Competition and the Market Process

aje on January 20, 2020

Lecture handout: Competition and the market process*

Textbook Reading: Chapter 5 (pp. 135-164)

Half of all U.S. publicly traded companies have disappeared within ten years of entering the market (West, 2017, p.12)

The point of this session is to critically examine the economic theory of competition, by contrasting “competition as a market structure”, with “competition as a behavioural activity”. This turns the debate away from market concentration, towards the issue of contestability and sustained competitive advantage. We also see that competition is the driving force of the market process, and how this relates to regulation. Indeed a cynical view is that anti-trust is simply the strategic use of government powers by incumbent firms to restrict competition.

The lecture mentioned the tricky case of patents, which are one of three areas of intellectual property:

  • Patents protect inventions
  • Copyrights cover creative works
  • Trademarks cover brand names

A timely example of anti-trust is the tech industry. See this article by Russell Brandom explaining the case against Amazon, Apple, Facebook and Google. By contrast, Megan McArdle says ‘Yes, Google has a monopoly: who cares?‘ I recommend Ben Evans’ discussion of tech giants and definitions of market share, and this tl:dr primer on why mergers and acquisitions are so important for the tech industry by the International Centre for Law and Economics.

I highly recommend Benedict Evans’ newsletter (no relation), particularly these articles:

Prior to becoming Chair of the Federal Trade Commission, Lina Khan, wrote a 2017 article ‘Amazon’s Anti-Trust Paradox‘ that pointed out that the traditional concern of competition authorities – that monopolists would use their market power to raise prices – is inappropriate when considering modern technology platforms. However, her stringent views on regulatory issues seem to neglect the concept of creative destruction. There’s a long list of examples of companies that appeared to be in a dominant position, undermined by the perennial force of competition.

Here’s a great thread on the same issue: https://twitter.com/BrianCAlbrecht/status/1640744685701406721?s=20

In 2023 Lina Khan was interviewed by Planet Money, and I found it interesting how she pursued her biggest cases primarily on the grounds of potential outcomes, and then defended them by claiming that they signalled that the authorities were going to be increasingly litigious and active. This antagonistic attitude struck me as being quite far from the original role of competition authorities, which is to ensure an even playing field and to prioritise consumers.

Compare that to the defense industry, with this great graphic showing consolidation over from 1980-2001:I also thinks it’s important to recognise that the general public typically overestimate the profit margins of large companies (source).

Sometimes I think that I’m using a straw man argument to suggest that an arbitrary 25% market share is used by serious people to determine policy. And then I see Rana Foroohar write this in the Financial Times (May 8th 2023):

Bertrand competition shows how the act of competition can take place even with just two companies. In fact, the concept of competition doesn’t rely on the number of competitors at all. For example this advert reveals how Usain Bolt’s lack of “competition” doesn’t prevent him improving himself.

This is a good explanation of the side by side market/firm diagram, and the process by which perfectly competitive firms make zero profit in equilibrium.

Some good examples of daft occupational licensing are in this Twitter thread.

This is a nice example of the difference between complements and substitutes, and whether external economies of scale mean that more competition benefits the competitors:

Consider the following points:

    • What is the value?
    • Are targeted ads better for the consumer than uniform ones?
    • Is Facebook merely a platform? Or a media company?
    • Re network effects: Is it a natural monopoly?
    • How do you regulate zero price products? [Don’t monopoly on pricing power! Do it on barriers to entry.]
    • Barriers or costs?
    • Why do they want to be regulated? Why do you think the congressional hearings took place?
    • Who owns your metadata? Are they really your likes?
Learning Objectives: Contrast competition in a static sense, defined in terms of market concentration, with competition in a dynamic sense, defined in terms of contestability. Understand the difference between barriers and costs.

