing and output decisions of one firm affect rivals' pricing and output as well
Why do prices in a perfectly competitive market tend toward the minimum average cost of production in the long run?
firms enter a market as long as profit is to be made and there is a lack of barriers to entry. Profit is made if the market price is higher than the minimum average cost of production. as firms enter the market, the supply curve shifts to the right, lowering the market price until it equals the minimum average cost of production. It could never go lower because then economic profit would be loss and firms will either not enter the market or leave the market. thus, free entry and exit will lead to 0 economic profit in the long run, ie price will be equal to the minimum average cost of production
It is often argued that price wars may be more likely to occur during low-demand periods (busts) than high-demand periods (booms). What factors make price wars likely to occur during low-demand periods?
firms may have excess capacity which increases their incentive to attempt to steal market share from competitors or a firm may "misread" another firm as an indication that one or more rivals are reducing their prices, potentially leading the firm to respond by reducing its own pricing and instigating a price war
what are the prices set at in monopolistic competitive markets?
firms set prices above marginal costs
entrants
firms that produce and sell in new markets
competitors
firms who strategic choices affect one another
what happens with prices if you have a mix of well informed and poor-informed shoppers
firms will engage in pricing with random sales that are intended to be unpredictable to rivals
what do distributional strategies cause prices to do
fluctuate unpredictably
what does the participant do in a survey for a conjoint analysis
for each choice task, a participant chooses between 3-4 hypothetical products that consist of different combinations of levels of product attributes, along with hypothetical prices and then chooses the most preferred option in each choice task
Why is uncertainty a key to the success of entry-deterring pricing strategies such as limit pricing?
for limit pricing, entering firms must be uncertain about some characteristic of the incumbent firm(cost structure) or the level of market demand if the entrant is uncertain about the post-entry price, then the incumbent's pricing strategy could affect the entrant's expectations
What are some reasons why deviating from cooperative pricing might be more attractive during high-demand periods than during low-demand periods?
gaining a dominant market share is more profitable during a boom than during a downturn. if a firm can retain some of its increased share after the boom, it will be in a better position during the downturn.
what are the techniques that attempt to decompose prices?
hedonic regression and conjoint analysis
what occurs with high quality complementarities?
higher quality in one dimension can increase the value of quality in other dimensions
what are the characteristics of cournot quantity competition?
identical goods each firm chooses its own quantity market price is the price on the market demand at the sum of quantities produced
How can you distinguish tit-for-tat for pricing designed to sustain "collusive" pricing from competitive pricing?
if collusion is extremely effective, you would not observe punishment behavior like a telltale pattern among firms
economies of scale
if economies are scale are significant, potential entrants may face cost disadvantages
Why is uncertainty a key to the success of entry-deterring pricing strategies such as predatory pricing?
if entrants lack certainty then price-cutting by an incumbent may affect the entrant's expectations of the incumbent's future pricing strategies
Explain why two firms in a duopoly face a "prisoners' dilemma" when attempting to set prices and production quantities (when the two firms' decisions are made simultaneously)
if firms could act as a cartel to maximize their combined profits, they would choose the monopoly price and given quantity however each individual firm has an incentive to "cheat" on a collusive agreement because of how high the monopoly price is relative to marginal cost. each individual firm "cheats" in an attempt to lower its own prices and increasing their own outputs to increase their own profit at the expense of their rival
when does a real option exist
if future information can be used to tailor decisions
Given competitive issues, how can a restaurant generate economic profit?
if it has a superior locations, or by creating a loyal following for its horizontal differentiated product, so that consumer demand is relatively inealstic
when does a soft commitment have a profitable strategic effect
if it involves strategic complements
when does a tough commitment have a negative strategic effect
if it involves strategic complements
when does a tough commitment have a profitable strategic effect
if it involves strategic substitutes
what occurs if prices are high enough in monopolistic competitive markets?
if prices are high enough to cover more than fixed costs - profit is made - more firms will enter the market
what occurs if prices are too low in monopolistic competitive markets?
