Course overview

1
Prices and Markets This Session

• Course overview
• A market simulation.
• Demand and Supply curves
• Market equilibrium and Welfare

Next Session
Consumer Choice and Demand (Read the first
part of the case and download data from website)
2
Why Do Economics?
Economic forces run the world we live in (whether
we like it or not!)

• Economics does NOT offer
• Simple recipes for dealing with every
  conceivable problem
• Give you the data you need to deal with
  managerial problems
• Give you definitive answers
• What Economics does offer
• Frameworks/Models of enduring value, that can
  help you think through
• a broad range of managerial/competitive
  issues.
• e.g., pricing, regulations, consulting

3
What Is This Course About?

• Provide you with core concepts and tools of
  microeconomics
• Central Unifying Theme
• What price should a firm charge for its product?
• Price you can/should charge depends on
• demand and costs
• market structure
• competitors reactions
• availability of information
• Additional Themes
• Think like an economist create general
  frameworks that explain/predict
• Improve analytical abilities modeling and
  problem solving

4
Understanding Cost (session 3)
Revenue Understanding Demand (session 2)
Profit Revenue Cost
Pricing
Monopoly Trade off b/w high P and low Q
(session 6)
Perfect Competition Supply and entry decisions
(session 4 5)
What if we can price discriminate? (i.e.,
different consumers pay different
prices) (session 9 10)
How pricing depends on demand through the
elasticities (session 7)
Strategic Competition Solving for the NE
price and quantity competition (session 12)
How timing matters Stackelberg (session 14)
Exotic topics Strategic Demand Network
externalities and Auctions. (session 15)
Tools Games Theory (session 11)
Externalities and Strategic interaction
Collusion (session 13)
5
Road Map for Prices and Markets Tools

• Demand and Supply Analysis
• Prices in a simple market
• Consumer surplus, producer surplus and welfare
• Demand and Revenue
• Revenue comes from the demand side
• Prices, Income, Advertising
• Elasticity of demand
• Costs
• Different kinds of costs and cost curves
• Costs to ignore and costs to include

TOOLS
6
Road Map for Prices and Markets Pricing under
Different Market Structures

• Competitive Markets
• Pricing under competition (commodity markets)
• Strategies to survive in a competitive market
• Short run and long run decisions
• Monopoly Pricing
• Pricing by a monopolist (e.g., Microsoft)
• Some pricing fallacies
• Not all gains from trade realized or extracted
• Price Discrimination
• Explicit market segmentation
• Implicit market segmentation

7
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
• Predictions ? Nash equilibrium
• Tension between Individual Rationality and Group
  Rationality
• Oligopoly
• Price games and Capacity games
• Implicit Collusion with Repeated Games
• Sequential, Leader-Follower games and First
  Mover Advantage

8
Road Map for Prices and Markets Pricing and
More Under Incomplete Information

• Exotic Goods Network Externalities
• Natural Monopoly from demand side
• Pricing strategies
• Exotic Goods Auctions
• Pricing strategies are much complex under
  information constraints

9
We Will Answer These Questions
10
(No Transcript)
11
Course Materials

• Things you have to buy Nothing!
• Things you may consider buying Pindyck Rubinfeld
  (if bored)
  
• Mankiw (if lost)
• Website http//faculty.insead.edu/strauss-kahn/p
  m
• Course Guide (handed out and posted on web)
• Articles/Cases in course pack
• Slides (before each class and posted on web)
• Solutions to Course Guide Exercices (posted on
  web)
• Extra Problem Sets and Solutions (posted on web)

12
Grades

• Final 90
• - closed book one A4 sheet allowed
• Mid-term 10
• - multiple choice
• Class Participation
• - not graded

13
Help!

• Strauss-Kahn Vanessa (instructor)
• Office EW 2.09
• Email Vanessa.Strauss-Kahn_at_insead.edu
• Phone [phone]
• Office Hours By appointment
• Carole Guillard (secretary)
• Office EW 2.14
• Email Carole.Guillard_at_insead.edu
• Phone [phone]
• See her for handouts and miscellaneous
• Francisco Ruiz-Aliseda (tutor)
• Review session for students with little or no
  economics background Saturday morning

14
Miscellaneous

• Be on time.
• Turn off mobile phones and pagers
• Be considerate to others with different
  backgrounds
• 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.
• Read before class.
• Market games between sections (start on week 4)

Negative Externalities
15
The Pit Market

• Your card is private information
• Do not show your card or discuss your card with
  anyone else, before, during, or after trading
• Your aim is to maximize your earnings
• 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
• After you have completed a trade, return to your
  seat