Market equilibrium

aje on January 20, 2020

Lecture handout: Market equilibrium*
Group activity:

Textbook Reading: Chapter 3 (Intro, Section 3.1, 3.2; pp. 65-83)

This video shows a behind the scenes look at “the ring”:

In March 2022 the price of Nickel jumped dramatically in early trading and the CEO of the LME decided to suspend trading and cancel previous orders. The hedge fund Elliott Associate had made almost half a billion pounds from the market turbulence and decided to sue. Read more about it here.

I use this as a follow up exercise:

Group activity: Copper at the LME, December 2022
Instructor resource: Copper at the LME Solutions, December 2022

And here is a useful activity:

Group activity: Comparative Statics Worksheet, December 2020
Instructor resource: Comparative Statics Worksheet Solutions, December 2020
Learning Objectives: Apply basic comparative statics to a range of economic events. Understand how interventions affect market activity

Focus on diversity: Legendary microeconomics instructor Walter Williams (1936-2020) wrote extensively on how government restrictions on mutually beneficial exchange can harm minority groups. He studied the impact of minimum wage legislation in apartheid South Africa and published a book called ‘The State Against Blacks‘ . Here is a video about his autobiography, ‘Up From the Projects‘. Here is video footage of a toast from 2003, which occurred when I was his student. Here is a fitting GMU economics department tribute to his career. And here is the gift he left people like me, to stop me doing things like this. 

Price discrimination

aje on January 14, 2020

Activity: Read the following Twitter thread (also available here).
Activity: Complete the India Worksheet, April 2019 or complete this India Quiz
Lecture handout: India DB*

Textbook Reading: Chapter 1 (Section 1.3; pp. 30-38) and Chapter 4 (Section 4.3; pp. 112-122)

The main concepts from this session – elasticity and price discrimination – lend themselves beautifully to practical implications. A nice application is an identification of the price, income, and cross price elasticities of various products. That said, I think it’s easy to misuse these concepts. Cross price elasticity is in part captured already in price elasticity (since a chief determinant of price elasticity is the availability of substitutes) and there can be an unfortunate tendency to use income elasticity labels inappropriately. I do not believe in any inherent distinction between “necessities” and “luxuries” – as Mary Douglas said, “there will always be luxuries, for rank must be marked” 1979 [1996] p.85). Income elasticities are better assigned to social groups, rather than the goods themselves.

Activity: Elasticity Assignment (30 points!)

In the lecture I talk about how Apple price in accordance with value creation. Perhaps the best alternative to this is Costco, whose business model is based generating as much consumer surplus as possible. They use economies of scale and small product variation to create massive efficiencies and then pass that on to members. The membership scheme is an effective way to cultivate loyalty, select for desirable customers, and generate useful data. As a long term business strategy, this may be more savvy than trying to convert consumer surplus into profit. For more on Costco I highly recommend:

Here’s a nice example of price discrimination:

The reason I think indirect price discrimination is such an under appreciated force for good in the world is because it often involves rich people subsidising poor. As this tweet recognises:

I use Mr Busy and Mr Savvy as examples rather than the female versions because I find the “Little Miss” designation to imply subservience. Also, there isn’t a direct equivalent for both. Although there is a Little Miss Busy (even though the picture is not as evocative of busyness as Mr Busy) there is no Little Miss Savvy. There is a Mrs Thrifty, which works well, but she only appears as a minor character (as the wife of Mr Thrifty).and doesn’t look very thrifty. There is an alternative, and obviously fake “Little Miss Thrifty” (pictured) but she doesn’t look thrifty either. Liking shopping is probably the opposite of thriftyness! That’s why I stick with the men.

The following is a great resource on price discrimination

How price discrimination relates to airlines, see:

In March 2024 Legoland announced that they would adopt a surge pricing model. They should have announced a model of “heavy discounts for off-peak times”, because that is the same thing, but surge pricing seems to be the (unpopular) term.

