Riassunti BIE Business And Industrial Economics

2 REVIEW: BASIC of MICROECONOMIES

Market: physical or virtual place where the demand meets the supplier, there is an exchange or transaction

that can happen in two different ways PRICE and AGREEMENT

Supplier: Offer a good (Storable) or a service (Not Storable) produce it is simultaneous with the

consumption.

Demand: Subjects that need a good or service and are willing to buy it

DEMAND FUNCTION: Q=Q(p) VS INVERSE DEMAND FUNCTION: p=Q(p)

For any p it returns the quantity Q demanded by Price as a function of Quantity (Demand) of the

-β

the whole market, so by all the customer whole market. Ex: p = a-b∙Q or p = a∙Q

WILLINGNESS TO PAY: Max price the number Q individual from the whole market will pay.

There are Q customer that want to pay P and price down it.

1 1

%

= | ⋅ | =

PRICE ELASTICITY: %

≤ ≤

Can be RIGID when if I change the price a lot, the Q (Demand) of the market

doesn’t change. It happens for not substitutive products like water or gasoline.

≥

Can be ELASTIC when if the price change, the quantity changes a lot. Happen for product with a lot.

Happen for product with a lot of substitutive like food or luxuries product (ex during the sale).

The demand can be moved (+/-) with: Income Increase (+); changes in culture, taxes (+/-); increase of price

of complementary (-); increase of price of substitutive (+).

COST: TOTAL COST: TC=TC(q) In order to produce a quantity q (one firm) should pay TC(q) that includes

. labor, material, plant, debts, interest and so on but even a minimum fair

. profit for stakeholders.

TC = F + VC(q) Fixed + Variable Cost(q) the variable change in the Short/Long run:

. Short-> Labor, Material, Salary…. Long-> everything instead the Patents

()

() =

MARGINAL COST: Additional cost that the firm have to sustain when they produce

additional unit of output. Goes up when we reach the saturation

()

() =

AVERAGE COST: High at the beginning because we are not spreading the cost, then

goes down (thanks to economies of scale) then up (close to saturation). Remember TC includes even

a minimum fair profit for the stakeholders.

ECONOMIES of SCALE (scale economies): happen when THAT company reach a certain level of spread

the total cost and production became efficient. After the minimum point of the AC called Minimum

Efficient Size or Scale (MES) we will start DISECONOMIES of scale because we are becoming closer to

saturation.

PERFECT COMPETITION: firms are price taker and cannot influence the market with their decision.

Hp SHORT RUN: 1) Homogeneous product Hp LONG RUN 4) No entry barriers

2) Full information (both part) 5) No exit barriers

3) Large number of small 6) Access to knowledge, possible

. firms, no one big firm. . imitation

PERFECT COMPETITION: SHORT RUN

Price taker firm, find profitable only if MC are ≤ than the price of the market and not 1 unit more so -1

p=MC(q) so since p is given by the market, they understand the q from the reciprocal of MC so q=MC (p)

S

It’s not sure that the company break even. The whole industry supply is Q = ∑ q and the equilibrium is the

i -

merging with the demand curve finding p*, Q*. So we have that each firm will decide his quantity q=MC

1

(p*) and this could be profitable or not: π * = (p* - AC(q )) ∙ q * so there are L-type (L type) firm that are low

i i i

cost firm, so with π>0 and H-type (h type) firm that are high cost firm and don’t find it profitable.

PERFECT COMPETITION: LONG RUN

In the long run there will be players that will exit from the market, new entrant and players that will imitate

the profitable ones. So we will have only efficient firm inside the market with:

LR MIN

p = AC LR D LR iLR i-1 LR LR LR iLR iLR

Q = Q (p ) q =MC (p ) N =Q /q 1 π =0

MONOPOLY: A market dominated by 1 firm which is a perfect price maker, sets the price that is most

profitable to it that exploit market power. Could be caused by Control of natural resources (hotel close to

sea, concessions); Innovation (industrial secrets, patents); Natural Monopoly (wireline, water distribution);

Abuse of dominant position (Predatory pricing). Since q=Q (because it is the only producer), the monopolist

objective is the profit maximization: π = R – TC = p(Q)∙Q – TC(Q) we can maximize in 3 ways:

1) If we have the function Rev – Tot Cost = R – TC we can see where is its minimum.