if prices are too low to cover fixed profits - firms incur losses - some firms will exit
The following are the approximate US market shares of different brands of soft drinks: Coke: 45%, Pepsi: 30%, Dr.-Pepper/7-Up: 15%, and All Other Brands: 10% Suppose that Pepsi Acquires Dr. Pepper/7-Up. Compute the post-merger Herfindahl.
if the combined firm has a market share of 45%, and "all other brands" are ignored: 0.45^2 + 0.45^2 = 0.2025 -0.2025 = 0.405
how does excess capacity deter entry
if the incumbent holds excess capacity it can credibly threaten to lower the price if another firm attempts entry
when does the price leadership strategy for cooperative pricing fail
if the leader does not retaliate if one of the follower firms defects
when is a market contestable
if the mere threat of entry can limit the incumbent firms' ability to raise prices or a possibility of hit-and-run entry (zero sunk costs
when is exploitation of brand name and reputation risky?
if the new product is unsatisfactory, customer dissatisfaction may harm the image of the existing products
when is cooperative pricing more likely to occur
in concentrated markets because the revenue loss from a price cut is larger while the potential gain from new customers is smaller
where does the value of commitment lie?
in creating inflexibility
how are entry deterring strategies effective
in discouraging potential rivals and are cost effect
Suppose a market consists of two firms with horizontally differentiated products who compete through Bertrand price-setting competition. Their demand curves are: Qx = 120-3Px + 2Py and Qy = 120-3Py+2Px Each firm has a marginal cost of $20 per unit and no fixed costs. What is the Bertrand equilibrium in prices in this market?
in the bertrand model, each firm chooses price to maximize its profits step 1: set marginal profit = 0 step 2: substitute the best response function for Py into the best response function for Px
Suppose an industry is a duopoly. The two firms, Firm X and Firm Y, compete through Cournot quantity-setting competition. Each year, the demand curve for the industry is P = 120-Q, where Q is the total quantity produced per year by Firm X and Firm Y combined. Each has a marginal cost of $60 per unit and no fixed costs. What is the Cournot equilibrium price, quantity, and profit for each firm?
in the cournot model, each firm chooses the quantity to maximizes its profits step 1: set marginal profit = 0 step 2: substitute the best response function for Qy into the best response function for Qx
How is it possible that the optimal decision for a firm to make can be different in the long run than in the short run?
in the long run, firms do not face the same constraints as in the short run for they have control over everything. for example, in the short run, firms face constraints concerning at least one of the inputs in its production which means it makes decisions that maximize its profits, subject to that constraint. however, in the long run, all the firm's factors are variable so no constraint exists, so the optimal profit maximizing decision for the firm will be different because their is no constraint
why do new entrants tend to upstage incumbents?
incentives to innovate often are stronger for new entrants the potential for cannibalization can limit incumbents' incentives to innovate the incumbent cannibalizes it's own products with innovation, whereas an entrant suffers no loss of existing business
what does better durability do?
increases the value of higher quality components
how does excess capacity work to deter entry?
incumbent has a sustainable cost advantage market demand growth is slow incumbent cannot back-off from the investment in excess capacity
what must occur for entry deterring strategies to work
incumbent must earn higher profits by keeping the potential entrant of the market and the strategy should change the potential entrant's expectations regarding post-entry competition
accommodated entry
incumbents should not bother to deter entry because there is growing demand or rapid technological change or because structural barriers may be low or strategic barriers may be ineffective or not cost effective
what are sunk costs for entrants
investment in specialized assets to obtaining government licenses
predatory pricing
involves setting the price below short run marginal cost with the expectation of recouping the losses via monopoly profits once the rival exits
what happens in a fight to become a monopoly network?
it can create a war of attrition in which most or all of the present value of expected profits might be expended in the competition to own the network
what is the disadvantage of a most favored customer clause
it can inhibit price competition
how is a distributional strategy a nash equilibrium?
it captures both types of customers instead of targeting one group
what happens with prices if shoppers are poorly informed?
it is better to exploit the ill-informed with high-prices than to sell a large number of units with no markup over cost
what is important to note about willingness to pay
it is not the same as a price difference, due to competition
What does it mean for a firm's economic profit to be 0?
