I have recently been showing my AP and IB Econ classes the following New Yorker interview with Columbia Professor Tim Wu, the man who coined the phrase “net neutrality”. Wu shares his views on the “cycles” of competition in the communications industry, from radio, telephone and television in the 20th century to the internet and the “mobile web” today.

I find it a useful video for starting discussions about the pros and cons of perfectly competitive markets (represented by the “chaotic” period of any new communications technology) and imperfectly, more monopolistic industries (represented by the period later in the cycle of any communications technology when market power becomes concentrated among a few large firms).

Watch the video and pause it along the way to discuss some of the questions below.

Currents: Tim Wu on Communication, Chaos, and Control : The New Yorker

Discussion Questions:

1. Why are new communications industries often characterized by “chaos” in their early years? How did the internet industry reflect the perfectly competitive characteristics in its early days, or even 10 years ago?
2. How are consumers affected as communications industries go from “chaos” to control under big companies like Apple and Google?
3. How does the behavior of firms like Google and Apple demonstrate the concept of non-price competition?
4. Would the technology industry be more efficient if it were more competitive?
5. Can you envision a world in which all of our online activities are done through one company, i.e. the “Googlenet” or the “Facebooknet” instead of the “Internet”? Would that world be better or worse than what we have now? Why?
6. How is the communications industry today similar to the telephone industry 30 years ago? How is it different?
7. Tim Wu suggest that in the future there will be no internet. Discuss as a class what you envision as a possible successor to the internet.
8. If you had a time machine and could travel back to 1970, how would you try to explain to someone on the stree how we communicate with one another in 2011. How would you have tried to explain the internet and smart phones? Do you think someone from 1970 would believe your descriptions of products like Skype, like Google, like a phone you could watch movies on, like video chat, like “Google goggles”, etc…?
9. If someone from 40 years in the future arrived in 2011 and tried to explain to you how humans are communicating in 2050, do you think you would believe them?
10. Economist Joseph Schumpeter referred to capitalism as a system driven by a system of “creative destruction”. How does the history of the communications industry demonstrate the concept of “creative destruction”?

Imperfect competition in the News: After watching the video and discussion the questions with your class, go to Welker’s Wikinomics Universe and follow the link to the “Econ News” tab.  Browse the headlines from the various news feeds and look for articles that you think may be about non-price competition between firms in a monopolistically competitive or an oligopolistic market.

When you’ve found one good article, open your Diigo toolbar and add highlights to the lines in the article that you think demonstrate non-price competition between the firms described. Add one or two sticky notes using the Diigo toolbar, and when you’ve added your own thoughts, bookmark the article. Be sure to share it to your class’s group before bookmarking it so your classmates can view your highlights and sticky notes online.

If there is time left in class, log into your Diigo account and visit our class group. Read some of the highlights from your classmates’ articles and discuss with the people around you the various types of non-price competition described.

Related posts:

1. Non-price competition in the market for… WIKIS!! Wetpaint makes a move to gain market share
2. Does Apple stand a chance?
3. Competition and rising costs force Southwestern farmers to consider alternatives

What makes oligopolistic markets, which are characterized by a few large firms, so different from the other market structures we study in Microeconomics? Unlike in more competitive markets in which firms are of much smaller size and one firm’s behavior has little or no effect on its competitors, an oligopolist that decides to lower its prices, change its output, expand into a new market, offer new services, or adverstise, will have powerful and consequential effects on the profitability of its competitors. For this reason, firms in oligopolistic markets are always considering the behavior of their competitors when making their own economic decisions.

To understand the behavior of non-collusive oligopolists (non-collusive meaning a few firms that do NOT cooperate on output and price), economists have employed a mathematical tool called Game Theory. The assumption is that large firms in competition will behave similarly to individual players in a game such as poker. Firms, which are the “players” will make “moves” (referring to economic decisions such as whether or not to advertise, whether to offer discounts or certain services, make particular changes to their products, charge a high or low price, or any other of a number of economic actions) based on the predicted behavior of their competitors.

If a large firm competing with other large firms understands the various “payoffs” (referring to the profits or losses that will result from a particular economic decision made by itself and its competitors) then it will be better able to make a rational, profit-maximizing (or loss minimizing) decision based on the likely actions of its competitors. The outcome of such a situation, or game, can be predicted using payoff matrixes. Below is an illustration of a game between two coffee shops competing in a small town.

In the game above, both SF Coffee and Starbuck have what is called a dominant strategy. Regardless of what its competitor does, both companies would maximize their outcome by advertising. If SF coffee were to not advertise, Starbucks will earn more profits ($20 vs $10) by advertising. If SF coffee were to advertise, Starbucks will earn more profits ($12 vs $10) by advertising. The payoffs are the same given both options for SF Coffee. Since both firms will do best by advertising given the behavior of its competitor, both firms will advertise. Clearly, the total profits earned are less when both firms advertise than if they both did NOT advertise, but such an outcome is unstable because the incentive for both firms would be to advertise. We say that advertise/advertise is a “Nash Equilibrium” since neither firm has an incentive to vary its strategy at this point, since less profits will be earned by the firm that stops advertising.