= =

2) We can put Marginal Profit to 0 (maximum of the derivative of profit)

MON MON

3) MR(Q ) = MC(Q ) with MR=∂TR(Q)/∂Q −()

=

MARK UP represent how much the price deviate from the marginal cost

Consumer Surplus: area under the demand function and over the price

Producer Surplus: vπ(Q) = R(Q) – VC(Q) (VC=variable cost)

SOCIAL WELFARE W= CS + vπ measures the overall industry efficiency,

summing net benefits of Consumer Surplus and Producer Surplus

Any price different from the perfect competition price, p*, causes a social welfare loss called allocative

inefficiency that is measured by DWL, Dead Weight Loss (also EL, Efficiency Loss; see the green triangle).

Monopoly create allocative inefficiency even because producer’s surplus increases less than consumer’s

surplus decreases, instead Perfect Competition Is the benchmark for the maximum social welfare.

3 REVIEW: GAME THEORY

Game theory is a method of building models for interdependent decision. The payoff (performance) of the

players depends from the other’s decision and the choices are done with strategy making. There are

i=1,2,3..n players and the action that they took could be discrete or continuous. The payoff function

1 1 1 2 2 2 1 2

depends from others player: π = π (α ;α ); π = π (α ;α )… We focus on non-cooperative games so players

do not cooperate. Normal Games: players choose actions simultaneously.

EQUILIBRIUM in DOMINANT ACTION: A given action of player 1, is a dominant action if it maximizes 1’s

payoff whatever the action taken by 2 and vice versa. An equilibrium in dominant actions (EDA) is an

outcome of the game where all players play their dominant action. EDA is more stringent than Nash Eq.

NASH EQUILIBIUM: If each player has chosen a strategy and no player can increase its own expected payoff

by changing its strategy while the other players keep theirs unchanged, then the current set of strategy

choices constitutes a Nash Equilibrium. We are in a NE if there aren’t players that find beneficial to deviate

unilaterally from the NE outcome. For ex in the prisoner dilemma, one prefers to confess because is more

profitable for each decision of the other. The other will think the same so both will confess and this is a

Nash Eq.

EFFICIENCY A LA PARETO: An outcome is efficient a la Pareto or Pareto Optimal if there isn't the possibility

to make one of the players improve without deteriorating the other players (make the other players

worse). That means that there isn’t the possibility to improve everyone condition without make worst at

least one. Given an initial situation, a Pareto improvement is a new situation which is weakly preferred by

all agents and strictly preferred by at least one agent. In a sense, it is unanimously-agreed improvement: if

we move to the new situation, some agents will gain, and no agents will lose. A situation is called Pareto

dominated if it has a Pareto improvement. A situation is called Pareto optimal or Pareto efficient if it is not

Pareto dominated.

SEQUENTIAL GAME: agents choose actions in different periods.

Game tree: players’ decisions at different times (actions) and final payoffs. Decision nodes: Name of the

player who is entitled to make decisions in that period & actions available to the player in the node; Payoffs

defined for each player in the final node; Subgame: Any (non final) decision node along with all the nodes

following it.

SUBGAME PERFECT EQUILIBRIUM (SPE): We should use the backward induction so start from the last

decision and ask which one is the best one in that node, then I go up and I ask the same question and so on,

finding in this way the best sequence that is the SPE. It is possible that a firm in order to not have new

entrants will commit itself to do something that is not profitable: they sign a commitment (IRREVERSIBLE

action) that must be: credible, costly, irreversible, visible (act as a signal) in this way new entrants know

that since there is this commitment the firm will fight hard to not share the market.

