Cooperative Decision-Making

Transcription

1 Cooperative Decision-Making Andy McLennan August 4, 2016

2 Chapter Outline About cooperative decisions and economic transactions. Examples of cooperative decisions: Marriage Customers-suppliers Trade has to be understood in a broad sense: it occurs in the market place, inside firms, inside households, etc. Economic transactions occur only if answer to the following two questions is YES: Does it create value? (In other words: is the sum of individual payoffs greater if the transaction occurs?) Is it individually worthwhile? (In other words: is it worthwhile for the players to engage in the transaction?)

3 Value chain of production Suppliers Factor price Inputs Business Price of product Products Customers

4 Example Vases Abroad Inc. (Gans p. 28) Vases Abroad Inc. are importers of rare vases from China, which they buy individually and publicize through a catalogue. Thus each vase has a unique value to each potential customer and a unique acquisition cost. In particular, dealer Ming21 is interested in purchasing a Ming Dynasty era vase.

5 Example Vases Abroad Inc. (Gans p. 28) Relevant information to this problem: One buyer, one seller, one unit of a product. v B is the value for buyer from exchange. v S is the value for seller from exchange. (v S is zero in the example) c B is the opportunity cost (value of outside option) for buyer from exchange. (c B is zero in the example) c S is the opportunity cost (value of outside option) for seller from exchange. (c S is $48,000 in the example, what the seller expects to make if not selling to Ming21)

6 Example Vases Abroad Inc. (Gans p. 28) Value creation from trade v B + v S }{{} c B + c S }{{} (1) joint gross payoff joint opportunity costs from trade (without trade) Notice that equation (1) can be written as (v B c B ) + (v S c S ) }{{} 0 (2) net joint surplus / payoff from trade

7 Example Vases Abroad Inc. (Gans p. 28) Value creation from trade v B + v S }{{} c B + c S }{{} (1) joint gross payoff joint opportunity costs from trade (without trade) Notice that equation (1) can be written as (v B c B ) + (v S c S ) }{{} 0 (2) net joint surplus / payoff from trade

8 Example Vases Abroad Inc. (Gans p. 28) Value creation from trade v B + v S }{{} c B + c S }{{} (1) joint gross payoff joint opportunity costs from trade (without trade) Notice that equation (1) can be written as (v B c B ) + (v S c S ) }{{} 0 (2) net joint surplus / payoff from trade

9 Example Vases Abroad Inc. (Gans p. 28) Value creation from trade v B + v S }{{} c B + c S }{{} (1) joint gross payoff joint opportunity costs from trade (without trade) Notice that equation (1) can be written as (v B c B ) + (v S c S ) }{{} 0 (2) net joint surplus / payoff from trade

10 Value creation Principle 1 Trade takes place only if the (potential) buyer and (potential) seller are jointly better off as a result of the exchange.

11 What about prices? Prices in a market economy serve different purposes as signals of costs, qualities, risks as incentives to buy, sell, invest, etc as instruments to divide the gains from trade Example Vases Abroad Inc. (continued): buyer-seller situation Suppose a price p > 0 is agreed Buyer s decision to participate: v B p c B (3) Seller s decision to participate: v S + p c S (4)

12 Participation constraints Principle 2 Trade will only take place at a price that makes both (potential) buyer and (potential) seller individually better off.

13 Participation constraints We can express equations (3) and (4) as v B c }{{ B } net gains for buyer willingness to pay p }{{} cost for buyer revenue for seller c S v S }{{} net cost for seller willingness to sell Notice: importance of opportunity costs in bargaining power.

14 Participation constraints We can express equations (3) and (4) as v B c }{{ B } net gains for buyer willingness to pay p }{{} cost for buyer revenue for seller c S v S }{{} net cost for seller willingness to sell Notice: importance of opportunity costs in bargaining power.

15 Competition vs. cooperation We ve seen that trade occurs if and only if (v B c B ) + (v S c S ) 0 }{{} cooperation and (v B c B ) p (c S v S ). }{{} competition Competition: how to get a bigger piece of an existing pie. Cooperation: how to increase the size of the pie.

