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Industrial Organization and Public Policy

by: Dr. Janiya Bernier

Industrial Organization and Public Policy ECON 121

Marketplace > University of California - Berkeley > Economcs > ECON 121 > Industrial Organization and Public Policy
Dr. Janiya Bernier

GPA 3.77


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Class Notes
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This 24 page Class Notes was uploaded by Dr. Janiya Bernier on Thursday October 22, 2015. The Class Notes belongs to ECON 121 at University of California - Berkeley taught by Staff in Fall. Since its upload, it has received 52 views. For similar materials see /class/226711/econ-121-university-of-california-berkeley in Economcs at University of California - Berkeley.


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Date Created: 10/22/15
Industrial Organization Economics 121 Spring 2006 Professor Joseph Farrell Lecture 1 What you know Perfect competition is efficient because it ensures price MC Monopoly is inefficient because it ensures price gt MC SO What Does perfect competition ever happen ls imperfect competition fairly efficient How imperfect does it tend to be How can we tell Compared to what Couldn t government keep price near MC Anyway why obsess over prices Isn t it more important that things be run ef ciently and imaginatively Answer to bullet 2 suggests so You need this class It s your best chance to learn answers to those questions Othenvise you wasted that Econ 101 time It s where microeconomic analysis meets the real world of business and policy Competitive strategy Procurement Antitrust Regulation Why you need this class 2 It s far more interesting than econ 100101 which you voluntarily took But don t come to me to add the class Why that s a bad idea A much better idea Pause for diagnostics Cournot oligopoly model Bertrand model Differentiated Vertical integration Horizontal mergers Partial derivative Linear regression Herfindahl index The Big Themes What competition is and isn t good at How much competition there is What determinesaffects this How to tell What we do about it Antitrust regulation Prices How things are organized Lost luggage and yield management Does market system sortof evolve to ef ciency Lost luggage and yield management Are airlines run by incompetent morons Are they run by ruthless bastards And why would ruthlessness lead to bad customer service Adam Smith on the baker Am I atypical Am Iwrong Technocratic secondguessing and incentives analysis Starting to think like an economist Modularity and the Internet Cable companies provide most residential highspeed internet access in US Little regulation Less and less regulation on phone companies internet access products too Will Comcast do a deal with Travelocity Excluding Expedia Incentives Would it be so bad How does that relate B Class Organization You must attend class and section Reading the textbook is not a good substitute It s not my linear algebra class Attendance will be noted Active participation will be noted Grading Office hours Class representation C What is a Firm Zone of commandandcontrol embedded within market economy Fuzzy idea incentives within firms longterm deals across firm boundaries Nevertheless Biggest unit whose behavior we assume to be maximizing something profit Do firms actually maximize Is there a better way to analyze economics Costs CampP chapter 2 You know this material from 101 How long ago Don t worry about multiproduct costs yet We ll use it not focus on it Don t letjargon obstruct thought Potential energy Shortrun and longrun How costs feature in predation policy trade policy Warmup exercises on costs Baggage handlers Diagnosing fat in gold mining Economies of Scale Traditional IO theme Concentration bounded determined by scale economies Too bad about the market power but Stalin Mao and the steel industry An envelope argument for economies of scale Is this right What is missing For Next Time Read CampP chapter 3 as carefully as you have time for but read it You already largely know it There will be time to go back to it later Don t obsess over definition of entry barrier First part of page 76 is garbled how We will discuss welfare economics of competition more broadly UC Berkeley Economics 121 Prof Joseph Farrell Lecture 15 7 March 14 2006 Price Discrimination Take 11 7 CP ch 9 For next class Read Ch 10 Why price discriminate PD Why not What might stop you How much PD do you do CP 7 evading the downside of MR Effect of increasing quantity sell more but price falls on all units PD allows you to continue charging higher price to inframarginal customers Someone is willing to pay pgtMC but less than market price 7 solution is PD Different buyers have different willingness to pay wtp