As illustrated above, the tools of Game Theory, including the “payoff matrix”, can prove helpful to firms deciding how to respond to particular actions by their competitors in oligopolistic markets. Of course, in the real world there are often more than two firms in competition in a particular market, and the decisions that they must make include more than simply to advertise or not. Much more complicated, multi-player games with several possible “moves” have also been developed and used to help make tough economic decisions a little easier in the world of competition.

Game theory as a mathematical tool can be applied in realms beyond oligopoly behavior in Economics.  In each of the videos below, game theory can be applied to predict the behavior of different “players”. None of the videos portray a Microeconomic scenario like the one above, but in each case a payoff matrix can be created and behavior can be predicted based on an analysis of the incentives given the player’s possible behaviors.

Assignment: Watch each of the five videos below. For each one, create a payoff matrix showing the possible “plays” and the possible “payoffs” of the game portrayed in the video. Predict the outcome of each game based on your understanding of incentives and the assumption that humans act rationally and in their own self-interest.

“Batman – the Dark Night” – the Joker’s ferry game:

Click here to view the embedded video.

“Princess Bride” – where’s the poison?:

Click here to view the embedded video.

“Murder by Numbers” – the interrogation:

“Golden Balls” – split or steal:

Click here to view the embedded video.

“The Trap” – the delicate balance of terror:

Click here to view the embedded video.

Discussion Questions:

1. Why is oligopoly behavior more like a game of poker than the behavior of firms in more competitive markets?
2. What does it mean that firms in oligopolistic markets are “inter-dependent” of one another?
3. Among the videos above, which games ended in the way that your payoff matrix and understanding of human behavior and rational decision making would have predicted?
4. How often did the equilibrium outcomes according to your analysis of the payoff matrices correspond with the socially optimal outcome (i.e. the one where total payoffs for all players are maximized or the total losses minimized)?

Related posts:

1. The “delicate balance of terror”: How game theory can be used to predict firm behavior (oh, and save the human race from utter annihilation)
2. Golden Balls: Game Theory, the Prisoner’s Dilemma, and the cold rationality of human behavior!
3. SAS Economists Podcast #6: The oligopolistic nature of the video game console market

A few summers ago, my wife and I spent three weeks travelling around the island of Bali in Indonesia. For six of those days we rented a jeep and circumnavigated the island. Our first stop was for two days of scuba diving in the northeast region of Ahmed. As we drove along the seven beaches near Ahmed, we observed there were around ten dive operators offering packages for the local dive spots (including one of Asia’s most famous dives, the WWII-era USS Liberty wreck). Based on our Lonely Planet recommendation, we settled on Eco-Dive, where we paid $60 a day for two dives and all our gear rental. We felt good about this rate and agreed that $60 was a fair and competitive price for a day of diving.

Our next stop, Pemuteran, a remote and relatively undeveloped area on the northwest coast just across the straits from Java, is also known for its great diving. On our first morning in Pemuteran, my wife and I strolled along the beach and found that there were only three dive operators to choose from! And guess what, they all charged between $95-$105 for a day of diving. That’s around 60% more than the operators in Ahmed charged! In the end, we decided to do only one day of diving in Pemuteran, and elected to spend our second day there reading by the pool.

Discussion Questions:

1. What was the difference between the scuba diving markets in Ahmed and Pemuteran? Which market was more competitive? Which of the four market structures did the two markets most resemble: perfectly competitive, monopolistically competitive, oligopolistic or monopolistic?
2. How were the dive operators in Pemuteran able to charge 60% more than the operators in Ahmed?
3. What do you think is keeping one of the three dive operators in Pemuteran from lowering their price to, say, $60 for a day of diving? How would the other two operators respond? Would this be good or bad for the dive operators of Pemuteran? Would it be good or bad for scuba divers?
4. Assuming that the cost of opening a dive operation was relatively low, and there were no government or other barriers to doing so in Pemuteran, what do you suspect will happen in the Scuba diving market as the tourism industry continues to develop in the remote town of Pemuteran? Explain.
5. Which village’s dive operators do you think were more “efficient” in their use of resources? Explain.

Related posts:

1. SAS Economists Podcast #6: The oligopolistic nature of the video game console market
2. Bali economics: “thinking like an economist” on the Island of the Gods!

The launch of the iPad earlier this year, heralded a new period of competition in the market for tablet and slate computers. The three videos below, suggest that although Apple may have seized the lead the in the growing market, many other competing firms will be launching new products to entice customers to part with their money.

Click here to view the embedded video.