it means that the firm did not generate more profit than it would have obtained by deploying its resources in their next best alternative use
what is the entrant's strategy against an incumbent's entry deterring strategies
judo economics
what are the determinants of reaction speed
lag in detecting price changes frequency of interactions with the rival ambiguity regarding which rival is price cutting inability to distinguish between price cuts by rivals and lower demand as the cause of drop in sales
what can a single misread do
lead a firm to alternative between cooperative and non-cooperative moves
what might a firm intentionally do when using indirect price discrimination?
limit a product's functionality in order to offer a lower price version
examples of entry deterring strategies
limit pricing, predatory pricing, and capacity expansion
what are the common attributes to group customers by for direct price discrimination
location other possessions or purchases status age employment gender
grim trigger strategy
lower price to marginal cost indefinitely in response to rival's price cutting in one period
tough commitment action
lower prices and increase quantity
what is the relationship between grim trigger pricing and tit-for-tat pricing
lowering the price to marginal cost from a grim trigger strategy only lasts one period because for tit-for-tat the future responses depend on future actions of the rival
what does a firm's long-term health require?
maintaining technological leadership and overcoming the tendency to be satisfied with existing products
indirect price discrimination
making offers that are available to everyone and letting customers select for themselves
chain store paradox
many firms are commonly perceived to engage in predatory pricing even when it is irrational to expect predatory pricing to deter entry
what are the characteristics of monopolistic competition?
many sellers each offering horizontal and or vertical differentiation
How would you characterize the nature of competition in the restaurant industry?
monopolistic competition because there are many sellers and each is slightly differentiated by the types of food it serves, the quality of the food, the service, ambiance, décor, and location.
What aspects of real-world behavior might be missing in static models?
multiple time periods
what is the herfindahl index
n-firm concentration ratio combined market share of the n largest firms in a market
Why do incumbents have less of an incentive to innovate than smaller new entrants?
new product launches by the incumbent will tend to compete with sales of the incumbent firm's own existing products. new entrants do not face the same trade-off and thus have a greater incentive to innovate
is predatory pricing rational?
no, if all the entrants can perfectly foresee the future course of incumbent's pricing, it will not work
is limit pricing rational
no, when multiple prices are considered, the incumbent has to set the price low each period to deter entry in the following period and would be better off being a cournot duopolist than limit pricing forever as a monopolist
what are the advantages to indirect price discrimination?
not necessary to observe individual consumer characteristics arbitrage is prevented by the design of the pricing scheme
what is the disadvantage of hedonic regressions?
on it's own, it is not sophisticated enough to separate supply effects from demand effects
what do strategic commitments limit
options but alters competitors' expectations
what does yield management directly account for?
peak and off-peak costs
The following are the approximate US market shares of different brands of soft drinks: Coke: 45%, Pepsi: 30%, Dr.-Pepper/7-Up: 15%, and All Other Brands: 10% Suppose that Pepsi Acquires Dr. Pepper/7-Up. Federal antitrust agencies would be concerned to see a Herfindahl increase like this one. Pepsi could respond by defining the market as something other than soft drinks. What market definition might they propose? Why would this change the Herfindahl?
pepsi should consider a market definition that would cause the market shares of firms to appear more fragmented by attempting to increase the size of the denominator that determines it market share. For example, include bottled waters, seltzer waters, sports drinks, and juices as its market definition and even include chops and candy. this would make the market pepsi competes in more fragmented because it is including products other than soft drinks
what entails the most intense competition?
positioning a product near the ideal spot for the largest mass of consumers
what is the long run equilibrium in a monopolistic market?
positive economic profit
what happens if the incumbent does not cut prices
potential entrants consider incumbent an 'easy' target
distributional strategies
prices are chosen from a statistical distribution in a random way
what happens with prices if shoppers are well informed
prices tends towards marginal cost(no markup)
what are examples of extreme direct price discrimination?
pricing based on individual purchase history, search history, usage, or other personalized data
yield management
pricing based on the foregone of a sale, which depends on the likelihood of a future buyer being turned away
based on a concept of substitutes, a market has firms with the same or similiar:
product performance characteristics occasions for use geographic market
what are the ways to create differentiation?