16 Detour: efficiency But how does this relate to efficiency? Definition Efficiency maximization of joint surplus That is, max(v B c B ) + (v S c S ). It is related but different question: trade can occur even if it is not efficient (e.g., there is a buyer that values the vase more than Ming21 but the seller does not know), or it may fail even if efficient (Ming21 may pretend her value is much less and seller does not know the value).

17 In other words... Definition A customer s willingness-to-pay is the maximum price they would pay to purchase a product. Definition A supplier s willingness-to-sell is the minimum price they would accept to sell a product. Definition Total surplus from trade is the difference between customers willingness-to-pay for a product and the supplier s willingness-to-sell.

18 Remarks Remarks: 1. The answer to the first question is YES (that is, value is created by trade) if total surplus is non-negative. 2. The answer to the second question is YES (that is, players are willing to participate in trade) if price is such that total surplus is split between buyer and seller.

19 Example from ebay Description: Canon EOS Rebel T3i 18.0 MP Digital SLR Camera - Black (Kit w/ EF-S 18-55mm IS II Lens) Ad 1 Ad 2 Ad 3 Condition New New New Kind Auction Buy it now Auction Reserve price $ $ $ Value for seller 1: v S1 = 0 Opportunity cost for seller 1: c S1 = $ Value for seller 2: v S2 = 0 Opportunity cost for seller 2: c S2 = $ Value for seller 3: v S3 = 0 Opportunity cost for seller 3: c S3 = $ Value for buyer: v B = $1,000 (suppose) Opportunity cost for buyer: c B = $ (buyer can guarantee himself surplus of $ by trading with Seller 2)

20 Example from ebay 1. Seller 1: Trade will never occur! 2. Seller 2: Trade might occur. 3. Seller 3: Total surplus = = 70 Total surplus = = 0 Total surplus = = 200 Trade might occur if p and if price is such that < p < both buyer and seller get surplus.

21 Extension to many customers and many sellers Suppose that a market for a product consists of four customers and four suppliers: WTB Customer 1 $1, 000 Customer 2 $800 Customer 3 $600 Customer 4 $400 WTS Supplier 1 $900 Supplier 2 $700 Supplier 3 $500 Supplier 4 $300 One possible matching: Supplier 1 Customer 1 Supplier 2 Customer 2 Supplier 3 Customer 3 Supplier 4 Customer 4 Total value created in the market = $400

22 Extension to many customers and many sellers (cont.) Competitive-market matching maximizes total value created: Supplier 3 Customer 2 Supplier 4 Customer 1 Total value created in the market = $1,000 $ 1, Maximal total value created Supply Demand Q To maximize the total value created, the customer with the highest willingness-to-pay should be matched with the supplier with the lowest opportunity cost and so on. Moreover, trades stop where the WTP of the next customer is less than the WTS of the next supplier.

23 Supply, demand, and business decisions (Gans pp ) A decade ago you developed a design for a high speed elevator, but assessed that demand would be insufficient. Now you notice that more new buildings have high speed elevators. Should you take your design into production? If demand has increased (that is, the demand curve has shifted out) then possibly yes. If other producers have increased their production (that is, the supply curve has shifted down or to the right) because their technologies improved, then you should not. Price acts as a signal guiding efficient resource allocation. In the first case price will be higher than it was a decade ago, and in the second case it will be lower.

24 Complementors Business strategy frameworks often overlook the role of complements. Brandenburger & Nalebuff ( Co-Opetition: (1) A Revolutionary Mindset That Combines Competition and Cooperation; (2) The Game Theory Strategy That s Changing the Game of Business ) suggest a new term complementor for players that provide complements. Firms can be complementors with respect to their customers, with respect to their suppliers, and with respect to other firms.

25 Complementors vs. competitors (customers) Definition A firm is your competitor if customers value your product less when they have the other firm s product than when they have your product alone. Example: Coke and Pepsi Definition A firm is your complementor if customers value your product more when they have the other firm s product than when they have your product alone. Example: fine wine and Riedel glasses

26 Examples of customer s complements computer hardware and software Core i7 chip and Microsoft Windows 7 cars and roads selling cars and car loans red wine and dry cleaners golf courses and real estate desktop color printers and digital cameras Foxtel and Foxtel guide Internet (Broadband) and YouTube

27 Customers complementors Technical definition: Definition Two businesses A and B are complementors with respect to a customer if the customer s willingness to pay (WTP) for both of their products together is greater than WTP for A s product alone plus WTP for B s product alone: WTP(A B) > WTP(A) + WTP(B).

