Porters 5 Forces: 1. Entrants sunk costs, switching costs, speed of adjustment, economies of scale, sunk costs, network effects, reputation, government restraints 2. Power of input suppliers supplier concentration, price/productivity of alternate inputs, relationship-specific investments, supplier switching costs, government restraints 3. Bargaining power of buyers - buyer concentration, price/value of substitute products or services, relationshipspecific investments, customer switching costs, government restraints 4. Threat of substitutes/complements price/value of surrogate products/ services, network effects, government restraints. 5. Industry rivals concentration, price, quantity, quality, or service competition, switching costs, timing of decisions, information, government restraints Marginal Analysis
Demand Law of demand Price and quantity demanded are inversely related Demand shifters income, prices of related Goods, advertising & consumer tastes, population, Consumer expectations Income (M) Normal goods: M = D Inferior goods: M = D Price of related goods Complements: P(x1) = D(x2) Substitutes: P(x1) = D(x2) Supply Supply shifters input prices, technology/ Government regulations, # firms, substitutes in production, tastes, produces expectations Market Equilibrium, Price Floor, Price Ceiling
Elasticity: A measure of the responsiveness of one variable to changes in another variable Elastic demand absolute value of own price elasticity > 1 Quantity of good consumed is responsive to changes in the price of the good Inelastic demand absolute value of own price elasticity < 1 Quantity of good consumed is unresponsive to changes in the price of the good Indifference Curve defines combinations of two goods that give a consumer the same level of satisfaction Marginal rate of substitution the rate at which a consumer is willing to substitute one good for another good and still maintain the same level of satisfaction Production Functions: Linear: Q = ak + bl Leontief: Q = min {ak, bl} Cobb-Douglas: Q = K a L b
Economies of Scale: exists when long-run average costs decline as output increases Economies of Scope: when the cost of producing 2 types of outputs together is less than the total cost of producing each type of output separately Vertical integration: a situation where a firm produes the inputs required to make its final product Horizontal integration: the merging of the production of similar products into a single firm Manager-worker principal-agent problem: profit sharing, revenue sharing, piece rates Industry concentration: Four-firm concentration ratio: the fraction of total industry sales generated by the four largest firms in the industry Herfindahl-Hirschman index: the sum of the squared market shares of firms in a given industry multiplied by 10,000 Elasticity of demand at the firm and market levels the demand for an individual firm s product is more elastic than that for the industry as a whole. Pricing behavior: Lerner Index: a measure of the difference between price and marginal cost as a fraction of the product s price L = P MC P Perfect Competition: 1. There are many buyers and sellers in the market, each of which is small relative to the market 2. Each firm in the market produces a homogenous product 3. Buyers and sellers have perfect information 4. There are no transaction costs 5. There is free entry into and exit from the market Monopoly: a market structure in which a single firm serves an entire market for a good that has no close substitutes Deadweight loss of monopoly: The consumer and producer surplus that is Lost due to the monopolist charging a Price in excess of marginal cost. Oligopoly: a market structure in which there are only a few firms, each of which is large relative the total industry
Cournot Oligopoly: an industry in which: 1. there are few firms in the market serving many consumers 2. the firms produce either differentiated or homogeneous products 3. each firm believes rivals will hold their output constant if it changes its output 4. barriers to entry exist *applies to situations in which products are either identical or differentiated *relevant to managers decision making, where output decisions are believed to not influence the output decisions of rivals Bertrand Oligopoly: an industry in which: 1. there are few firms in the market servan many consumers 2. the firms produce identical products at a constant marginal cost 3. firms engage in price competition and react optimally to prices charged by competitors 4. consumers have perfect information and there are no transaction costs 5. barriers to entry exist *leads to zero economic profits (P = MC) Simultateous-move, one-shot games: go with dominant strategy (highest payoff regardless of the opponent s action; if no dominant strategy, go with secure strategy (highest payoff given the worst possible scenario); Ex. Pricing strategies Nash equilibrium: a condition describing a set of strategies in which no player can improve her payoff by unilaterally changing her own strategy, given the other player s strategies Atrribution: All information adapted from: Baye (2014). Managerial Economics and Business Strategy (8 th ed.).