Econ 212 Midterm III

Positioning Your Product

Balancing act between demand-side considerations, like appealing to customers, and supply-side factors like differentiating as much as possible from your competition and their products.

What happens when your firm has low Market Power?

Buyers can buy from competing firms if you raise your prices.

Scaring off Potential Entrants

By building excess capital and a reputation for not backing down from a price war, you can convince prospective firms you're willing to accept lower prices in order to outcompete them.

Perfect Price Discrimination

Charging each customer their reservation price.

Non-Price Competition

Competing to win customers by differentiating your product.

Advertising Aims To...

Convince Your Customers that Your Product is Great: Shifts Demand Curve to the Right Create Brand Loyalty: Causes your Demand Curve to Steepen

Unique Cost Advantages (Supply Side)

Create a more efficient method of production to keep earning a profit even when other firms' marginal costs = the market price. Must be unique so other firms can't copy it. Learn By Doing: Experience in production leads to efficiency Research and Development: New ways to produce or organize goods Leverage your Relationship With Suppliers to get a Better Price Limiting Access to Key Inputs can Freeze Your Competition -Ex: American Airlines signing a 32 year contract for loading gates at a large airport.

Creating Customer Lock-In (Demand Side)

Creating Switching Costs: Makes it costly for customers to switch to buying from another business Network Effects: By creating network effects, your product becomes more useful and therefore customers are less likely to use a different one. Ex: Reviews on Amazon

Product Differentiation

Efforts by sellers to make their products differ from those of their competitors. Ex: Jeans because there are so many cuts and styles (Lightwash, ripped, flared, etc.)

The Grim Trigger Strategy

If the other players have cooperated in all previous rounds, you will cooperate. But if any player has defected in the past, you will defect over and over.

Advertising in Imperfect Competition

In Imperfect Competition, firms should emphasize their particular product's position and the unique value that it will bring their customers. Not only will this increase Demand for the product, but it will allow you to steal customers from your rivals.

Advertising In Perfect Competiton

In perfect competition, your firm is only a small part of the market so it's not as possible to advertise. Your ad campaign will likely benefit your rivals more than yourself.

Advertising in a Monopoly

Monopolies use advertising to shift the Market Demand Curve for their product. Their ad campaign is likely focused more on promoting their product, rather than their brand.

Different Shapes of Firm's Demand Curve Depending on Market Structure

Monopoly: has a lot of MP, your Firm's DC will equal the Market DC. Inelastic. Monopolistic/Oligopoly: Some MP; a higher price will cause the demand curve to shift left and flatten. Some customers will buy from other Firms, but not all. Some elasticity. Perfect Competition: Least MP; horizontal line. A change in Price will result in a huge change in Demand. Highly Elastic.

Barriers to Entry

Obstacles that make it difficult for new firms to enter a market.

Price Competition

Occurs when businesses compete for customers by offering lower prices. Most likely to occur when two or more firms sell similar products, prices are easily observable, and switching costs are low. Ex: Two competing gas stations

Hurdle Method

Offer lower prices only to those who are willing to overcome some hurdle or obstacle. Design the hurdle so that only customers with a low reservation price will bother overcoming it.

Hold-Up Problem

Once you have made a relationship-specific investment, the other side might try to renegotiate so that they get a better deal. Ex: Your landlord raises rent once you sign a 2-year lease.

Enlisting Government Policy to Prevent New Entry (Regulatory Strategy)

Patents, Copyrights, and Trademarks all give you a monopoly over intellectual property and prevent other firms from using it. - Zoning, Licensing, Etc. - Lobbying politicians to create MORE regulations can create more costs for existing firms or prevent others from joining the market.

Group Pricing

Price Discrimination by charging different prices to different groups of people. Ex: Senior, Student, or Military discount

Profit Margin

Profits per unit sold. Represented by the gap between your firm's demand curve and its average cost curve. = Price - Average Cost

Informative Advertising

Provides information about a product and it's attributes.

Game Tree

Shows how a game plays out over time, with the first move being the trunk, and each subsequent choice branching out, so the final leaves show all of the possible outcomes.

Average Revenue Curve

Shows revenue per unit. Also represents your firm's demand curve. Price = Total Revenue/Quantity

The Rational Rule for Entry

States that you should enter a new market if you expect to earn a positive economic profit.

Firm's Demand Curve

Summarizes how the quantity that buyers demand from your individual firm varies as you change your price. The shape is determined by your Market Power.

Marginal Revenue

The addition to total revenue you get from selling one more unit.

Best Response

The choice that yields the highest payoff given the other player's choice.

