This document provides an agenda and summary for a class on market power, structure, and failure as well as labor economics. The agenda includes discussing market power and structure, market failure, and labor economics. Under market power and structure, the document covers different market structures including perfect competition, monopoly, barriers to entry, and monopolistic competition. It then discusses market failure including public goods, natural monopoly, externalities, and tragedy of the commons. Finally, it summarizes some topics in labor economics such as determinants of labor supply, motivation theories, and comparative advantage.

1. Principles of Business I Market Power, Structure, and Failure Labor Economics Week 4 – September 28, 2011 Professor Whitaker

2. Agenda for Class 1. Market Power and Structure [break] 2. Market Failure [break] 3. Labor Economics [questions]

3. Market Power and Structure

4. Market Structures

5. Perfect vs. Imperfect Competition Efficiency vs. Power In perfect competition, firms are powerless – They do not set price. They can only respond. Economists believe perfect competition creates efficiency which allocates resources effectively – “allocative efficiency.”

7. High barriers to entry

8. Price-maker not price-taker

10. Examples of Barriers to Entry Pharmaceutical company: scientists, patents, money to fund clinical trials, marketing support Beer company: recipe, vast factories, access to ingredients, distribution and bottling system, partnerships, marketing, merchant relationships Gallery: expertise of owner in choosing artists, cost of space, language barrier, relationships with clients Conferences (e.g., Artelligence): reputation, relationships, money to secure space (risk and cash flow) Artist: space and time to work vs. gallery representation Auction Party vs. Auction House: cost of compliance and marketing

11. Availability of Substitutes

12. Other substitutes?

13. Competitive industryPrice signallingCollusion

14. Monopolistic Competition Competition on brand or other forms of market segmentation The determination has to do with whether there are substitutes – perfect, imperfect, improvised or otherwise You Are Here.

15. Strategy of Monopolistic Competition Non-price competition - differentiation Influence over demand via advertising, branding Increase switching costs - stickiness Bolster number of complements Extended service agreements, frequent upgrades Network externalities Technical standards (Blue Ray v. HD DVD)

16. Differentiation - Tactics Quality – strong warranties, reliability, customer satisfaction data Innovation – technological sophistication, uniqueness Customer responsiveness – service reputation, speed and ease of problem resolution, ability to customize Examples: Nordstrom, Mercedes, Apple, Dell

17. Cost and Differentiation cutting-edge production technologies, just-in-time production improved information systems: communications, ordering, data analysis Cost Controls Cost-shifting to customer via self-service provisioning Disintermediation of value chain Off-shoring, outsourcing Differentiate products to satisfy more segments and sub-segments Smaller production runs for “mass customization” Parts standardization and other operational efficiencies Enable larger runs of same platforms despite “differentiated” final products Examples: Target, Uniqlo, Southwest

18. Cost, plus focus and differentiation

19. Pure monopolists are the whole market For competitive firm: MR = MC = P because P is “taken.” If you tried to raise price, you would lose all sales. For monopolist, MR  P; rather... MR is always less than P so long as demand curve is downward sloping

20. Demand Curves(market power means being able to set price) P P Q Facing the individual firm The market overall Q

21. The Monopolistic Firm is the Market P D Q

22. What this looks like P (Price) D (Demand) Q (Quantity) MR

23. Marginal Revenue for Monopolists Example: Perfect competition: price = $5 MR = $5 no matter what Monopoly: To sell more units, you have to lower price: At price of $5, you sell 20. TR = 100. At price of $4, you sell 30. TR = 120. MR = Change in total revenue divided by change in output = (120-100)/(20-30) = 20/10 = 2

24. Oligopolies - groups of firms that together behave as monopolies

25. Group of eyeglasses firms dominating the industry

26. Tests of Market Power Number of producer firms Size of each firm Barriers to entry Availability of substitute goods In essence, is the market contestable?