want to charge as close to buyer s wtp as possible to the extent that you can determine each buyer s wtp Steeply downward sloping demand curve indicates diverging wtp 7 most anxious to PD in this case Esp attractive to PD if consumers wtp is correlated with something you can detect 3 types of discrimination Perfect charge wtp for each buyer Use observable differences to segment market gender student status age etc Selfselection 7 buyers can choose which group with which to identify ex select how quickly you want to receive stock prices When is PD feasibleprofitable Must be able to prevent resalearbitrage Competitive constraint 7 must make up for discount by charging higher price to other group 0 Example Student prices at the movies Lower price must go along with something you can prove else impractical Upgrade pricing for software 7 two ways to view 1 Person who already owns software likely to pay less than person who doesn t yet have the product 2 Or purchasing the product has revealed your preference for the product and it goes the other way note that it is harder to prove that you don t have the previous version Are pro tmaximizing prices signi cantly different refer to notes for graph Pro t peaks for two groups are similar Can use compromise price rather than segmenting market Won t be worthwhile to price discriminate Surprising how willing rms are to PD given that it doesn t lead to big change in pro ts Recall calculation done earlier in semester 10 price distortion yields approx 1 change in pro ts Subgroups with Different Demand Elasticities Use Lerner condition for each group Demand elasticities are what counts not wtp Illustrations l GrabowskiVemon on generic prescription drugs generics typically charge about 12 branded price after patent expires ltrefer to notes for graphsgt branded product has incentive to cut price alternative approach branded left with less elastic residual demand only has priceinsensitive demand left and raises price market segments itself 2 Airline pricing PD based on timing of purchase partially costbased but mostly separates pricesensitive from business travelers selfselection can either buy exible or in exible product Recall group purchasing organization from earlier 7 joining GPO tells rm that you have elastic demand Differences in how willing you are to go to a competitor Welfare Economics of PD PD is more pro table for the rm Good or bad for consumers Some people get higher price others get lower price Not obvious how it affects overall welfare For a given Q price discrimination reduces total efficiency Would increase total welfare if marginal low consumer didn t buy and marginal high consumer did buy Total ef ciency can only rise if Q increases enough Weighing consumer surplus vs producer surplus Usually give equal weight But maybe you care about pro ts more Ex patents broadband buildout I can get more innovation without doing much harm to consumers I New products improve ef ciency but might not be pro table to introduce I Need PD for product to be pro table amp will increase TS pmc is prescription for consumption ef ciency given that product will be supplied But maybe product won t be supplied Does total bene t cover total cost Seller needs to capture most of TS paverage value not marginal value Weighted welfare economics maX CS H subject to H20 maX aCS bH weight value of each Leads to Ramsey pricing closely related to PD Refer to notes 314 or 316 for derivation of Ramsey pricing and related graph Ramsey pricing formula pcplds PD by monopoly is on the frontier of set of feasible points for pro ts and consumer surplus refer to graph drawn in class Not easy to tell whether PD is good or bad for ef ciency If pro ts are a proxy for good things suggests sympathetic attitude towards PD Washington economics PD is ok Price discrimination in CP is based on monopoly Welfare implications in a competitive market are different than for monopoly case Not same demand elasticity as you would use for Ramsey pricing Oligopoly Lecture 2 Economics 121 Spring 2006 Joseph Farrell Briefly The Midterm Most people did well as I intended What if you re an exception Jenny will discuss in section Office hours Pick up your exam at end of lecture Friday is dropadd date Enrollment bureaucracy Recall Cournot model When the assumptions make sense Capacity that s cheap to use once built Expecting price responses that preserve rivals planned output levels Conjectural variation How we solved it Residual demand elasticity is es Then easy algebra Cournot Intuitive Results Continuum between competition and monopoly High concentration close to monopoly Symmetric case high concentration small N Low concentration close to perfect competition Decreasing returns to decreases in concentration Of course depends on measuring scale