Click here to view the embedded video.

Click here to view the embedded video.

From first impressions, the market seems to be oliogopolistic in nature, where a few large firms (Apple, HP, Lenovo/IBM) share a large portion of the total market. At the moment it appears that Apple has the lead, and has created a product with unique selling points such as touch capability and a book reader. You can envisage from the video that HP will closely follow developments and try introduce other selling points eg. USB ports, built-in camera.

Discussion Questions:

1. What are the key difference between an oligopoly and monopolistic market structure?
2. What do you think will happen to Apple’s profits once more and more firms begin releasing their own version of the iPad? What must Apple do to try to maintain its profits in the tablet PC market?
3. What are “barriers to entry”? What are some of the barriers to entry that exists in the market for tablet computers?
4. Do you think firms in the tablet market would opt for price competition or product differentiation strategies to gain market share? Explain the advantages of each.

Related posts:

1. Non-price competition in the market for… WIKIS!! Wetpaint makes a move to gain market share
2. Does Apple stand a chance?
3. Is Nokia in denial?

Kiwifruit has been one of New Zealand’s niche exports for over the past forty years. New Zealand producers nearly 30% of the international traded kiwifruit. Kiwifruit is purchased by one large monopsony and then on sold to the international market by the large dominant buyer. During this period of time the value of kiwi exports has risen and fallen. Lately due to technological developments the fruit has undergone a process of product differentiation through cross-pollination of existing species and intensive marketing. Zespri a New Zealand company is attempting to extert dominance in the market to maximize profits.

Kiwifruit was originally known by its Chinese name, yáng táo (Sunny Peach) but was marketed as Kiwifruit in the 1950’s by the New Zealand export industry. This was to fit with the needs of the North American market. The name Kiwifruit was however never trade marked and thus other producers from Chile, Europe and China cashed in on the marketing and New Zealand producers lost their unique advantage and potential monopoly advantage.

In 1996 the New Zealand Kiwifruit industry undertook a new marketing venture to rebrand the humble kiwifruit as Zespri, a term that captured the zesty nature and vitality of the furry fruit. Overtime the New Zealand product again became noticeable in supermarkets in Europe and Asia and thus differentiated from the competition through branding. In 1987 the first yellow kiwifruit was developed by New Zealand horticulturists and last week the first red hulled fruit was developed for the export market. The NZ Herald reports here that

A variety of red-centred kiwifruit, called Hongyang, already exists but it doesn’t travel or store well so researchers are working on developing a more commercially useful version that can feed the huge export market.

The new red fruit is slightly smaller than the traditional green kiwifruit and has a sweet taste that resembles a tamarillo. Around the core is a deep red colour, which changes to yellow- green nearer the green skin.

Zespri has the largest kiwifruit species breeding programme in the world, keeping up to 50,000 seedlings in trial.
“We are trying to deliver the next generation of kiwifruit for the market to grow and increase the brand around the world,” said Rosstan Mazey, green produce category manager for Zespri.”

Globally the market for kiwi exporters potentially fits the assumptions of several market structures. The international market appears to fit the characteristics of an oligopoly. The barriers to produce and knowledge to export kiwifruit are significant. Nations or export focused companies such as Zespri are attempting to differentiate their products using new cross-pollination techniques to thus develop different varieties and to clearly distinguish their products from other exporters. The qualities of each variety may be very similar but customers will be willing to pay a little more for the uniqueness of the product. The costs of production for the different species of kiwifruit will likely be very similar in the long run thus firms can expect significantly higher profits.

These are some characteristics of market structures which can help us understand the Kiwifruit market.

Numbers: Although there are many producers in the international market for Kiwifruit it appears that a few firms or countries have a high concentration of the total global market share, Italy, New Zealand and Chile. The theory also suggests that each firm in an oligopolistic structure is interdependent on each other. You could argue that instead kiwifruit producers are independent and there is a high degree of competition and not collusion.

Ease of entry: There does exist some barriers to entry in the market due the high costs of setting up a fruit growing industry and then developing the channels to successfully export the product. But these barriers are also discouraging firms from exiting the industry. Farmers and the industry have large sunk costs, which would be hard to recover if they were forced to enter the market. A kiwifruit vine is a clear example of a sunk cost and is research and development. We could therefore assume that the industry is oligopolistic.

Product: Each firm or country in the Kiwifruit industry attempts to produce a branded product. There are becoming distinct differences in the products on offer as illustrated by the development of new species of yellow and red centered kiwifruit in New Zealand. Many economists believe that the main form of competition in oligopoly is non-price competition, and advertising in particular, to highlight the differences in the products. These differences such as country of origin increase the perceived value of the product.

This analysis perhaps explains how technological developments in cross-pollination are leading to a change in the global market structure for Kiwifruit as firms are able to produce significantly different products leading to technological barriers to entry and less contestability. Thus shifting the description of the market from monopolistic competition, which it may be been in the 1960’s to towards a perhaps oligopoly structure without the collusion, but with high barriers to entry and with greater competition.