product synergies and lock-in quality complementaritiess
examples of indirect price discrimination
quantity discounts, "buy one get one at half price", published coupons, bundling products, plane ticket restrictions
soft commitment actions
raise prices and lower quantity
It is often argued that price wars may be more likely to occur during low-demand periods (busts) than high-demand periods (booms). What factors might lead to the reverse?
recognizing the inevitable downturn in their market following a boom period, a firm may be tempted to capture profits to serve as a cushion during an economic downturn
In what ways are monopolistically competitive markets "competitive"?
relatively low barriers to entry allow other firms to enter the market and compete. more selling firms reduce the individual firms' market shares and in the long run eliminates economic profits
what happens in bertrand price competition if products are not differentiated?
rivalry between those firms with non differentiated goods results in a perfectly competitive outcome
what do advance announcements allow firms to do
roll back the price changes if the rival deviates from cooperative pricing
what type of data is required by hedonic regression?
sales and pricing data and product attribute data
examples of direct price discrimination
senior citizen discounts, corporate employee discounts, frequent flyer rewards
comparison shoppers
shoppers "well-informed" about rivals' prices
how does tit-for-tat pricing work
since each firm knows that it's rival will match any price cut, neither has an incentive to engage in price cutting
Adam and Catherine are choosing between two ice cream shops, Icy and Frosty, located at either end of a 1-mile-long beach. Adam is standing in front of Icy, while Catherine is standing in front of Frosty, Both Adam and Catherine are each willing to pay, at most, $6 for one ice cream cone. It costs them $1 to walk the 1-mile distance between the shops. Icy is government-run, so the price is fixed at exactly $4/cone and will not change. The shops face costs of $0.25/cone. What price should Frosty charge if it is to maximize its total profits from Adam and Catherine, assuming Adam and Catherine will be well-informed about the prices of each shop ? What will their profit be?
since icy faces a fixed price of $4/cone and the consumers face a travel cost of $1. at its highest price frosty could charge catherine $4.99 with a profit of $4.74. however, frosty can charge each adam and catherine $2.99 with a profit of $2.74 each and a total profit of $5.48
what do lock-ins do?
soften price competition across ecosystems even when each competitor offers it's own ecosystem
what is important to note about strategic commitment and games
strategic commitment can make a simultaneous move game into a sequential move game
what are model prices in a bertrand duopoly
strategic complements
what are model quantities in a cournot duopoly?
strategic substitutes
what are the types of barriers to entry
structural and strategic
what is the equation for the herfindahl index?
sum of all the shares squared
what are both grim trigger and tit-for-tat pricing capable of
sustaining cooperative pricing
what is an example of a network
telephone network social media network credit card network
what may distributional strategies not represent
the beginning of a price war
what does the strategic effect of a commitment depend on
the commitment involves strategic substitutes or strategic complements and if the commitment is tough or soft
what happens if a firm in a bertrand price competition with horizontally differentiated products lowers its prices?
the firm will steal only some of its rival's customers
what happens when orders are lumpy
the frequency of competitive interactions is reduced
blockaded entry
the incumbent does not need to take any action to deter entry
An incumbent firm is considering explaining its capacity. It can do so in one in one of two ways. It can purchase fungible, general-purpose equipment and machinery that an be resold at close to its original value. Or it can invest highly specialized machinery which, once it is put in place, has virtually no salvage value. Assuming that each choice results in the same production costs once installed, under which choice is the incumbent likely to encounter a greater likelihood of entry and why?
the investment that is more visible, understandable, and irreversible is more likely to deter entry, works like excess capacity strategy. You want the entrants to know about the commitment to the equipment to deter their entry. Essentially the firm whose investment has no outside option has increased its own exit barrier. Once the investment is made the firm has no option but to utilize it within this particular industry. This sends a strong signal to the competition and causes them to behave less aggressively.
how does limit pricing work
the low price set by the incumbent may be an entry deterrent if the entrant infers that post-entry price will be low
what occurs for a monopolist in its input market?