16
Trading Prices Round 1
17
Trading Prices Round 2
18
Trading Prices Round 3
19
Pit Market A Tax on Sellers

• The government has decided to impose a tax of 2,
  to be paid by sellers
• The tax is thus equivalent to a cost increase of
  2 for every seller
• Sellers enter a cost equal to the number on their
  card plus 2, when calculating earnings
• The negotiated price must be at least 2 greater
  than the number on the sellers card

20
Trading Prices with Tax Round 1
21
Trading Prices with Tax Round 2
22
What is this Price where the market is moving to?
Buyers valuation Cutoff point is V below which
she wants to trade.
V
Purchase price
0
Prefer to buy
Prefer not to buy
Sellers cost Cutoff point is C above which he
wants to trade.
C
0
Purchase price
Prefer to sell
Prefer not to sell
Gains from Trade Buyer V P Seller P C
Total V C
23
What is this Price where the market is moving to?
6 buyers whose valuations are 700, 700, 600,
400, 400, 300 7 sellers whose costs are 100,
100, 200, 300, 450, 600, 700 Find the market
demand and supply curves. Find the market
equilibrium as well.
24
(No Transcript)
25
Consumer Surplus
P
Qd 3
26
Some Quick Definitions
Total Valuation v (Q) for first Q buyers ? Area
under the valuation graph up to Q Marginal
Valuation of the Qth unit (Demand) ?
The demand curve is the inverse of the marginal
valuation curve
Consumer Surplus Area under demand curve and
above price line v (Q) PQ
27
(No Transcript)
28
Producer Surplus
P
Qs 3
29
More Quick Definitions
Total Cost c (Q) for first Q sellers ? Area
under the graph up to Q Marginal Cost of the
Qth unit (Supply) ?
The supply curve is the inverse of the marginal
cost curve
Producer Surplus Area above supply curve and
below price line PQ c (Q)
30
Lesson so far

• The demand curve slopes down.
• The supply curve slopes up.
• The area under the demand and above price is
  consumer surplus.
• The area above the supply and below price is
  producer surplus.

31
Consumer surplus
Producer surplus
32
(No Transcript)
33
Back to the Pit Market

• Sellers costs
• 1 1 1 1 1 2 2 2 2 2 2 2 2 3 3 3 3 3 3 3 4 4 4 4
  5 5 5 6 6 6 7 7 7 7 8 8 9 10
• Buyers values
• 10 10 10 10 9 9 9 9 8 8 8 8 7 7 7 7 7 7 6 6 6
  5 5 5 5 5 5 4 4 4 4 3 3 3 3 2 2 1

34
Price Where Supply equals Demand
Price
Quantity
35
Pit Market Supply and Demand

• The supply and demand curves show that
• The equilibrium price is 5
• The equilibrium quantity is 25 27
• Why?
• At a price of 5.5 or higher, there are many
  people trying to sell, and few trying to buy
• At a price of 4.5 or lower, there are few trying
  to sell and many trying to buy
• At a price of 5, the number of willing buyers and
  sellers is equal

36
Surplus with Many Consumers
Price
CS
S
P
PS
D
Q
Quantity
37
Welfare

• Are prices and markets a good way to organize
  economic activity?
• The market price maximizes total surplus.
• We say that markets are an efficient way to
  organize economic activity.

38
Lesson so far

• There exists a magic price at which S D.
• This price in which S D is an equilibrium.
• The forces of supply and demand drive you to the
  equilibrium price.
• The equilibrium maximizes total surplus.

39
A numerical example(to be filled in during class)

• Demand Q 120 - 2P
• Supply Q P
• Equilibrium Price
• Equilibrium Quantity
• Consumer Surplus
• Producer surplus

40
Predicted Effect of the Sales Tax Pit Market
Price
Quantity
41
The Sales Tax

• The sales tax can be viewed as a shift of the
  supply curve
• It results in an increase in the price and a
  decrease in the quantity traded
• Although the tax went up by 2 euros, the
  equilibrium price went up by 1 euro

42
Consumer and Producer Surplus with SalesTax
Deadweight loss
Price
S
CS
S
P
Tax
PS
D
Q
Quantity
43
Main Lessons from Tax Exercise

• A per-unit tax on sellers shifts up the supply
  curve by the amount of the tax
• A per-unit tax on Buyers shifts down the demand
  curve by the amount of
• the tax
• A per-unit sales tax leads to unrealized gains
  from trade. Total welfare
• is reduced deadweight loss.
• For thought Does this mean there should be no
  taxes??

44
Wrap Up on Demand, Supply

• Demand curve is inverse of marginal valuation
  curve
• Supply curve is inverse of marginal cost curve
• Equilibrium is where demand supply.
• Both buyers and sellers gain from trade.
• Buyers gains from trade consumer surplus.
• area below demand curve and above price
  line
• Sellers gains from trade producer surplus.
• area above supply curve and below price line
• The equilibrium maximizes total surplus Markets
  are efficient
• Sales Taxes are distortionary and impose
  deadweight loss