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 amine.ouazad@insead.edu 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 Afonso.ALMEIDACOSTA@insead.edu Weekend or review sessions for students with little or no economics background. Appointments welcome. Assistant: Carole Guillard carole.guillard@insead.edu 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