For more reading on contestable markets, oligopolies and monopolistic competition the UK site here  S-Cool – Economics is a great start.

Discussion Questions:

1. Find examples from your local area of oligopolies, monopolistic and contestable markets?
2. What do the MR / AR curves look like for an oligopoly and monopolistic structure?
3. Compare and contrast the difference between an oligopoly and monopolistic competition?
4. How is a monopoly different from a monospony?
5. Find other examples of how technological change is altering a market structure. Does Apple have monopoly power in the portable music industry?

Related posts:

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2. Rough necks and rig hands: Wyoming’s booming gas industry
3. The questions no one seems to be asking about the auto industry bailout!

Teaching the Prisoners’ Dilemma Will Never Be the Same Again « Cheap Talk

Rarely does such a perfect illustration of the Prisoner’s Dilemma come along for Econ teachers to use in their classroom:

The payoffs are clear:

Each player has a weakly dominant strategy, which is to choose to steal. By choosing to steal, the player has a chance at maximizing his own payoff, but will do no worse than he would if his opponent also chooses to steal and at least will have the satisfaction of thwarting his opponent’s attempt to steal the money.

There are three Nash equilibria in the game, which are outcomes at which a player can not do better on his or her own by changing his or her strategy. The outcome Steve was hoping for by chosing “split” (50/50) was not a Nash equilibrium because Sarah knows she can do better if she chooses steal when Steve chooses split. Steve doomed himself by choosing split because he should know that Sarah’s dominant strategy is to choose steal. However, Sarah would also have doomed herself by choosing split because she should assume that Steve would also chose steal since steal is a dominant strategy for him too.

John Nash, who pioneered the field of Game Theory, assumed that humans were coldly rational, self-interested, deceptive creatures that would not hesitate to stab one another in the back to get what was best for themselves. His theory of human behavior is only partially proven correct in this game, in which Steve is shown to be the sucker and Sarah the coldly rational self-interested player. The best chance for Steve to go home with any money would have been for him to use the one minute of discussion time to convince Sarah that he would choose SPLIT, yet be willing to go home with something LESS THAN $50,000 and accept that Sarah was going to choose STEAL. He could have threatened to chose steal if she did not agree to share her winnings with him to some extent. Then again, any promise Sarah makes she could later break, thus further empowering the players to choose steal.

Discussion questions:

1. What in the world is going on here? Why did Sarah choose steal rather than collaborate with Steve and share the $100,000?
2. Was Steve totally wrong to choose split? What would you have done in his situation?
3. How do the choices faced by Steve and Sarah relate to the choices faced by firms in oligopolitic markets? Now that you’ve seen this video, can you explain why collusive agreements between oligopolists often fall apart? Why do cartels such as OPEC often fail to achieve the high price targets agreed upon in meetings of their leaders?

Related posts:

1. The “delicate balance of terror”: How game theory can be used to predict firm behavior (oh, and save the human race from utter annihilation)
2. Understanding Oligopoly Behavior – a Game Theory overview
3. Resource market case study: New York’s manhole covers forged with human sweat and blood…

This week in AP Microeconomics students get to play online games, watch movies, and compete with their classmates in strategic competitions in which there are proud winners and sad losers. That’s right, we’re studying oligopoly!

What makes oligopolistic markets, which characterized by a few large firms, so different from the other market structures we study in Microeconomics? The answer is that unlike in more competitive markets in which firms are of much smaller size and one firm’s behavior has little or no effect on its competitors, an oligopolist that decides to lower its prices, change its output, expand into a new market, offer new services, or adverstise, will have powerful and consequential effects on the profitability of its competitors. For this reason, firms in oligopolistic markets are always considering the behavior of their competitors when making their own economic decisions.

To understand the behavior of non-collusive oligopolists, economists have employed a mathematical tool called Game Theory. The assumption is that large firms in competition will behave similarly to individual players in a game such as poker. Firms, which are the “players” will make “moves” (referring to economic decisions such as whether or not to advertise, whether to offer discounts or certain services, make particular changes to their products, charge a high or low price, or any other of a number of economic actions) based on the predicted behavior of their competitors.

If a large firm competing with other large firms understands the various “payoffs” (referring to the profits or losses that will result from a particular economic decision made by itself and its competitors) then it will be better able to make a rational, profit-maximizing (or loss minimizing) decision based on the likely actions of its competitors. The outcome of such a situation, or game, can be predicted using payoff matrixes. Below is an illustration of a game between two coffee shops competing in a small town.

