Transcript Slides for Session 1

Prices and Markets
Session 1:
“Demand, Supply, and Markets”
Prof. Amine Ouazad
This Session:
Demand, Supply, and Markets
1. Intro & 4 Golden Rules of Economics
2. Working together:
Timeline, Admin, and Grading
3. Trading on an open outcry pit market
Wednesday: Consumer Demand Analysis
Read case instructions, and download data from website
See syllabus for details on deliverables
Why do economics?
Economic forces run the world we live in (whether we like it or not!)
What economics does NOT offer
Simple one-line recipes: e.g. taxes are undesirable, free trade is always good,
minimum wage hurts employment etc.
One-handed solutions.
Economics does not offer simple recipes to run a business.
What economics offers
Simple and enduring models/ways of thinking that will help you understand
apparently complex issues: pricing of products, forecasts of capacity,
segmentation of your markets, effect of taxes on prices, possibility of collusion,
danger of price wars.
Four Golden Rules of Economics
1. People respond to incentives
2. Think in terms of marginal or incremental returns.
Personal decisions
Undertaking an MBA: Wage increase, Payback period, Tuition cost,
Difference in cost of living, Opportunity cost.
Business Decisions
Marginal benefit MB
Change in revenue as capacity increases
Marginal cost MC
Change in cost as capacity increases
Increase activity if MB > MC, Lower activity if MB < MC
MB = MC: Optimal
3. “Economists do it with models”
Pick up a problem and analyze manageable pieces.
Four Golden Rules of Economics (cted)
3. “Economists do it with models”
Pick up a problem and analyze manageable pieces.
Think about: The benefits of free trade
• Two activities: mowing the lawn and playing basketball
Countries specialize in the production of the good in which they have a
comparative advantage.
4. Think strategically.
Golden Rule 4: Think strategically … in football
 Tournament: 1994 Shell Caribbean Cup
 Players: Barbados vs. Grenada
 Rules: 1. Barbados need to win the match by two goals to advance
2. One (golden) goal in extra time counts as 2 goals
 70th minute: Barbados leads 2-0
 83rd minute: Barbados leads 2-1
 87th minute: Game tied 2-2
Golden Rule 4: Think strategically
Interactions between markets
Epson & HP 1989
Epson producing cheap inkjet printer
HP producing high-priced laser printers
Epson introduces cheap laser printer…
Inkjet printer anyone?
Put yourself in your competitor’s shoes
1993: Unilever largest seller of shampoo in Chile (Sedal brand)
1993: Procter and Gamble introduces Pantene brand
and capture market share equal to Sedal’s.
P&G cuts prices to capture Sedal’s market shares. Outcome??
What is this course about?
Provide you with the tools and concepts of microeconomics.
Central Unifying Theme:
What should a firm charge for its product?
Price you charge will depend on:
• Demand and cost.
• Market structure.
• Competitors’ reactions.
• Availability of information.
Additional Themes:
Think like an economist: use or develop models that can explain or predict.
Hone analytical abilities: modeling and problem solving.
Road Map for Prices and Markets:
Pricing under Different Market Structures
Monopoly Pricing
• Pricing by a monopolist (e.g., Microsoft)
• Some pricing fallacies
• Not all gains from trade realized or extracted
Price Discrimination
• More exotic pricing strategies
• Explicit market segmentation
• Implicit market segmentation
Competitive Markets
• Pricing under competition (commodity markets)
• Short run and long run decisions
• Strategies to survive in a competitive market
Road Map for Prices and Markets:
Pricing under Different Market Structures
Real world somewhere between the polar cases of monopoly and perfect
competition. Unfortunately, this is a much harder problem to solve and
requires the techniques of GAME THEORY
More Tools: Game Theory
• Importance of Strategic Thinking
• Simultaneous and Sequential Games
• Predictions → Nash equilibrium and backward induction
• Tension between Individual Rationality and Group Rationality
Oligopoly
• Price games and Capacity games
• Leader-Follower games and First Mover Advantage
• Implicit Collusion with Repeated Games
• Entry Deterrence through Reputation
• Strategic Irrationality
Auctions
• English auctions and eBay.
We Will Answer These Questions
Topic
Demand and Supply
Analysis
Know Your Market
Costs
Pricing Strategies
Questions
What is a reasonable price for a product?
How to anticipate price changes?
How do prices change after taxes?
How to estimate demand functions?
How do changes in prices of other products
affect market for your product?
Which costs are important in pricing decisions?
Which are not?
Can Microsoft charge any price for Windows?
How does price depend on market structure?