Ex: 2 firm: I (Incumbent), E (new Entrance). I have to decide if start a price war or not or sign a commitment

4 SUSTAINABILITY and SDGs

SUSTAINABILITY: Ability to meets the needs of the present without compromising the ability of future

generation to meets their needs. The process to achieve sustainability is called sustainable development

and include economic growth, environment protection and people.

SDGs: In the world there are Grand Challenges that are a family of initiatives fostering innovation to solve

key global health and development problems. Governments are dealing with grand challenges trying to

reach the 17 Sustainable Development Goals (SDGs) like No Poverty, Zero Hunger, Climate Action and so

on. The consumers have an important role on that but business enterprise have a fundamental role on that.

There is a Triple Bottom Line TBL approach, the firm care about: A) Profit and People, B) Profit and Plant; C)

All together and should follow this last option. SDGs are important for business enterprise because they act

as a checklist of the expectation that government and society have, so SDGs have a value even for the firm.

SYNERGIES: There are synergies between one SDG and other SDGs but even trade off (negative synergies)

that we must considered because for example we cannot have an incredible increase in production for

everyone and don’t have waste.

SUSTAINABLE INNOVATION: In order to remedy to trade off, it’s possible to have: Governments action (next

lecture) or Sustainable Innovation developed by business enterprise. Sustainable innovation are:

Technological, organizational, design, and/or institutional innovation introduced by business enterprises

and other players into markets or organizations to foster sustainable development and fix its trade-offs, an

ex is reuse the waste. 5 OLIGOPOLISTIC MARKETS

Between Monopoly and Perfect competition there is the Oligopolistic Markets so a situation in which there

are more firms who compete and their actions are influenced by the behavior of others companies.

DUOPOLY: To model the Oligopolistic Markets we will use the duopoly, so a market where there are 2 firm.

Models can be Collusive (illegals, like cartels) or Competitive. There are 2 Competitive models.

→

1) Simultaneous Model (Cournot, Bertrand) Quantities as a key variable and

→

2) Sequential Model (Stackelberg) with Prices as a key variable.

ASSUMPTIONS: Duopoly relies on some assumptions: Homogeneous products (same product, customer

care just at price and quantity); firms have perfect information and act rationally (maximize profit); barriers

= – ∙

= ∙

to entry/exit; linear cost and inverse demand functions: and

à la COURNOT: Simultaneous decision, Competition choosing quantity (choose the production capacity)

This model is based on finding a Nash equilibrium: since each firm will try to maximize the profit,

both will create a reaction function (or best-response function) that represents the optimal

(=profit maximizing) quantity choice for the firm for any possible quantity produced by the other

firm: At the right there are the result, down there is how to do it:

()⋅

1

= =

1) Calcolo il marginal Revenue

1 1

=

2) Calcolo il marginal cost

1

3) impongo MR = MC e ricavo q = f(q )

1 2

Questa e` la Reaction function 1 o Best Response function.

4) Ripeto lo stesso per q 2

5) dopo che ce le ho entrambe le pongo a sistema per trovare il punto di incontro che e` l

equilibrio (stiamo cercando l'equilibrio di Nash cioe` il punto in cui entrambi non si vogliono

spostare. Infatti data la quantita` q , per massimizzare il profitto la firm 1 vorra` produrre alla

2

quantita q . Lo stesso vale per la firm 2 quindi, risolvendo il sistema trovo i due valori di q

1

6) Calcolo Q = q + q e sostituisco Q in P(Q) e in π =p *q -TC

1 2 1 1 1 1

STACKELBERG: Sequential decision, Competition choosing quantity

In this model there are the leader (first decision) and the follower (second decision). We have to

use Backward Induction the leader know that the follower will use the Cournot reaction function

R2(q ) so the leader will maximize his profit knowing the quantity that the follower will produce.

1

By maximizing his profit, the leader will find his quantity q and the follower will Cournot react.

1

))

= ( , 2( ⋅ − ⋅

1) 1 1 1 1 1 1

1 =0

2) Maximize π finding q :

1 1

1

3) The second firm will Cournot reach (start from first point up for q )

2

Compared to Cournot, the leader ends up producing more and making larger profits, while the

follower ends up producing less and making lower profits (first-mover advantage). Note that this

is valid also if the firms are identical.