27. Red Flags for Antitrust Patents Competitors must establish alternate means of producing or license process from patent holder Supply & Distribution Control Control distribution outlets Also: control essential supplies, resources Mergers and acquisitions

28. Concentration Measures of Monopoly Concentration Ratio – market share of top 4 firms >60% is considered oligopoly 2. Herfindahl-Hirschman Index – sum of squares of all the market concentrations if merger creates an HHI > 1800: DOJ will challenge if merger creates an HHI between 1000 – 1800: DOJ will challenge if merger if likely to increase HHI by 100 points or more

30. market failure

31. Public Good Consumption by one person does not interfere with consumption by another Private good: donut Public good: water, air Free-rider problem The market tends to overproduce private goods and underproduce public ones

32. Public vs. Private Goods Museums vs. individual paintings Clean air vs donuts A park vs. a backyard Anything for which one person’s enjoyment does not interfere with another’s

33. National Parks and Art Museums? Nicholas Kristof, New York Times, course homepage under “Seminar Reading.”

34. Natural Monopoly Industry like a utility or the post office that is so vast only one firm can support the fixed cost structure

35. Minimum Efficient Scale (MES)

36. Externalities Costs or benefits of production that are borne by a third party – Costs that don’t get added or subtracted + beekeeper who lives next to a flower grower - pollution, excessive noise, environmental damage Positive externalities tend to get subsumed into business models, negative externalities are often regulated

37. Positive Externality: the beekeeper and the flower grower

38. Negative Externality: pollution Key Issue – what’s good for one isn’t good for many

39. Tragedy of the Commons

40. What an externality looks like: S2 S (Supply) P (Price) P2 Adding the cost of an externality to the supply curve P1 D (Demand) Q (Quantity) An exclusion of a portion of the cost of a product

41. Externalities: Environmental Case Study Pollution and its effects: acid rain, bio-accumulation of mercury in food stocks, asthma due to airborne particulates, etc., emissions of CO2 and other contributors to climate change

42. Costs of Pollution Estimating the cost of environmental damage/ Tangible or specific costs can be calculated by: Diminished life expectancies Lost work days Direct medical costs Productivity losses Cost of replacing, restoring, remediating environmental damage

43. Direct and indirect costs Diffuse and concentrated benefits and costs

44. Payment for power includes infrastructure costs but not externalities like pollution How can externalities be included?

45. Regulation Governments are generally best positioned to address the problem of externalities by altering the rules under which a particular market operates.

46. Press / Public Knowledge

47. Taxes The additional cost is borne directly by the end user in the exact proportion to the quantity of product consumed.

48. Including the externality as a cost: S2 S (Supply) P (Price) P2 Adding the cost of an externality to the supply curve P1 D (Demand) Q (Quantity) An exclusion of a portion of the cost of a product

49. Cap and trade Assigning property rights

50. Coase Theorem A resource allocation can be efficient as long as contracting costs are sufficiently low and property rights are assigned clearly, enforced well, and exchanged readily. Ronald Coase, 1960 The free market is more powerful in producing efficient outcomes than previously thought Pricing in externalities lets people trade them. Even if the price isn’t set right the first time, the market will correct it. Assumes transaction costs and monitoring costs are low enough.

51. Outright Prohibition

52. Indirect Intervention:Incentives for Innovation Focus on renewables Supporting capital-intensive start-up costs Making alternative energy cost-competitive

53. 1: Renewable Portfolio Standards Utilities agree to obtain a certain percentage of their power from renewable generators by a point in time. Aadopted by 28 states. Creates two markets with two separate demand curves: a price for fossil fuels and a price for renewables.