Advanced Pricing
Strategies
R&D Strategies
Game Theory
Network Externalities
Scale Economies
Why are business and leisure airline tickets priced
differently?
Why is popcorn more expensive in movie
theatres?
Why sell season tickets to sports games?
Should a pharmaceutical company invest in a new
drug?
Why is patent protection important?
How to behave in strategic situations?
Why do price wars occur?
Why do cartels get formed?
Why can it be rational to over invest in capacity
and not use it?
When is appearing irrational actually rational?
Why is eBay hard to replicate?
Why is there a single local phone company?
This Session:
Demand, Supply, and Markets
1. Intro & 4 Golden Rules of Economics
2. Working together:
Timeline, Admin, and Grading
3. Trading on an open outcry pit market
Wednesday: Consumer Demand Analysis
(Read case instructions, and download data from website)
See syllabus for details on deliverables
The Course: Prep, Timeline, and Admin.
• What should I buy?
Nothing !
• What you could buy:
Pindyck and Rubinfeld (if bored)
Mankiw (if lost)
• What should I read:
Syllabus with Class Prep
Course Guide
Reading the Course Guide
• How to prepare for a class:
Class preparation in the syllabus
• Videos, simulation, cases:
www.ouazad.com/Courses/MBA/
(login: pm password: insead2013)
• Interactions outside class:
LinkedIn group
INSEAD Prices and Markets 14J Group
join today!
• Tutorials:
Every Friday and Saturday,
alternating schedule.
1st one: Saturday at 1.30pm.
• Speed of the course:
Targeting the median.
• Practice exercises:
Exercises from the course guide
The Course: Prep, Timeline, and Admin.
Market power games
• Schedule:
Starts for sessions 12-15,
Strategic thinking.
• Skills:
Collusion, Coordination, Pricing.
• Who’s playing:
Whole INSEAD Fonty+Singapore
• Prizes:
Champagne, champagne.
• Instruction sheet:
On the course website
http://www.ouazad.com/MBA/
• Teams:
Your group.
• Debrief:
Wrap-Up in Session 16.
Grades
 Quiz 1
10%
September 20, 0900-1000
 Quiz 2
10%
October 2, 0900-1000
 Final
70%
October 21, 1430-1730
All exams are closed book; one A4 sheet (both sides) allowed
for quiz; 2 A4 sheets for Final
 Participation in Simulation Games held outside class
10%
 Class Participation
- not graded
Help !
Amine Ouazad
[email protected]
Office in East Wing EW2.21
Office number: 01 60 72 48 49.
Mobile number: auctioned in session 12.
Appointments welcome..
Tutor: Afonso Almeida Costa
[email protected]
Weekend or review sessions for students with little or no economics background.
Appointments welcome.
Assistant: Carole Guillard
[email protected]
Office in East Wing EW2.01
For handouts, admin, and appointments.
The Course: Prep, Timeline, and Admin.
• Be on time.
Negative Externalities
• Turn off mobile phones
• You may use computers but only to take notes – no surfing/emailing
• Questions may be postponed/not answered if:
• It is more relevant for later sessions
• It is outside the scope of the course
• It interrupts the flow of the class
• Clarifications are encouraged.
• Yawn… = “Ask me a question”
This Session:
Demand, Supply, and Markets
1. Intro & 4 Golden Rules of Economics
2. Working together:
Timeline, Admin, and Grading
3. Trading on an open outcry pit market
Wednesday: Consumer Demand Analysis
(Read case instructions, and download data from website)
See syllabus for details on deliverables
So we begin: Valuation and Cost
Buyer’s valuation V
Seller’s cost C
Cutoff price below which she wants to trade.
Cutoff price above which he wants to trade.
Total gains from trade
V-C
0
C
P
Seller’s gains
P-C
V
Buyer’s gains
V-P
Bargaining on a Pit Market
- Bargaining Power
• With equal bargaining power?
Likely that gains are split 50: 50
• One person makes take-it-or-leave-it offer?
Seller: Offers P = V and all gains accrue to seller
Buyer: Offers P = C and all gains accrue to buyer
Trading on a Pit Market
Buyers receive a blue card with a number: valuation V.
Sellers receive a yellow card with a number: cost C.
Each trader can execute at most one trade; 9 = 9; 6 = 6
Your card is private information
Do not show your card or discuss your card with anyone else,
before, during, or after trading
Aim: Maximize your earnings (V – P for buyers; P – C for sellers)
Prices must be in 50 cent ($0.5) increments
You have limited time to make a deal
If you do not make a deal, your earnings are zero
Completed a trade: Tell assistant trading price; return cards & return
to your seat
No trade at end of round: Return card & return to seat