Also see this video on the concept of bundling:

And the concept of tying (from Alex Tabarrok):

Group activity: Wembley Stadium, July 2012
Learning Objectives: Understand different techniques for price differentiation. See the relationship between revenue and elasticity

Cutting edge theory: The case includes a discussion of PWYW pricing models

Focus on diversity: The case is set in India

Economies of scale

aje on January 12, 2020

Case: “Dogfight over Europe: Ryanair (A)” Harvard Business School case no. 9-700-115, November 21st 2007

Discussion question: What are some sources of economies of scale? How do they apply to British Airways in 1986?

Textbook Reading: Chapter 2 (Section 2.3; pp. 54-59)

During class I also recommend:

Case: “Dogfight over Europe: Ryanair (B)” Harvard Business School case no. 700116, June 12th 2000

A 2014 newspaper report likened the rise of budget supermarkets (such as Aldi and Lidl) to the strategy that saw Ryanair outcompete BA:

Finding ways to reduce costs is super important. As Jeff Bezos said, “cost reduction means inventing a better way, and when you invent a better way you make the whole world richer.”

If you are interested in aviation, this episode of Cockpit Casual starts with a fascinating account of how airline companies (and airports) reacted to covid given the large number of leased planes and the substitutability of passenger and cargo payloads.

The pioneer of no frills airlines were Southwest. See “Why are no-frills airlines so cheap?” The Economist, October 18th 2013. This article explains some of their key decisions. Which include:

  • Only flying 737s
  • Simple fare structure
  • Point-to-point (for less congested airports)
  • No assigned seating
  • No inflight meals
  • Only one fair class

(Note that this demonstrates a lack of price discrimination. Whereas Ryanair do lots of it.)

Learning Objectives: Understanding internal and external sources of economies of scale.

Spotlight on sustainability: Use of waste products

Cost curves

aje on January 12, 2020

Case:

  • La Marmotte, January 2012
    Instructions: Complete Exhibit A and provide suggestions for the two key decisions

  • Spreadsheet.xlsx
  • Note: parts of this case rely on finding derivatives. Here is a background note:
Lecture handout: Cost curves*

Textbook Reading: Chapter 2 (Intro, Section 2.1 and 2.2, pp. 39-54)

La Marmotte was published by Sage in 2019. La Marmotte is a fictitious restaurant but based on a real business in Montalbert. You can see whether the skiing is good right now with this webcam.

Here is a video explaining the concept of the planning horizon:

A key part of this session is grasping the power of this tweet by Sam Altman:

My favourite example of the importance of having an intuitive understanding of the shape of average costs curves is this one:

Learning Objectives: Sunk cost fallacy, short term shut down condition, profit maximisation, deriving a supply curve.

Cutting edge theory: La Marmotte was published in 2019!

Understanding cost

aje on January 12, 2020

Lecture handout: Understanding cost*

Textbook Reading: Chapter 2 (Intro and Section 2.4, pp. 39-34 and 59-63)

The aim of this session is to understand the economic concept of opportunity cost.

Group activity:

  • Malhotra, Deepak, 2005, “Hamilton Real Estate: BUYER”, Harvard Business School Case No. 9-905-052 (£)
  • Malhotra, Deepak, 2005, “Hamilton Real Estate: SELLER”, Harvard Business School Case No. 9-905-053 (£)

In Patrick McKenzie’s infamous blog post on salary negotiation, he says: “Every handbook on negotiation and every blog post will tell you not to give a number first.  This advice is almost always right. ”

I recommend the following Lex Fridman interview with FBI hostage negotiator Chris Voss. Voss talks about the three “voices” of negotiation, which are:

  • Assertive (loud and clear commands, direct and honest but recipients can feel attacked and not engage well)
  • Accommodative (smiling, optimistic, hopeful – relationship building)
  • Analyst (likes decision trees, systematic thinking, fact driven, and quite introspective. They recognise that accommodators often get better deals than assertives)

He also makes clear that lying is usually a bad idea, for the following reasons:

  1. If the other side are a better liar than you they’ll notice straight away
  2. It could be a trap to see if you’re willing to lie
  3. It’s likely that the other side will find out it was a lie, and then they will treat you much worse

I believe that the case discussion demonstrates our inherent reluctance to lie. However:

Here is a more recent example of obtaining copyright for the use of a photograph (see here for the background):


In the debrief it’s important to realise when someone is being evasive. A good example of this is in the U.S. version of The Office, where Andy has to repeat the same question to Angela 3 times before he gets to the truth. (Season 5, Episode 12, from 9:22 – 10:13).

A common way for companies to attempt to take costs seriously is to engage in cost-benefit analysis. This session helps managers to think broadly about what constitutes a cost, and find ways to measure them more accurately. But there is some criticism to the implication that everything can be reduced to a monetary value, and decisions should focus on profit above all else. But cost-benefit analysis is a tool. It is merely an input into decision making. As David Schmidtz has argued in Chapter 16 of ‘Living Together’ (2023):

Cost-benefit analysis is not a theory about what to do… Instead, it is a crude but serviceable tool of moral science, useful for (among other things) subjecting policies of administrative state to public scrutiny. (p.159)

I also like this part:

Critics of CBA think they capture the moral high ground when they say some things are beyond a price. They miss the point. Choosing to call elephants priceless does not settle what to do about them. We still need to know whether our ways of protecting them are effective ways of spending whatever dollars we have available to spend on protection. We may also need to know whether we are saving them as a cost of sacrificing something equally priceless. (p. 169)

Then, when talking about Sophie’s Choice:

Sophie’s CBA was not causing the catastrophe so much as acknowledging and coping with it. Reducing values to mere commodities can be shattering, but the world sometimes forces tradeoffs that in a better world we would have been lucky enough to avoid. (p.170)

Finally

If you must resort to a CBA, you are already in a situation where no one will get all they want, but if you can use CBA, you have a potential peacemaker: a way of deciding that is no inherently insulting. (p.175)

Recommended article:

Recommended cases:

  • Desai, M.A., and Ferri, 2006, “Understanding Economic Value Added”, Harvard Business School Case No. 9-206-016
  • Desai, M.A., Egawa, M., and Wang, Y., 2004, “Continuing the transformation of Asahi glass: Implementing EVA”, Harvard Business School Case No. 9-205-030

Here’s a good post on the downsides of using EBITDA as a measure of profitability:

https://twitter.com/SecretCFO/status/1565027764813561862

Activity: Applying EVA

The Economist reports that at the start of 2023 the e-commerce firm Shopify deleted 12,000 recurring meetings from their employees shared calendars, and asked managers to think seriously about whether they should be reinstated. The results:

“The company reports a rise in productivity as a result of the cull.”

Finally, don’t forget that we never see opportunity costs, and we can only properly recognise them in the context of a market system:

“Opportunity costs are subjective variables of choice that only emerge as a by-product of exchange” (Boettke et al 2024, p. 64)

Learning Objectives: Opportunity cost reasoning, basic principles of negotiation.

Focus on diversity: The Hamilton Real Estate case is used as the first session on the Harvard MBA course on negotiation. It was written by Deepak Malhotra who has a recent book called ‘Negotiating the Impossible‘. You can follow him on Twitter @Prof_Malhotra.

Max U

aje on January 12, 2020

Case:
Group activity: Complete the Max U quiz.

If you’re unsure about the basic rules of differentiation, see this handout:

If you’re unsure about using the Lagrangian method, here’s a video overview:

Another good example is here:

Learning Objectives: Analyse alternative indifference curves. Solve a Lagrangian maximisation

Focus on diversity: Joan’s utility function is named after the famous economist Joan Robinson

How to…

aje on January 7, 2020

I know some of these links are dead, but don’t worry: the internet remembers!