the monopolist faces little or no competition and has the ability to raise its input prices
what occurs for a monopolist in its output market
the monopolist faces little or no competition and has the ability to raise output prices
how does price leadership work as a strategy for cooperative pricing
the price leader in the industry announces price changes ahead of others and others match the leader's price
what type of market conditions drive down prices towards marginal costs in a perfectly competitive market?
there are many sellers products perceived to be homogenous there is excess capacity or free entry
what is true about strategic commitments
they have long run impact and are hard to reverse
when using distributional strategies are firm's decisions really random?
they may be reasoned rather than random, but will appear random if the reasons are not known to the rival
In what ways are monopolistically competitive markets "monopolistic"?
they produce products that are slightly differentiated and earn economic profits in the short run by leveraging those differences from their competitors the slight product differentiation makes a firm's product unique or "monopolistic"
how can incumbents build strategic barriers
through expanding capacity, limit pricing, and predatory pricing
what is the regression analysis from a conjoint analysis used for?
to estimate "part-worths" for each level fo each attribute
what is the difference between a tough and soft commitment
tough commitments hurts the competitors while soft commitments helps competitors
what are barriers to arbitrage
transportation costs legal impediments to resale personalized products or services thin markets and matching problems informational problems
t/f strategic commitments can affect choices made by rivals
true
what confers a degree of market power
uniqueness
judo economics
use the incumbent's size to the entrants advantage by have a smaller "revenue destruction effect" for a small entrant and by being more flexible due to lack of sunk costs
what are "interaction effects"
used to capture the additional value from having both feature present when there are complementarities between features
The following are the approximate US market shares of different brands of soft drinks: Coke: 45%, Pepsi: 30%, Dr.-Pepper/7-Up: 15%, and All Other Brands: 10% Suppose that Pepsi Acquires Dr. Pepper/7-Up. What assumptions were made?
we assume that the market shares of individual firms and products do not change as a result of the merger as long as no changes cause "all other brands" to gain market share at the expense of the merger, then the herfindahl index represents the minimum post-merger herfindahl index.
what is true about dynamic and static models
what appears as short term profits in a static model are often followed by long term negative effects in a dynamic model
what types of questions do dynamic models address that static models do not
what determines the intensity of price competition
incumbents vs entrants
what is sunk costs for incumbents is incremental costs for the entrants
what are are strategic substitutes actions
when a firm's action induces the rival to take the opposite action
what are are strategic complement actions
when a firm's action induces the rival to take the same action
arbitrage
when customers who obtained a low price resell to customers who were offered a higher price
when is price cutting hard to detect
when demand conditions are volatile and the firm can observe only it's own volume of sales
when do structural barriers to entry exist
when incumbents have cost advantages, marketing advantages, and are protected by favorable government policy and regulations
when do economies of scope in production exist
when multiple product lines are produced in the same plant
when can cooperative pricing be maintained at any discount rate
when price cuts are matched instataneously
when does predatory pricing deter entry
when the incumbent seeks reputation for toughness
when are limit pricing and predation rational strategies?
when the incumbent wants the entrant to lower its expectations for post-entry price entrant lacks information about incumbent's costs incumbent's pricing strategy can alter entrant's expectation when there is asymmetric information
when does tit-for-tat pricing not perform well
when the possibility for misreading a rival's move
when are deviations from cooperative pricing harder to detect
when the products are custom-made for individual buyers than when they are standardized
when does cooperative pricing become easier to sustain?
when the speed with which a firm can respond to a rival's moves increases
when are deviations from cooperative pricing easier to detect
when the transactions are public
when is flexibility valuable
when there is uncertainty because future options are kept open
when are misreads more likely to occur
when transactions are more complex than simple
what is perfect multicollinearity
when two features are never observed without each other - perfect correlation between two x's
what does tit-for-tat strategy do
when two firms compete over several periods, it may make cooperative pricing strategy
when is predatory pricing rational?
when uncertainty and information asymmetry are present
when is coordination easier
with fewer products that are identical
in some markets, how can entry be deterred?