As illustrated above, the tools of Game Theory, including the “payoff matrix”, can prove helpful in helping firms decide how to respond to particular actions by their competitors in oligopolistic markets. Of course, in the real world there are often more than two firms in competition in a particular market, and the decisions that they must make include more than simply to advertise or not. Much more complicated, multi-player games with several possible “moves” have also been developed and used to help make tough economic decisions a little easier in the world of competition.

While Game Theory can be useful in predicting firm behavior in oligopolistic markets, believe it or not that is not its most useful application developed. In fact, would you believe me if I told you that Game Theory may be precisely what saved the world from nuclear holocaust during the 20th Century? It’s true. The US government employed Game Theory to avert annihilation by nuclear attack from the Soviet Union during much of the 20th Century. This video tells the story!

Related posts:

1. Golden Balls: Game Theory, the Prisoner’s Dilemma, and the cold rationality of human behavior!
2. Understanding Oligopoly Behavior – a Game Theory overview
3. SAS Economists Podcast #6: The oligopolistic nature of the video game console market

Professor Preston McAfee on Price Discrimination

(you must have RealPlayer to view this video. Mac users can download it here)

CalTech Economics professor Preston McAfee is an expert on prices. His research spans three decades and examines the pricing behavior of firms in various market structures. In the lecture linked above the professor shares several examples of firms practicing price discrimination. I was surprised to see that many of the examples he discusses are ones that I have been using in my own lectures on price discrimination for the last few years.

McAfee presents a mathematical formula for monopoly pricing, which no AP or IB text that I’ve seen has included:

Monopoly Price = [PED/(1-PED)] x MC where PED is the price elasticity of demand of the customer and MC is the firm’s marginal cost of production.

The basic idea is that the more inelastic the customer’s demand, the higher price the monopolist should charge over its marginal cost. The implication, therefore, is that a monopolist prefers to charge higher prices to customer’s whose demand is inelastic and lower prices to customers who are “price sensitive” or whose demand is elastic. The charging of different prices to different consumers for the exact same product is what economists call price discrimination.

McAfee begins talking about price discrimination at minute 8:44 in the video. His examples include:

• Movie theaters: Charge different prices based on age. Seniors and youth pay less since they tend to be more price sensitive.
• Gas stations: Gas stations will charge different prices in different neighborhoods based on relative demand and location.
• Grocery stores: Offer coupons to price sensitive consumers (people whose demand is inelastic won’t bother to cut coupons, thus will pay more for the same products as price sensitive consumers who take the time to collect coupons).
• Quantity discounts: Grocery stores give discounts for bulk purchases by customers who are price sensitive (think “buy one gallon of milk, get a second gallon free”… the family of six is price sensitive and is likely to pay less per gallon than the dual income couple with no kids who would never buy two gallons of milk).
• Dell Computers: Dell price discriminates based on customer answers to questions during the online shopping process. Dell charges higher prices to large business and government agencies than to households and small businesses for the exact same product!
• Hotel room rates: Some hotels will charge less for customers who bother to ask about special room rates than to those who don’t even bother to ask.
• Telephone plans: Some customers who ask their provider for special rates will find it incredibly easy to get better calling rates than if they don’t bother to ask.
• Damaged goods discounts: When a company creates  and sells two products that are essentially identical except one has fewer features and costs significantly less to capture more price-sensitive consumers.
• Book publishers: Some paperbacks cost more to manufacture but sell to consumers for significantly less than hard covers. Price sensitive consumers will buy the paperback while those with inelastic demand will pay more for the hard cover.
• Airline ticket prices: Weekend stayover discounts for leisure travelers mean business people, whose demand for flights is highly inelastic, but who will rarely stay over a weekend, pay far more for a roundtrip ticket that departs and returns during the week.

McAfee also goes into a fascinating discussion of price dispersion which is essentially a theory of oligopoly pricing. All Econ teachers should watch this video and find examples of price discrimination and oligopoly pricing that they can incorporate into their own class.

If you’re up for a challenge, try deciphering some of the mathematics in McAfee’s free, downloadable intro to economics text, available here.

Related posts:

1. Price Discrimination 101
2. Microeconomics teachers: Have you discovered Econgirl yet?
3. From heart transplants to watermelons: Understanding price elasticity of demand

In  IB Economics, we are currently learning about how firms in imperfectly competitive markets differentiate their products in order to increase their market power and their price-making power.

In a market with a few large firms such as the laptop computer market, companies must do what they can to increase demand for their own products over those of their competitors. Apple Computer is an example of a company that has successfully differentiated its line of laptop computers in recent years, regularly improving the features of its line of MacBooks to attract consumers away from its competitors and into the world of Macs.