54. 2: Federal Tax Subsidies for renewable energy producers Tax incentives rather than direct support Takes the form of accelerated depreciation and Production Tax Credits (PTCs). PTCs are tax credits approximately equal to 20 cents for each kWh produced by the facility for the first 10 years of its life. An alternative to a PTC is an Investment Tax Credit (ITC) – 30% of construction cost on completion

55. 3: 2009 Stimulus Package Cash Grants and Federal Debt Guarantees

56. Pros and Cons Pros Better than no policy support Cons Hazards associated with the government attempting to pick winners High transaction costs Uncertainty stemming from short vs long-term incentives Competing and conflicting govt. subsidies. Tax credits for renewables made less effective by subsidies for natural gas production.

57. Externalities in the Arts? Education Public Goods Positive effects on test scores or innovation Others?

58. Labor Economics

59. Some Labor Stats The top 500 companies employ 20% of the workforce Walmart employs 0.8% of the workforce Most jobs in the economy are held in small firms. There are approximately 26 million small businesses, of which 19 million are sole proprietorships. Small businesses employ over half of private sector workers and create 60-80% of new jobs. (See Kauffman Foundation for more information)

60. Determinants of Supply of Labor Tastes Income and Wealth Expectations (for income and wealth) Prices (of consumer goods) Taxes Local markets, skills, barriers to entry and exit

61. Daniel Pink on Motivation The human question under the economic one: What motivates people to work? purpose, autonomy, money . . . http://www.youtube.com/watch?v=u6XAPnuFjJc&feature=player_embedded

62. Steven Levitt Ted Talk The Market for Crack Dealers http://www.ted.com/talks/lang/eng/steven_levitt_analyzes_crack_economics.html

63. Motivation according to Economists Work in order to have leisure time Trading off intrinsic satisfaction and a paycheck Income effect: raising wages makes people work less. Reduce hours without losing income. Opportunity cost of leisure is higher because leisure is more scarce. Substitution effect: raising wages makes people work more. They substitute work for leisure. Income effect substitution effect

64. Shapes of Supply Curves Investment Banker?

65. Shapes of Supply Curves Famous Actor?

66. Shapes of Supply Curves Freelancer?

67. Monopsony vs. Monopoly(one buyer, many sellersvs. one seller, many buyers) WalMart, Gates Foundation, Warren Buffett. . .

68. Work vs. Leisure Iain Duncan Smith and the case of benefit reform in England (House of Commons video) http://news.bbc.co.uk/democracylive/hi/house_of_commons/newsid_9080000/9080728.stm

69. Opportunity Cost of not Working Approximately 55 million people Benefits: 28% of public expenditure (£193bn in payments and tax credits) Up to £26,000 in benefits As of April 2010, £20.30 per week was paid for the first child (including the eldest of a multiple birth) and £13.40 per week was paid for each additional child.

70. Economics in Everyday Life: “James”

71. James is a investment analyst and a new dad. Would he rather spend his time at work or at home?

72. Both. . . (but not assembling Ikea furniture)

73. Comparative Advantage David Ricardo David Ricardo’s 1817 book On the Principles of Political Economy and Taxation It always makes sense to produce the thing you are best at, even if you are good at other things. Consider two men who live on an island. If they can each either fish or pick coconuts. Both pick coconuts at the same rate (10 per day) but one fishes faster than the other (12 fish instead of 6), then the one who is good at fishing should specialize in that and the other should pick coconuts. This maximizes the total number of fish and coconuts. James has comparative advantage in work and in childrearing. Other people are far better at cribs, and he is willing to pay more than they charge.

74. (wearing “the economists” hat. . .) From the perspective of society, James specializes in investments. From the perspective of himself and society, he also specializes in parenthood. From his perspective re the crib, it’s all about opportunity cost of his time.

75. Demand for LaborMalcolm Gladwell Industry norms Concentrated costs, diffuse benefits or vice versa Noneconomic thinking Value-based pay vs. market-based pay

76. Museum Workers

77. Links AAMD Guidestar Bureau of Labor Statistics

78. Economics in Everyday Life (or, the power of non-economics in everyday life): Charmingly kind retirees offering maps