with relatively few, carefully placed products
how do you measure market structure?
with the herfindahl index
example of product synergies and lock-in
word, excel, powerpoint all work well together single remote controls samsung tv, blu-ray player, speaker system
Can a market be vertically differentiated and horizontally differentiated at the same time? If not, why not? If so, give some examples?
yes, a market can be vertically and horizontally differentiated. for example, the laptop market. some consumers prefer the design, aesthetic, and operating systems found among different laptop brands like apple or dell, which shows horizontal differentiation. while there are some laptops that are identical to each other except for key features like processing power or screen resolution, these features valued by customers shows vertical differentiation because it is based on the quality not the variety differences
In the restaurant industry, are there important substitutes that constrain industry?
yes, home-prepared meals and frozen dinners
In the restaurant industry, are there submarkets with distinct competitive pressures?
yes, the prices that can be charged for the differentiating features are constrained by the geographical location of the restaurant and local competition
When launching a new smartphone, Apple often continues selling a previous-generation model and lowers its price by $100. The new model often includes all of the features of the previous-generation model, plus a few new features. Suppose Apple wants to determine whether the new features added to this year's model will command a market price of at least $100 more than the discounted previous-generation model. Suppose the new features (not present on the previous generation) are a second rear camera with a ultra-wide lens and a "night mode" photo processing feature that improves the quality of images taken in low light. Explain why you would choose to use conjoint analysis to answer the question of whether the new features will command a market price of at least $100 more than the discount previous-generation model. What limitations kept from choosing hedonic regression?
you may choose conjoint analysis if you believe there are NOT existing products on the market that incorporate similar features thus requiring hypothetical product feature combines enabled by conjoint analysis. alternatively, if there are such products in the market, that have concern with multicollinearity issues for which hedonic regression could not separate the effects. you can deal with limitations of conjoint analysis by including a feature for which the market price difference is known to allow to adjust for hypothetical bias
When launching a new smartphone, Apple often continues selling a previous-generation model and lowers its price by $100. The new model often includes all of the features of the previous-generation model, plus a few new features. Suppose Apple wants to determine whether the new features added to this year's model will command a market price of at least $100 more than the discounted previous-generation model. Suppose the new features (not present on the previous generation) are a second rear camera with a ultra-wide lens and a "night mode" photo processing feature that improves the quality of images taken in low light. Explain why you would choose to use hedonic regression to answer the question of whether the new features will command a market price of at least $100 more than the discount previous-generation model. What limitations kept from choosing conjoint analysis?
you may choose hedonic regression if there is a belief that there are existing products on the market that incorporate similar features. the hedonic regression allows the analyst to decompose market prices of products into hedonic prices of product attributes.. you choose hedonic regression over a conjoint analysis if you are concerned that the conjoint analysis does not yield measures of market price differences but only differences in "willingness to pay", which is likely to overstate actual differences in market prices
what must happen to preserve flexibility?
you must modify the commitment as conditions evolve possibly delay commitment until better information is available on profitability sometimes make unprofitable commitments today to preserve valuable options in the future
When launching a new smartphone, Apple often continues selling a previous-generation model and lowers its price by $100. The new model often includes all of the features of the previous-generation model, plus a few new features. Suppose Apple wants to determine whether the new features added to this year's model will command a market price of at least $100 more than the discounted previous-generation model. Suppose the new features (not present on the previous generation) are a second rear camera with a ultra-wide lens and a "night mode" photo processing feature that improves the quality of images taken in low light. Suppose you perform both a hedonic regression and a conjoint analysis to answer the question above and got different results. How do you interpret the difference in the results?
you should expect the conjoint analysis to yield a higher value than hedonic regression because conjoint analysis yields a difference in wtp while hedonic regression yields a difference in market price. given the presence of competition in the market, the results of the hedonic regression are a more conservative estimate of a potential market price difference if the conjoint analysis yields a lower value than the hedonic regression for the same product feature, then one or both of the analyses is unreliable
what is the long-run equilibrium in a perfectly competitive market?
zero economic profit
what is the long-run equilibrium in monopolistic competitive markets?
zero economic profit