Last year Apple launched the MacBook Air, the lightest and thinnest laptop on the market, creating a huge buzz in the technology world and converting millions to Apple’s line of laptops. This year, Apple has launched yet another innovation in laptop computing, in the hope of once again increasing demand for its products, and making consumers think they cannot live without the sleek, shiny Apple computers. This year’s innovation? The “MacBook Wheel”… watch:

Apple Introduces Revolutionary New Laptop With No Keyboard

The goal of an imperfectly competitive firm like Apple is to increase its market power by increasing demand for its particular product through product differentiation, advertising, developing brand loyalty, and “hype”: all forms of non-price competition. If Apple were to simply charge a lower price than its competitors for its products, it would also succeed in increasing the amount of computers it sells to consumers, but may also end up accepting lower profits due to the lower prices it must sell for.

Through differentiation, which means making its products unique and attractive to consumers, Apple attempts to increase market demand for its computers, while simultaneously making demand less elastic. With higher, more inelastic demand, Apple gains price-making power over the laptop computer market, as can be seen in the graphs below, which show that after the successful launch of a new product like the MacBook wheel Apple is able to charge a higher price, produce a similar quantity, and earn greater economic profits.

In the video, one customer says that he’d buy “buy almost anything if it’s shiny and its made by Apple”. Such statements reflect that among loyal customers, demand for Apple’s products is highly inelastic. While the firm is certainly not a monopolist in the market for laptop computers, Apple has surely succeeded to increase its market power and thus its power over prices through product differentiation, brand loyalty, and the “hype” surrounding the launch of new products like the MacBook Wheel.

Discussion questions:

1. In the graphs above, the slopes of the demand curve increases after successful product differentiation by Apple. Why does this happen?
2. Assuming the market for laptop computers is monopolistically competitive, what will likely happen to Apples economic profits over time? What must Apple do if it wishes to maintain its profits in the long-run?
3. What are some real ways companies like Apple and its competitors have attempted to differentiate their products over the years? Would YOU buys a MacBook Wheel if it were real?

Related posts:

1. Shanghai American School and the imperfectly competitive market for international teachers
2. Does Apple stand a chance?
3. Market structure and the iPad

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Pepsi Tests ‘Naturally Sourced’ Beverage – Advertising Age – News

Pepsi is just about to launch its first new beverage since 1992.  The drink, called “RAW” will present consumers with a healthier alternative to the artificially flavored soft drinks that dominate the oligopolistic market.

Apple extract, sparkling water, grapes, coffee leaf, raw cane sugar. The list of ingredients sounds like it belongs to a health drink, but those are the components of Pepsi’s newest variant.

Pepsi Raw, being launched in U.K. test markets, is meant to be a more healthful alternative to the traditional cola. A type of Pepsi made from only “naturally sourced” ingredients, it taps into demand for premium, less-processed products.

Sounds great, right? But would you be willing to pay more for a “natural” Pepsi than for the good old fashioned artificially flavored Pepsi and Cokes you grew up with? Pepsi is betting the drink will appeal to young hipsters, and is launching it primarily at clubs and bars in six UK cities to test out the market.

So when can Americans expect to  enjoy the natural goodness of Pepsi RAW? Unfortunately, Pepsi seems to think Americans are a bunch of fat tightwads:

 ”It makes sense to launch first in the U.K. because health concerns are a bigger issue there,” Ms. Dornblaser said, adding, “It might not fly as well in the U.S. because of the price.”

Oh, and if you’re too young to remember what Pepsi’s last attempted new product launch was, allow me to jog your memory:

Click here to view the embedded video.

Hey, I LOVED Crystal Pepsi! So, would you be willing to pay more for a healthier Pepsi?

Related posts:

1. Black Friday sales data: what does it tell us about American consumers?
2. Does Apple stand a chance?
3. Is Nokia in denial?

Nokia Won’t Play iPhone’s Tune

As we know, oligopolistic markets are characterized by a few large firms which act interdependently based on the actions of one another. Examples of such interdependence may include pricing and output behavior, advertising behavior, sales and promotions, non-price competition, services offered to consumers, and so on. The “game” of oligopoly is played with one very important goal in mind: maintaining market share in the face of competition from rivals.

In a previous post I discussed some of the strategies Apple has used to break into the oligopolistic market for cellular phones, which it recently did by introducing the thus far wildly successful iPhone. A chart in that post showed that as of earlier this year, the dominant firm in the mobile phone market was Nokia, with a market share of 35.1%. Apple was not even a competitor in this market until July of this year, which saw the successful launch of the iPhone, causing some of the incumbent mobile phone makers to pay close attention to the newcomer’s behavior.

Nokia executives, however, appear to be in denial of the potential threat posed by the iPhone to its dominance in the cell phone industry:

Nokia managers would never admit to being influenced by the Apple iPhone, which mobile phone industry insiders regard as clever but technologically unimpressive. “We don’t determine strategy based on the competition,” insists Anssi Vanjoki, Nokia executive vice-president and general manager for multimedia. “The consumer is our compass.”