28 Complementors vs. competitors (suppliers) Definition A firm is your competitor if it is less attractive for a supplier to provide resources to you when it is also supplying the other firm, than when it is supplying you alone. Example: A firm supplying parts to automobile parts may prefer to supply to only one auto manufacturer, thereby obtaining economies of specialization an avoiding the conflicts between the needs of different manufacturers. Definition A firm is your complementor if it is more attractive for a supplier to provide resources to you when it is also supplying the other firm, than when it is supplying you alone. Example: Other consumers of electricity and aluminum manufacturers, who can halt production when electricity demand is peaking.

29 Examples of supplier s complements Supplying wheels to car majors: even if different wheels, it is less costly if there are two or more customers HP and Dell: compete with each other for the latest Intel / AMD chip, but complement each other in defraying Intel / AMD s R&D costs Virgin and Qantas: compete with each other for passengers, freight, landing slots, and gates, but complement each other in defraying Boeing s or Airbus R&D costs

30 Suppliers complementors Technical definition: Definition Two businesses A and B are complementors with respect to a supplier if the opportunity cost (OC) for supplying both of their products together is less than the OC of supplying A s product alone plus the OC for supplying B s product alone: OC(A B) < OC(A) + OC(B).

31 Example of complementarity among different players Example When going on vacation, individual consumers look to the price of the holiday as a whole. If p a is the price of airfare and p h is the hotel price, consumers will look at p a + p h to see whether a holiday s price is less than their willingness-to-pay. If they do not co-operate, airlines and hotel operators will base their own pricing on their own willingness-to-sell. This might mean that they set their prices too high and fail to exploit value-creating opportunities between them. Expedia is an example of how airlines and hotels join together to exploit the fact that they are complementors in the eyes of consumers.

32 Flip side of complementors Jekyll & Hyde: your complementors often help your competitors too. Several hats: your complementors might be your competitors too. Horizontal dimension is (usually) easy: complementors are friends and substitutors are foes. Vertical dimension is gray: mix of cooperation (increasing the pie) and competition (dividing the pie).

33 Example of complementors-competitors Example Kodak and Fuji created the Advanced Photo System (APS or Advantrix): Cooperation: Creating a new market for an easy-to-use, flexible camera system. Joint product development. Joint development of processing systems. Competition: Competing for sales within the market. Continuing competition in traditional markets.

34 Workers as complements The great increase of the quantity of work which, in consequence of the division of labor, the same number of people are capable of performing, is owing to three different circumstances; first to the increase of dexterity in every particular workman; secondly, to the saving of the time which is commonly lost in passing from one species of work to another; and lastly, to the invention of a great number of machines which facilitate and abridge labor, and enable one man to do the work of many. Adam Smith

35 Complements inside the firm In order to minimize transactions costs, workers who complement each other often (but not always) work for the same firm. Coordination between complementary workers is usually more efficiently handled by command-and-control than by market transactions. The surplus that complementary workers create is itself a potential source of conflict, and a managerial issue. Hosting and managing teams of complementary workers is perhaps the most important way that firms create value.

36 Comparative advantage David Ricardo recognized that specialization is most efficient when each worker performs the task for which she has the greatest comparative advantage. An example (Gans p. 43): Jack can fill 12 pails of water per hour, and can carry 4 pails of water down the hill in an hour. Jill can fill 20 pails of water per hour, and can carry 12 pails of water down the hill in an hour. Working separately, Jack can produce 24 pails of water in an 8 hour day, and Jill can produce 60 pails. If Jill specializes in carrying (even though she is better at filling than Jack) and Jack only fills, together they can produce 96 pails in a day.

37 Concluding remarks Bottom line: Gains from trade: value creation is essential for exchange to happen. Take into account net gains: (v B c B ), (v S c S ). Price is used to divide social gains. The principles of value creation extend to multiple-agent situations (many buyers, many sellers). Understand opportunities for cooperation (increasing the pie) and constraints of competition (dividing the pie). Division of labor is a particularly important form of cooperation that is guided by comparative advantage.