2014

Managerial EconomicsStefan Markowski

Managerial EconomicsStefan Markowski

How? When?How? When?

WhatWhat??

0

20

40

60

80

100

1st Qtr 2nd Qtr 3rd Qtr 4th Qtr

East

West

North

The economics of competitive advantage

Why?Why?

Where?Where?

WhoWho??

Market research and marketanalysis

Detailed course scheduleDay no 

Topic Textbook 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 elasticities Ch. 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 power Chs. 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 perspective Ch. 14

12 (9 Dec; 2 hrs)

12. Revision13. Examination

 

13 (11 Dec; 2 hrs)

Examination  

Topic 10: Market research and market analysis, Auction and rings

Strategic behaviour

Topic Contents

9.1 Managerial perspective

9.2 Understanding structure

9.3 Understanding conduct

9.4 9.4 Understanding performance

9.5 Market conduct: Auctions9.5 Market conduct: Auctions

9.6 Further reading

9.1 Managerial perspective• Firms make decisions with reference to their

operational environmentoperational environment, i.e., rivals, suppliers, customers and labour markets

• They measure the competitiveness competitiveness of their industry by looking at various measures of industry measures of industry concentration,concentration, the higher concentration the less competitive it is

• They are also concerned with the size of other firms (turnover, employment, capitalisation), industrial leadership (who dominates), conditions of entry and exit, mergers and takeovers, and so on

9.1 Managerial perspective• In other words, they are interested in Structure, Structure,

Conduct and Performance Conduct and Performance of a market/industry

• The structure-conduct-performance paradigm structure-conduct-performance paradigm is used to discuss industry growth industry growth and sustainable sustainable competitive advantagecompetitive advantage

• In practical applications in management this has been adapted by Michael Porter as the Five Forces Five Forces Framework Framework for industry/market analysis:– Entry conditions

– Industry rivalry

– Substitute and complementary products

– Power of input suppliers

– Power of buyers

9.2 Understanding structureFirm sizeFirm size

• Firm size is an indicator of its influence, possible dominance and terms of entry/exit. Size matters

• Google and look up the annual Fortune Largest Fortune Largest 2000 Global Companies2000 Global Companies, which not only ranks the largest companies but also contains links to each company’s annual report

Industry concentration Industry concentration

• The concentration of largest firms in the industry’s total turnover/sales is a measure of its competitiveness

9.2 Understanding structure

• Concentration ratios Concentration ratios measure the proportion of sales or production attributed to the largest firms

• Four firm concentration ratio Four firm concentration ratio

C4 = (S1+ S2+ S3+ S4) / ST, where

Si is sales of the firm i

ST total sales of all firms in the industry/market

wi = Si / ST

C4 = (w1+ w2+ w3+ w4)

9.2 Understanding structure

• Herfindahl-Hirschman index Herfindahl-Hirschman index (HHI) is the sum of the squared market shares of firms in a market multiplied by 10,000 to avoid decimals

HHI = 10000 (wi)2 and wi = Si / ST

• It takes the value between 0 (all firms very small and very numerous so nearly 0% shares) and 10,000 (only one firm with 100% share)

• Instead of T measuring all firms in a market or an industry we can focus on the top 50 or 100

TechnologyTechnology

• Various technology related indices e.g., R&D shares in costs or sales

9.2 Understanding structureCapitalisation measuresCapitalisation measures

• We can use the number of workers/operatives per $1 million of sales or capital-labour ratios

Demand conditionsDemand conditions

• This is to capture demand characteristics of a market or an industry

• Rothschild index Rothschild index measures the ratio of own price elasticity of demand for the total market, T, to the own price elasticity of demand for an individual firm, Fi, R = ET / EFi

• It takes values between 0 and 1 (similar elasticities)

9.2 Understanding structure

Entry/exit barriersEntry/exit barriers

• Measures of capital intensity

• Patents

• Economies of scale

9.3 Understanding conductPricing behaviour of rivalsPricing behaviour of rivals

• Lerner index Lerner index L = (P-MC) / P, where P is price and MC is the marginal cost

• When P=MC L=0 as P-MC increases L 1

• This can be rearranged as

P= (1 / (1 – L) ) MC, where 1 / (1 – L) is the mark-up factor

• Recall MR = P ((1 + E) / E), where E is own price elasticity of demand and MR is marg. revenue

P = MR (E/(1+E)) and to max profits MR = MC by

manipulation L = 1 – E / (1+E)

9.3 Understanding conduct

Mergers and acquisitionsMergers and acquisitions

• Different mergers and acquisitions can occur in a market/industry:– Vertical integration

– Horizontal integration (economies of scale)

– Conglomerate integration (economies of scope)

AdvertisingAdvertising

• Spending on advertising reflects the competitiveness of a market/industry

R&DR&D

• A function of technical change and competition

9.4 Understanding performanceProfitabilityProfitability

• Profitability ratios

Rent seekingRent seeking

• Stakeholders ’ (e.g., workers, bankers) ability to capture rents

Social benefitSocial benefit

• This measures the impact of a market/industry on social welfare (all of us)

• Dansby-Willig preformance index Dansby-Willig preformance index ranks markets/ industries by the degree of an incremental increase in output would increase s. welfare (if 0 no change if >0 improvement)

9.5 Market conduct: Auctions9.5 Market conduct: Auctions• In an auctionauction, buyers compete directly (bid) for the

right to buy a good or service

• Types of auctions– English auction English auction – bidders observe bids of other bidders and

respond by increasing their bid or abstaining from bidding

the auction ends when only a single bidder remains and is successful if his/her offer price exceeds the seller’s reservation price

– First-price sealed-bid auction First-price sealed-bid auction – bidders made written offers (or electronic) and the highest bid wins if the offer price exceeds the seller’s reservation price

– Second-price sealed-bid auction Second-price sealed-bid auction – bidders made written offers (or electronic) and the highest bid wins but pays the offer of the next highest bidder (if the offer price exceeds the seller’s reservation price)

9.5 Market conduct: Auctions9.5 Market conduct: Auctions

– Dutch auction Dutch auction – the auctioneer begins with a high price and bids it down to the highest acceptable offer

• In principle, bids in the English and Dutch auctions should end up at the same level but in reality the auction dynamics could be different as people are emotional

• The optimal bidder strategy for an English auction is to set a reservation (own valuation) price and bid no more than that

• In a second-price sealed bid auction the bidder’s best strategy is to make a written offer equal his/her reservation price

9.5 Market conduct: Auctions9.5 Market conduct: Auctions

• This is an interesting auction it is the second mouse that sets the bid but the first mouse gets the cheese

• The optimal strategy is more complicated for the first-price sealed-bid auction and the Dutch auction – generally one should bid less than one’s reservation offer price

• Winner’s curse Winner’s curse occurs when the winning bidder overestimates the true value of the item and bids too much – do not copycat other people’s valuation

• Gambler’s ruin Gambler’s ruin – when a series unfavourable outcomes occurs in a row

9.5 Market conduct: Auctions9.5 Market conduct: Auctions

• When you assess the value of items you wish to make an offer for you must decide whether it is an essentially private (subjective) valuation essentially private (subjective) valuation independent of other people’s assessments or not. Do you buy it for your own enjoyment or resale?

• At some auctions all bidders may wish to use the same valuation (e.g., when they bid to buy and resell the item), but they do not know what to pay. Here they may influence each other and value the item higher (set higher reservation price) when they see other bidders bid more (learning by bidding could be expensive)

9.6 Further reading

Baye (2010): chs. 7 and 12