Cournot and Concentration Herfindahl index of concentration Relates to weighted average gross margin industry average profit rate on sales We Predict concentrated industries more profitable on average comparing industries Expect cleaner results if allow for e as well as H Inside an industry predict larger firms more profitable High shares go with low MC general formula lineardemand case Other Simple Oligopoly Models Other conjectural variations in prices Pricesetting oligopoly Pricematching Other conjectural variations in quantity Pricesetting static models Eschew conjectural variation Gametheoretic purity Is this sensible Undifferentiated Bertrand Two firms each sets a price Oneshot static game Lower price gets whole market Split it if equal Examples Nearexamples Analysis with constant unit costs Perhaps differing between firms Drastic and nondrastic cost differences Undifferentiated Bertrand ll Analysis with economies of scale Average cost or marginal cost How fixed costs affect price contrary to the Econ 101 slogan Recall freeentry equilibrium CP page 76 Capacity limits Concentration and Competition Cournot High concentration may signal that there s little competition Causes of high concentration in Cournot Few firms high concentration by definition Asymmetric MCs mostefficient firms face little competition so dominate market Undifferentiated Bertrand Fierce competition may causally increase concentration Stackelberg Model CP Stackelberg in quantity Firstmover advantage Commit to being aggressive rival backs off Why would a firm move first Contrast Stackelberg in price Extensiveform games Simultaneousmove games in extensive form CP Figure 69 Would it matter for the PD Differentiated products Examples most goods Differentiation makes a firm s residual demand curve less elastic Hard to lose all your sales even if your price is high Hard to attract all rival s customers even if your price is great Softens competition Various Oligopoly Models Static oneperiod pricesetting game Differentiated products Various approaches to differentiation Space metaphor Roughly CP chapter 7 Measures of differentiation How much consumers care about which product versus about price Inverse measure crosselasticity of demand Given rival s price this contributes to your residual demand elasticity Differentiatedproduct demand Demand quantity for good 1 decreases in price 1 increases in prices 2n Inverse demand price for good 1 decreases in all goods quantities but by more in good 1 s Difference in coefficients reflects differentiation CP equations 74 78 For next time Read CP chapter 7 to page 220 representative consumer model Hotelling Model Model of location given price pgtc Special case no differentiation Remember model of TV programming choice Changes if prices also variable Not so clear what happens then What ifthree firms rather than two Hotelling Model Prices given locations Locations at ends of line segment Could be away from ends see problem set Each consumer wantsjust one unit Could have own demand curve instead Firms set prices Nash equilibrium in pnces Ignoring price dynamics as discussed Solving Hotelling Model Can calculate each firm s bestresponse function eg p0p1 Solve the simultaneous linear equations What are we doing by doing that Result p ct Makes sense qualitatively Solving with Residual Demand Another way of solving the Hotelling price model Uses familiar concept of residual demand Calculated slope of residual demand It is 12t ln symmetric equilibrium each firm s quantity 12 Hence Lerner equation implies answer Group central purchasing Already discussed idea examples Let s see how it works in otherwise Hotelling model of differentiation pricing If everyone else joined would you Price if you join Price if you don t Transportation cost if you do if don t Monopolistic Competition Free entry but soft competition Monopolistic competition Too many brands of toothpaste How does residual demand elasticity vary with entry Entry increases competition most models Entry just shares demand this model Examples BresnahanReiss CP page 78 Entry against a monopoly or duopoly lowers price very noticeably Entry into oligopoly with 3 firms doesn t do nearly so much Workable competition with 3 firms ls subsequent entry wasteful What makes competition monopolistic Something about behavior Just don t rock the boat keep price where it was Or something about product differentiation Then entry may not be wasteful even if it doesn t affect price Some announcements Problem set 2 Due Correction Fair warning My office hours today next Tuesday Midterm next Thursday Reading CP chapter 8 to page 267 SCP studies CP describe many difficulties in profit regressions What econometrics says about this Publication biases


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