The Five Forces Framework of Strategic Management

The core insight is that your long-term profitability is largely determined by the competitive forces in your market, and how you adapt to them. 1.) Existing Competitors The Type and Intensity of Competition 2.) Potential Competitors Pose a Threat of Entry 3.) Competitors in other Markets Create a Threat of Potential Substitutes 4.) The Bargaining Power of Suppliers Determines the Prices you Pay 5.) The Bargaining Power of Buyers Determines the Prices you Charge

Average Cost

The cost per unit. Includes fixed costs (Land, Capital Equipment) and variable costs (Inputs) = Total Costs/Quantity

Market Power

The extent to which a seller can charge a higher price without losing many sales to competing firms.

Long Run

The horizon over which you, or your rivals, may expand or contract production capacity; new rivals may enter or existing firms may exit the market.

Reservation Price

The maximum price a customer is willing to pay for a product. This is equal to their marginal benefit received from buying that good. By charging a price just below this point, firms are able to get gain as much profit as possible.

Second Mover Advantage

The strategic advantage that can follow from taking an action that adapts to your rival's first choice. Ex: If Walmart is the first store to advertise it's holiday specials, Target will be able to respond by offering the same products at slightly lower prices.

First-Mover Advantage

The strategic gain from an anticipatory action that can force a rival to respond less aggressively.

Accounting Profit

The total revenue a business earns minus it's financial costs = Total Revenue - Explicit Financial Costs

Good Equilibrium vs. Bad Equilibrium

There can be two equilibria where one is objectively better than the other. Ex: Stability or a Bank Run

The Discount Effect

To sell that one extra unit, you'll have to lower the price. This means lowering the price for ALL units of that good. Even a small discount can lead to a large decline in revenue.

Economic Profit

Total revenue a business earns less the financial and opportunity costs. = Total Revenue - Explicit Financial Costs - Implicit Opportunity Costs

Persuasive Advertising

Tries to persuade or manipulate customers into believing they'll enjoy a particular product. Exploits emotion and rarely contains factual information.

Coordination Games

When all players have a common interest in coordinating their choices. Ex: Phone Tag

Constant Returns

When long run average cost remains constant as output increases because output is rising in proportion to the inputs used in the production process. Considered perfectly elastic.

Quantity Discount

When the per-unit price is lower when you buy a larger quantity. Bundling creates a hurdle to getting the second good at a lower price.

Free Entry

When there are no factors making it particularly difficult or costly to enter the market. Leads to decreasing economic profits, eventually driving them to 0.

Vertical Integration

When two or more firms along a production chain combine to form a single company.

Finitely Repeated Game

When you face the same strategic interaction a fixed number of times.

Indefinitely Repeated Games

When you face the same strategic interaction an unknown number of times. In this scenario, cooperation is more likely.

Repeated Game

When you face the same strategic interaction with the same rivals and playoffs in successive periods.

Strategic Interactions

When your best choice may depend on what others choose, and their best choice may depend on what you choose.

Anti-Coordination Game

When your best response is to take a different (but still complimentary) action than the other player.

Business-Stealing Effect

While its privately profitable for Pepsi to advertise, from society's perspective its wasteful because Pepsi's gains are offset by Coke's losses.

Competitors in Other Markets Create a Threat of Potential Substitutes

You also face competition from firms in other industries whose products are potential substitutes for yours. Think expansively about possible substitutes. Ex: Roses can be substituted by chocolate on Valentines Day Substitutes are a larger threat when switching costs are low. Ex: Books from Barnes and Noble vs. E-Books from Amazon

Preventing Resale

You can use a variety of methods to prevent resale of your products. For example, Sony assigns an area code to PS4 games, so they cannot be used in consoles from different regions. This is to prevent a game purchased in Thailand, where it is cheaper, being sold to a person in the U.S.A, where games are more expensive.

What Occurs when New Firms Enter Your Market

Your Market Share and Power will Decrease Your own Quantity and Price will Decrease

Price Discrimination

the business practice of selling the same good at different prices to different customers.

Using the Rational Rule with the Marginal Revenue Curve

1.) Choose your quantity by selling until your Marginal Revenue is equal to your Marginal Cost. 2.) Choose your Price by looking upwards to the Demand Curve

Solutions to The Coordination Problem

1.) Communication 2.) Focal Points, Culture, and Norms 3.) Laws and Regulations

Four-Step Process for Making Good Strategic Decisions

1.) Consider All of the Possible Outcomes. 2.) Think About the "What Ifs" Seperately. 3.) Evaluate Your Best Response 4.) Put Yourself in Someone Else's Shoes

Types of Barriers to Entry

1.) Customer Lock-In (Demand Side) 2.) Unique Cost Advantages (Supply Side) 3.) Government Policy (Regulatory Strategies) 4.) Scaring off Potential Entrants (Deterrence Strategies)

Segment Your Market Based on Three Criteria

1.) Groups whose Demand Differs: Student's demand for products is different than adults. They typically have lower reservation prices (less money to spend) 2.) Target Groups based on Verifiable Characteristics: Age, area (address), etc. 3.) Base Group Discounts on Characteristics that are Hard to Change: Getting a student ID is difficult if you're not a student.