The message seems clear enough: “No one influences our firm’s behavior except the consumer”. If this were true, it would seem that our basic assumption that oligopolistic firms act interdependently based on the actions of the firms with which they compete may be incorrect. But wait a minute, is Mr. Vanjoki being truthful here? Has Nokia really simply ignored the impact that Apple’s launch is having on the mobile market? Let’s look more closely:

Nokia announced a new initiative Dec. 4 that seems aimed squarely at Apple. Beginning next year, higher-end Nokia phones will come with a built-in music service offering unlimited downloads of songs for a year. Nokia has signed up Universal Music to provide its catalog, including top contemporary musicians such as Amy Winehouse and Kanye West. And the handset giant is already negotiating with other major music companies, Vanjoki says.

Hmm… a Nokia cell phone with music playing and downloading capabilities. Surely Apple’s iPhone had NOTHING to do with this new product, right? The presence of Apple on the mobile market has clearly influenced the incumbent firms, even the unflappable Nokia, whose claims of acting only at the behest of consumers seems to ignore the reality of the matter: consumers demand phones that play music because Apple makes a phone that plays music. Is it really a coincidence that Nokia launches their first music playing phone only months after the launch of the iPhone?

In AP Microeconomics we study oligopolistic market structures under the assumption that firms in such markets act interdependently of one another. If a firm like Wal-mart slashes its prices for, say, board games, then Target and K-mart are likely to respond by announcing price cuts on board games or other such products themselves. They don’t behave this way because they want to sell their products at a lower price, they do so because if they don’t, then Wal-mart threatens to increase its market share at the expense of Target and K-mart.

In the mobile phone market, firms respond not only to the behavior of consumers but to the actions of other firms as well. In this case, Nokia knows that the arrival of Apple and the iPhone has changed the name of the game for mobile makers. The iPhone’s technology may be “unimpressive” to Nokia, but who could help but be impressed by Apple’s clever decision to make a user-friendly all-in-one Mp3, video, web-browsing cell phone? Clearly, Nokia is broadening its product selection and features to include such “Applesque” features to try and maintain that 35% market share in the face of Apple’s newfound success in the mobile market.

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Related posts:

1. Does Apple stand a chance?
2. Where have all the iPhones gone?
3. Product differentiation in imperfectly competitive markets – the MacBook Wheel

China Mobile negotiating with Apple to carry iPhone

Try try as he might, Steve Jobs and Apple can barely launch their hottest new product, the iPhone, before the Chinese have copied it and put a knockoff on the market as quickly as you can say “can you hear me now?” But what is Apple doing making a cell phone anyway? Isn’t the mobile phone market pretty much dominated by a few big name companies already? How will apple ever survive in a market with such well established firms as Nokia, Samsung, and Motorola?

The answer is through product differentiation. The iPhone is truly an innovative little gadget. More than an MP3 player, more than a cell phone, the iPhone has features that differentiate it from most products available from the established firms in the mobile phone market. Like any firm, Apple advertises its iPod through commercials and other media in order to inform consumers about what makes its product special. What message does the following advertisement send about the iPhone?

Click here to view the embedded video.

The table below shows the market shares of the larges mobile phone makers as of late last year (before the release of the iPhone). A simple calculation finds that the four firm concentration ratio in the mobile market was 75.6%, clearly putting the market in the realm of an oligopoly (a market in which the four firm concentration ration is 40%).

With 75% of the market being controlled by Nokia, Motorola, Samsung and Sony Ericsson, the question arises whether Apple will be able to overcome the barriers to entry in the mobile market and establish itself as one of the big boys. Apple’s strategy for profits and market penetration certainly leverages the power of product differentiation and non-price competition, both firm behaviors common among firms in oligopolistic markets.

To make matters worse for Apple, only months after the iPhones release, and in the midst of negotiations between Apple and China Mobile to officially launch the product in China, a cheap, 4 GB knock-off of the fancy device comes along to entice Chinese consumers away from the 5,000 RMB (nearly $700) real deal. Check this thing out… would you be able to tell the difference?

Click here to view the embedded video.

Discussion Questions:

1. What barriers to entry exist in the market for mobile phones?
2. Why do you think so few firms produce mobile phones?
3. Do you think Apple will be able to successfully penetrate the mobile market?
4. What threat do cheaper “knock-offs” of the Apple iPhone pose to Apples attempts to compete in China’s mobile market?

Related posts:

1. Is Nokia in denial?
2. Where have all the iPhones gone?
3. Creative Destruction: Google, Apple, Facebook and the future of competition in the market for our minds…

BBC NEWS | Technology | Nintendo warns of Wii shortages

Looks like Brits dreaming of the Wii from Nintendo may have to wait a while longer this holiday season, as British retailers are finding it nearly impossible to fill customers’ orders. It turns out there is quite a shortage for the hot new gaming system from Nintendo!