BERTRAND: Simultaneous decision, Competition choosing price

Assumption: Firms simultaneously decide their price; Homogeneous costs; Price is the only

variable.

Consumers demand the good from the company with the lowest price (no differences in the

quality of products) and if two sellers charge the same price, the demand will be half and half.

But If a firm chooses a price p higher than the marginal cost, the other one will undercut it, by

choosing a slightly lower price (p – ε, where ε is a sufficiently small quantity) and stealing all

P=MC

market demand. So at the end both the price will be equal to that is a Nash equilibrium.

π=0

This is not realistic because there aren’t firm that want to product without gaining profit: .

In reality firm set a price that is higher than the MC because they have limited capacity K that

i

( + ) = − ∙ ( + )

merge the inverse demand curve: and q =q

1 2

COLLUSION: Is almost a monopoly:

1) Profits are summed

2) Final profit is derived partially for each q 1

3) System to find each q i

7 INDUSTRY CONCENTRATION and MARKET POWER

INDUSTRY: group of firms offering similar product for a group of customers for ex European hammer’s

customers.

MARKET STRUCTURE: Structural (long-term) characteristics of the market (industry structure), for ex:

Concentration, location, installed capacity and so on.

INDUSTRY CLASSIFICATIONS: Business enterprise are clustered into industries following one of these 3

approach (depends from the place): EU NACE; US NAISC; UN ISIC

INDUSTRY CONCENTRATION: The size distribution of firms belonging to the same industry. A concentrated

industry could be when very few firms dominate the market or many firms but only few have a large size.

We can measure the size of an industry with: Output (ex. Revenues); Added Value (ex. Revenues – Costs);

Inputs (ex. Number of employees).

MARKET SHARE: weight of the firm relatively to the industry (ratio between firm size and industry size).

[ ]

= ; … . Percentage of

CONCENTRATION VECTOR: industry’s market shares in decreasing order.

1

CONCENTRATION INDICES: Are a summary of the concentration vector and are used to compare the same

industries over time, or different industries at the same time. There are x type:

1) Concentration ratio: an absolute concentration index that sums the first K market shares, for

ex from the concentration vector I took the first 4 value, I divided by 100% and this is the C . Is

4

not good in capture asymmetries.

2) HHI Index: an absolute concentration index that weighs the market share of each firm by the

∑ (

= ⋅ )

share itself so can capture asymmetries =…

3) Lorenz curve: Curve of Cumulated Market Shares, Perfect equality: the first 10% of firms serve

10% of the market, the first 20% serve 20% of the market, and so on;

Absolute inequality: 1 firm serve all the market. We have to look at the right triangle,

between the straight line and the curve there is the concentration area.

=

4) Gini Index: summarize the Lorenz curve information

Perfect equality: the Gini Index is equal to 0; Absolute inequality: the Gini Index is equal to 1

ENCAVA and JACQUEMIN’S classification of market structures (MS = Market Share, quello che prima era s )

i

– Monopoly: 1 firm with a MS higher than 80%

– Dominating firm: 1 firm with MS between 50% and 80%, and the others much smaller

– Duopoly: 2 firms account for 80% of the market

– Asymmetric oligopoly: 3 or 4 firms control 80% of the market, the highest share is around 40%

– Symmetric oligopoly: 3 or 4 firms equally control 80% of the market

– Asymmetric competition: the largest firm holds a share between 20% and 50%

– Symmetric competition: the largest firm controls 20% of the market maximum

CONCENTRATION and MARKET POWER: Industry concentration imply firm’s profitability but also

inefficiency because firm will exploit market power that is the ability of a firm to profitability raise the

market price. A measure of market power is the Lerner Index:

− ∑

= ⋅

=

firm level and Industry level =,…

−

=

CONCENTRATION AND LERNER INDEX: Are connected with because Greater is the

ability to make a larger margin the smaller wil