Incentives matter

aje on January 6, 2020

Lecture handout: Incentives matter*
Case: Incentive Design, January 2023 // or complete this form
Activity: Soviet Planning, June 2022 // or complete this form

Textbook Reading: Chapter 1 (Intro and Section 1.1; pp. 5-16)

Incentives are what economists define as the relationship between the benefits (the value we expect to gain) and the costs (the value we expect to give up) of a decision.

In this lecture we saw how conventional wisdom believes that seatbelts make you safer. But economic wisdom asks how they affect the benefits and costs of being in an accident. The lecture content on seatbelts comes from a great book called “Risk“, by UCL’s John Adams. Risk compensation is a well known concept in international relations – in September 2023 Jake Sullivan, national security advisor to Joe Biden, proposed adding all 5 members of the UN Security Council to the existing nuclear hotline system. As The Economist reported, however, the response was discouraging:

“If you wear a seatbelt in a car, you’re going to be incentivised to driver faster and more crazy, and then you’ll have a crash. So, in a way, better not to have the seat belt.”

An interesting argument against mandatory car seats for children is that by making it harder to fit three or more children into a car, it reduces fertility rates and this outweighs the safety benefits (i.e. we lose more children through a lower birth rate than are saved through better protection in an accident). According to this study, seat belts saved the lives of 57 children in 2017, but reduced the birth rate by 8,000! For more, see “On Car Seats as Contraception” (and if you do want 3 young children you can do what my sister did and buy a wide bodied Ford S Max. In europe, minivans never caught on, and in America, they’re dying out). 

Regarding bicycle helmets, here is the New York Times article claiming that “Bicycle Helmets Put You At Risk”. In terms of academic studies, there is some interesting evidence. Schmidt et al (2019) find that wearing helmets reduces the cognitive control of riders, and reduces risk sensitivity. Hoye et al (2020) found that the cyclists under their observation in Denmark who wore helmets did not demonstrate signs of riskier behaviour than those who didn’t, but acknowledged that this may be because their risk compensation is inhibited by the fact that people who wear helmets are more likely to be safety conscious than those who don’t. Indeed given that helmet wearers are systematically more likely to be risk averse, evidence of no difference in actual risk taking may be considered evidence for risk compensation! Finally, the issue is serious and I have no intention of contradicting the claim that if you happen to be in an accident, it is good to have been wearing a helmet. Indeed Olivier and Creighton (2017) looked at 40 studies to conclude that for people who are involved in an accident, helmet use reduced the likelihood of serious and fatal head injuries. I am grateful to an ESCP GMP student for sending me these studies.

In 2025 this woman chose the date of her caesarean section to be eligible for a government funded child care scheme.

Activity: Here is short quiz on the effect of taxation

Here is a video of a Cuban receiving his first paycheck after moving to America.

The lecture also looked at how coordination might take place without centralised control. This clip of San Francisco in 1906 demonstrates a spontaneous order:

And here’s a video on the concept of “shared space”, and what happens when traffic lights are removed:

This is a great photo essay about “continuous sidewalks” and here’s a video about their usage in the Netherlands:

Learning Objectives: Understand and apply the “Economic Way of Thinking”.

Spotlight on sustainability: A discussion of cycling safety

My websites

aje on January 6, 2020

Blogs I edit(ed)

“Strategies emerge for coping. There are many, but in essence they all boil down to two: filter and search”  Gleick, 2011, p.409

The Filter^ was created in a Birkenhead chippy, in January 2004. Stephen Lai and Anthony Evans were both recent graduates from the University of Liverpool, and wanted to present interesting and accessible academic ideas to a wider audience.

Created in July 2004, The Filter^ REVIEW is an online assembly of cultural essays. Encompassing opera, music, theatre, and architecture our range of reviewers provide honest and independent assessments of live events. Our motivation is enthusiasm, and providing our part of the social contract between audience and stage. My theatre reviews are available here.