“Although we’re receiving regular deliveries from Nintendo, Sony and Microsoft and getting the products onto the shelves as fast as we can – it’s possible that demand will outstrip supplies on some products, for example the Nintendo Wii, which has been hugely popular all through the year,” read a statement from high street gaming specialist Game…

“The Nintendo Wii consoles have proved extremely popular with our customers and have been flying off the shelves whenever we get new stock in,” said a spokeswoman.

It seems like the shortage of Wii’s in the UK should send a message to Nintendo and its retailers: RAISE THE PRICE!! One way retailers have tried to do this is by bundling the consoles with up to three or four games, meaning to take home a console shoppers would have to fork over 300 GBP. This seems like a great strategy for retailers faced with strong demand from customers, given that they are probably not allowed to charge above Nintendos suggested retail price for the console itself.

It is too bad Nintendo cannot figure out how to price their consoles more effectively to avoid such shortages. Given that the Wii is the cheapest of the three main video game consoles, a price hike would seem the logical response to such shortages as that in the UK. So why isn’t Nintendo raising their price? What rational reason might they have for keeping the price low? The Undercover Economist, Tim Harford, wrote an article two years ago about the XBox 360, which at the time was experienced excess demand similar to that in the market for Wii’s right now. Here’s his reasoning for why companies like Microsoft and Nintendo may keep prices irrationally low in times of shortages:

Why don’t companies raise prices when supply is short and demand is frenzied? Leaving aside oxygen and a few other essentials, there is no such thing as an absolute shortage of anything: There is only a shortage if the price is too low. At the moment, Microsoft is easily selling out the half-million or so Xbox 360 units (there’s no official number) for prices starting at $300 for the basic package. Why doesn’t Microsoft price them at $700 instead? That’s the figure that the consoles are fetching on eBay.

Perhaps the sellouts are supposed to generate free publicity. By deliberately giving Xbox consoles away too cheaply today, Microsoft gets the column inches before Christmas, and that may boost demand and sell more in the long run. If you had put that theory to me last year I might have believed it, but after all the hot air over gasoline prices this fall, no longer. It’s now obvious that you can get just as much publicity by raising prices as you can by selling out at low prices. But raising prices makes money, and creating lines of frustrated customers who can’t get the product doesn’t.

Maybe Microsoft is worried that this would be the wrong kind of publicity, because customers would dislike a price hike. That’s possible, but the publicity is already bad: Many empty-handed customers seem convinced that Microsoft has a secret hangar in Roswell stuffed full of Xboxes that they’ve decided not to release just yet.

In any case, strange as it may seem, even if the consoles sold out at a higher price, the average Xbox aspirant wouldn’t be any worse off: The increased price should be exactly balanced by the shorter lines, reduced aggravation, and greater chance of getting a console. Customers are infuriated by the shortage itself, whether that shortage is expressed in lines (as it is today) or in high prices (as it could be if Microsoft raised them). If Microsoft is going to aggravate its customers, why doesn’t it at least make a buck out of it?

Harford then goes on to share the ideas expressed my his friends in several different universities’ economics departments about why companies like Nintendo and Microsoft don’t raise their prices in times of shortage. If you’re interested in the various theories, click here.

What about you? Do you think the execs at Nintendo are simply ignorant to the laws of Demand? Shortages should send the clear signal that price is too low, and that demand is highly inelastic, meaning that an increase in price should clearly lead to an increase in total revenue, and therefore greater profits for Nintendo. So why do you think they don’t take this opportunity to raise their profits?

If you haven’t seen it yet, check out this excellent podcast by two AP Econ students at SAS about the video game console market! SAS Economists Podcast #6: The oligopolistic nature of the video game console market.

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Related posts:

1. SAS Economists Podcast #6: The oligopolistic nature of the video game console market
2. McAfee on Price Discrimination: a must-read for teachers of Microeconomics
3. One version of Windows XP per child…

by Annie Sung and Kristie Chung

Which do you prefer, the Wii? the XBox 360? the PS3? How about other video game consoles? Can you even think of any other video games consoles? Hmm… let’s see… how about the Sega? Wait, no, haven’t seen any of those in a while… what about the Atari? Oh, shoot, nope! Oh yeah, don’t forget the Caleco Vision (for the record, Mr. Welker’s earliest video game memory was of playing Smurfs on a Caleco Vision).

The fact is, today, the market for video game consoles has shrunk to three dominant firms: Nintendo, Microsoft and Sony. This podcast will investigate the video game console market, examine its characteristics, including the elasticity of demand for the different consoles, and conclude whether it exhibits the features of an oligopoly.

Click here to view the embedded video.

Related posts:

1. SAS Economists Podcast #8 – Shanghai’s fake DVD market
2. SAS Economists Podcast #3: Competition in the Baked Goods Market at SAS
3. The “delicate balance of terror”: How game theory can be used to predict firm behavior (oh, and save the human race from utter annihilation)