5 Key Insights Of Imperfect Competition

1.) Having More Competitors Leads to Less Market Power 2.) Market Power Allows You to Pursue Independent Pricing Strategies 3.) Successful Product Differentiation Gives You More Market Power 4.) Imperfect Competition Among Buyers Gives Them Bargaining Power 5.) Your Best Choice Depends on the Actions of Other Firms

Market Power Leads to Four Things

1.) Higher Prices: Usually more lucrative to charge a higher price to a few customers than sell a larger quantity at a lower price. 2.) Inefficiently Smaller Quantity: Firms are reluctant to lower prices because it means less revenue from existing customers. 3.) Larger Economic Profits: Firms choose to perform below the perfect competition outcome. This is because at a higher price, and a lower quantity produced, they gain more profits. 4.) Businesses With Market Power can Survive Even with Inefficiently High Costs.

Product Positioning Insights

1.) Supply the Underserved Side of the Market (Think of the Ice Cream cart on the beach metaphor) 2.) Demand-Side pressures suggest positioning your product next to your rival to get the most customers. This will increase the quantity you sell. 3.) Supply Side pressures suggest positioning your product as far away from your rival as possible to reduce price competition.

The Two Forces Affecting Marginal Revenue

1.) The Output Effect 2.) The Discount Effect

When is Price Discrimination Feasible?

1.) Your Firm has Market Power: if your firm lacks MP, customers will buy from other firms. 2.) You Can Prevent Resale: Otherwise, people you offer discounts to will resell your product for a profit. 3.) You Can Target the Right Prices to the Right Customers.

Payoff Table

A Table that lists your choices in each row, the other player's choice in each column, and so shows all of the possible outcomes and payoffs.

Search Good

A good that you can easily evaluate before buying. Ex: A computer and it's unique specifications

Imperfect Competition

A market featuring few competitors, but with sufficiently limited competition so that sellers still have some market power. Includes Monopolistic Competition and Oligopoly.

Natural Monopoly

A market in which it is cheapest for a single firm to service the market.

Monopolistic Competiton

A market in which there are many competitors selling differentiated products.

Monopoly

A market in which there is one dominant seller. Ex: YKK Zippers

Oligopoly

A market which is dominated by a handful of large firms. Ex: The smartphone market (Samsung vs. Iphone)

Tit for Tat Strategy

A means of encouraging cooperation by at first acting cooperatively but then always responding the way your opponent did (cooperatively or competitively) on the previous trial.

One-Shot Game

A strategic interaction that only occurs once. Here, you don't need to worry about how today's decision might change how others will treat you in the future.

Bargaining Power

Ability to Negotiate a Better Deal for Yourself. Determined by Your Next Best Alternative.

Collusion

An agreement by rivals to limit competition with one another. This allows both of them to gain higher profits.

Perfect Competiton

Markets in which all firms within an industry sell an identical good; there are many buyers and sellers, each of whom is small compared to the size of the overall market.

Solutions to The Hold-Up Problem

- Long Term Contracts - Reputation and Repeated Interactions - Vertical Integration

Nash Equilibrium

An equilibrium in which the choice that each player makes is a best response to the choice other player will make.

The Output Effect

An extra unit of output will boost my revenue by an amount equal to the price of the item sold. Ex: An extra unit of output will boost my revenue by an amount equal to the price of the item sold.

Switching Costs

An impediment that makes it costly for customers to switch to buying from another firm. Ex: Iphones use a higher quality when sending pictures to other Iphones, rather than devices from other brands.

Relationship-Specific Investments

An investment that is more valuable if the current business relationship continues.

Competition Policy

Laws and Regulations designed to ensure that markets remain competitive. Remember, its not illegal to BE a monopoly, only to practice monopoly strategies.

Marginal Revenue Curve

Lays below the Demand Curve and Declines faster.

Market Power based on Market Structure

Least Power Most Power Perfect Comp. --> Imperfect Comp. --> Monopoly

Decreasing Returns

Long-run cost curve slopes upward until your firm is eventually selling it's products at a price where profits = average cost.

When Using a Game Tree...

Look Forward: To anticipate the likely consequences of your actions Reason Backwards: Start by analyzing the last period of the game. Use this to reverse engineer the game by deciding the most likely choice your rival will make at each stage.