14.20 Spring 2003 Post-midterm Review Topics

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1 14.20 Spring 2003 Pst-midterm Review Tpics This is a rugh guide, with varying levels f detail acrss tpics. Yu shuld use yur lecture ntes t guide yur studying. Nte: All discussin tpics are fair game. Empirical Evidence n Price Discriminatin 1. Brenstein and Rse: Airline pricing Dispersin appears t be affected by cst variatin and price discriminatin Prices seem t discriminate acrss custmers based n their brand/airline lyalty i. Evidence fr this: dispersin increases with cmpetitin in a market higher fr duply than mnply, etc. 2. Shepard: Gasline pricing Gasline statins appear t discriminate acrss custmers based n willingness t pump wn gasline. Evidence: Differential between full and self-serve is higher at statins with bth service than acrss statins that prvide nly ne type f service Argument is that multi-type statins can increase differential, as custmers wh dn t want t pay higher full-serve price might stay at statin and pump wn gas. At single-serve statin, custmers wh dn t want t pay higher full-serve price all leave t rival statin. Prduct chice & quality 1. Spatial mdels f prduct differentiatin (Htelling line, Salp circle) 1.1 Fixed prices, chse lcatin: equilibrium (with 2, 3(?), 4 firms) principle f minimum differentiatin 1.2 Fixed lcatin, chse prices equilibrium (differentiated Bertrand) mark-ups, prfits a functin f differentiatin Maximal differentiatin 1.3 Free entry equilibrium: (Salp circle mdel) Knw hw t slve fr market demand fr firm, as functin f distance between firms, transprt csts Cmpare free entry, mnply, scial ptimum equilibrium What accunts fr differences acrss these utcmes? Welfare trade-ffs 1.4 RTE Cereal discussin (Nev paper): What are the stylized facts abut cereal entry, cmpetitin, prfits? What mdel f cmpetitin accunts fr these best? 2. Prduct quality First, bservable quality: 2.1 Hw d firms chse prduct quality? Knw hw t derive ptimal chice given demand P(q,s): s = quality Mnply may ver- r underprvide quality relative t scial ptimum

2 Depends n difference between marginal cnsumer s marginal valuatin f quality (mnplist s fcus) and average marginal valuatin f quality acrss all cnsumers (scial ptimum s fcus). 2.2 Durability Why des durability f prduct distrt prductin chices ver time? Think cmmitment! Hw des leasing/renting slve the durable gds prblem fr mnplist? If leasing isn t available, hw might this distrt durability decisins by the firm? Secnd, unbservable quality 2.3 Adverse selectin and mral hazard What prblems arise if firms have better infrmatin abut prduct quality than d cnsumers? Lemns prblems: selling used cars, health insurance, free agency Hw can signaling be used t mitigate these prblems? When can signaling wrk? (what makes a credible signal?) What types f signals d firms use? Mral hazard: when des this arise, what prblems des it create? Entry 1. What are majr barriers t entry Structural/exgenus Strategic/endgenus 2 Strategic investment behavir in the face f ptential entry 2.1 Accmmdatin v. deterrence f entry Examples: Strategic technlgy chice, capacity chice, etc. Strategic investment games: knw hw t set up and slve fr ptimal investment, given bjectives (deterrence r accmmdatin) The rle f cmmitment Taxnmy: Deterrence: want rivals prfits t be negative Accmmdatin: increase yur prfits n assumptin that rival enters What influences chice between bjectives? What are strategic cmplements and strategic substitutes? What des it mean that an investment makes a firm tugh r sft? Hw des the ptimal actin depend n the gal (accmmdatin r deterrence)? What is the imprtance f fat cat and tp dg, etc. strategies? 2.2 Price wars Pst-entry price declines: hw shuld we evaluate whether pricing is t aggressive? (predatry pricing) Static v. dynamic marginal csts Learning-by-ding Netwrk effects

