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Class 01

Econ 243 Class 01 of 11 Sept 2015

Notes: I often add details that fill in what we discussed during class.

• syllabus stuff: it’s all online. to emphasize case studies, I am eliminating textbook material that I’ve used in the past that is ancillary to our particular cases

even if it’s neat economics, but with an exception or two where it’s useful for understanding other industries important today (e.g., network economies)

– aside: I’ll slip back and forth between calling our subject the “economics of business strategy” and “industrial organization.” 

aside: as noted in class today, strategic considerations are omnipresent. parts of the theory side were developed by mathematicians (not economists, not quite political scientists) trying to think through the cold war nuclear standoff between the US and the USSR: how deter war? the “IO” term derives from the origins of the field in the Sherman Antitrust Act of 1890, when counting the number of firms and arguing about whether there was or was not a monopoly was paramount.

• Miller Lite 1975 → Bud Light only in 1982

– questions: why so slow? 

Anheuser-Busch had the best lab in the industry world-wide, they sure knew about the technology, as it was patented in 1969 (and the prior to that would have been “patent pending”). it wasn’t yet proven to have any commercial, and Rheingold then actively marketed their production process. it wasn’t ignorance, it was deliberate.

aside: non-alcoholic beers were made from the 1920s – lite’s challenge: reduce calories, taste like beer, and yet have enough alcohol to generate a buzz?

first mover disadvantage? let them “create the market” and then free ride on their marketing. in other words, there’s a positive externality to the amount of advertising of “lite” that you can benefit from.

uncertainty: A-B could have thought the product would fail.

rational delay: A-B was a dominant firm; fighting fringe competitors would require lots of resources (lowering price on all your beer) while ignoring them would hurt only a little (losing a teeny bit of market share). an image: a big animal like A-B attracts lots of flies. it would starve to death if it tried to swat them all. 

– what type of beer would A-B launch?

too obvious to belabor. but it is not quite so obvious if my lead-in to the topic was that of Hotelling (1929) of ice cream vendors choosing a location on a beach.

– what happens if a 3rd firm enters?

there’s no stable equilibrium

aside: what happens if there are 4 firms? what happens if firms enter sequentially and are locked into place? play with these sorts of assumptions – these two do generate a clear strategy.

this is typical of many of the models we will use. a slight change in assumptions changes the optimal strategy. there are a lot of these models. see the text by Jean Tirole, the most recent Nobel Prize winner. it’s already laden with variations of basic models, and since then there’s been 30 years of PhD students trying to find one more model.

– application: Mock Con and the primaries. 

In politics Hotelling transmutes into the Median Voter Theorem. The median voter in primaries is far from the center. My sense is that in practice this is truer for Republicans than Democrats: voters who might otherwise constitute the extreme on the Democratic end have left for the Green, Socialist and Communist Parties. In contrast, there’s no “3rd party” on the right. Hence the median voter in Democratic primaries is closer to the center of the political spectrum than the median voter in Republican primaries. My sense is that the (successful) Democratic presidential candidates were in fact able to move right of center and capture voters who in days of yore might have counted themselves as Republicans (such as myself). By the end of Mock Con you likelywill know much more about this than I will!!

– assumptions

indeed, having only one dimension is a vast simplification! so we need to work with two axes, a box and circles around (x,y) product choices … but I had a speaker years ago who shared a presentation he’d just made to his board of directors that was exactly that.

we also left out price! lots of models there, complicated and I don’t recall any clear bottom lines from the ones I’ve looked at, though some do have a solution.

flexible preferences. I rephrased as ice cream vendors on a beach. if in fact people aren’t willing to walk very far, then the effect is to cause sellers to move away from each other. our jargon: product differentiation

we see that in beer: microbrewers have lots of dissimilar products. SABMiller Coors and InBev Anheuser Busch [not their formal corporate names] behave differently. why?

the pricing issue leads to our first group of models, a downward sloping demand curve. in basic micro (Econ 101 / Econ 210) you spend most of your time thinking about producers who take price as a given.

I claim that is not the world in which beer firms operate: they can choose a higher price at some loss in market share. once we understand how to model that we can look how two firms interact strategically in the price-quantity area. we’ll return to product differentiation later in the term.