3 Switching csts Predatin Mdels f predatry behavir: The rle f infrmatin and ratinality Reputatin mdels: Ordver-Salner Perfect Bayesian Equilibria: What are the basic ideas behind this (set up, randmized strategies, cnsistent beliefs, updating) What characterizes the equilibrium in this game? 2.3 Applicatins: DuPnt in titanium dixide: preemptive capacity expansin What cnditins might make this a desirable mve frm DuPnt s perspective? What are the ptential csts/risks? Sctt Mrtn: UK shipping cartels: mre likely t prey upn entrants wh are smaller utsiders with limited financial resurces American Airlines case: What behavir cncerned the gvernment (specifics, please)? What are psitive (pr-cmpetitive) and negative (predatry) interpretatins f this behavir? What difficulties arise in deciding an apprpriate plicy respnse? R&D 1. The imprtance f R&D t the ecnmy (especially dynamic cst reductin and prduct innvatin 2. The rle f apprpriability & innvatin incentives 3. Wh innvates? Divergence between private and scial incentives fr R&D The rle f gvernment in intellectual prperty prtectin (patents, cpyrights, etc). The rle f market structure Static market structure: mnply v. cmpetitive incentives fr cstreducing innvatin ( Replacement effects) Dynamic market structure: incumbent v. entrant incentive t innvate (nn-drastic innvatin; what des this mean?): Efficiency effects Strategic investment incentives: innvatin as a cmpetitive tl Understand prblem set 3 questin n this (hw des the nature f innvatin interact with the nature f cmpetitin acrss firms: return f the strategic investment taxnmy) Patent races: hw can cmpetitin fr the market increase investment in R&D? Can this lead t scially excessive investment? The rle f imitative (business stealing) investment in R&D (see WSJ article n drug cmpany innvatin) Advertising 1. The rle f advertising in markets

4 Advertising in the ecnmy The impact f advertising (demand expansin v. rtatin) 2. Advertising chice Types f gds and advertising intensity (search v. experience) Advertising/sales ptimizatin: knw hw t slve ne f these prblems Rule f thumb fr ptimal advertising intensity (A/Sales = - elasticity A /elasticity P ) 3. Advertising strategy Oligply advertising chices 4. Applicatin: Cigarette industry Rle f advertising in cmpetitin Plicy change: what effect might advertising limits have fr firm prfits? Hw des impact likely vary with incumbent v. entrants, branded v. generic prducts? Existing smkers v. new smkers? If reductin in advertising means existing smkers are mre f market (fewer new smkers), and these are mre brand lyal smkers, what effect wuld yu expect this t have n price dynamics? Thery f the firm: 1. What determines firm/market bundaries? Changes in firm bundaries ver time (rise f larger, multidivisinal firms) Alternative theries f firm bundaries Transactins csts, mnitring, asset specificity, incmplete cntracting, etc. -cntracting applicatins (sales frce, cal cntracts applicatins) - 2. What d firms maximize? Principal-agent prblems Cmpeting bjectives Alternatives t prfit maximizatin Cnstraints n managerial behavir Market cnstraints: cmpetitin, market fr crprate cntrl, managerial labr market Internal cnstraints: incentives inside firms, Executive pay and incentive cntracts Prblems with incentive pay (and manipulatin) Reducing discretin Turnaments, efficiency wages -cnstraints n managerial behavir -internal incentives (e.g., executive pay) Vertical rganizatin 1. Vertical structure: bundaries alng the vertical chain f prductin

5 2. Vertical integratin: Mtives and cnsequences Market pwer (e.g., Alca) Efficiency Duble marginalizatin] What is it, when des it ccur, what prblems des it create? 3. Alternative vertical restraints and antitrust plicy Slutins t duble marginalizatin Resale price maintenance/ quantity frcing Tying Tw-part tariffs Slutins t investment/mnitring Exclusive territry/exclusive dealing Franchising Dentsply example: arguments fr and against exclusive dealing restrictins impsed by Dentsply. Efficiency v. freclsure f cmpetitin. What is the rle f dwnstream market structure and supply relatinships? GUEST LECTURE: Michael Levine n airlines: The rle f service v. price cmpetitin in the early airline industry Hw did this interact with innvatin? Deregulatin: Netwrk airlines: surces f cmpetitive advantage Lyalty prgrams (switching cst effects; links t principal agent prblems: wh pays fr ticket, wh chses the airline?) Cnvenience The rle f labr in relative csts and cmpetitin Mutual Aid Pact: Hw des this change incentives t bargain with unin? Recall this pact invlves a revenue sharing agreement: Airlines with labr strike will receive a substantial share f the increased revenue at ther airlines that results frm passenger diversin t ther airlines. Lw cst carriers (Suthwest, etc.) What accunts fr their cntinuing increase? Bankruptcy: financial rerganizatin, nt necessarily ecnmic rerganizatin accunting v. ecnmic lsses (e.g., cntracted aircraft lease payments v. pprtunity csts f aircraft leases)