2. 2014 Managerial Economics Stefan Markowski Managerial Economics Stefan Markowski How? When? What? The economics of competitive advantage Why? Where? Who? Public sector perspective

3. Detailed course schedule Day no TopicTextbook ch. 1 (24 Nov; 3 hrs) 1. Introduction. Decision making process and its elements. The scope of economic decision making. Application of marginal analysis Chs. 1-2 2 (25 Nov; 3 hrs) 2. Demand analysis and demand elasticitiesCh. 3 3 (26 Nov; 3 hrs) 3. Buyer product valuation and choices. Consumer surplus. Buyer pricing decisions Ch. 4 4 (27 Nov; 2 hrs) 4. Production/transformation process. Production technologies and input-output structure Ch. 5 5 (28 Nov; 2 hrs) 5. Cost structure and cost drivers of producer pricing strategies. Production scale and scope. Chs. 5 and 7 6 (1 Dec; 3 hrs) 6. Structure-conduct-performance. Market structures: competition and contestability. Pricing strategies of buyers and sellers Ch. 8 7 (2 Dec; 3 hrs) 7. Market structures: monopoly/monopsony, monopolistic competition and oligopoly. Pricing strategies and strategic behaviour Chs. 9-10 8 (3 Dec; 3 hrs) 8. Input sourcing and investment. Pricing and market powerChs. 6 and 11 9 (4 Dec; 2 hrs) 9. Decision making under conditions of uncertainty. Informational asymmetries and risk management Ch. 12 10 (5 Dec; 2 hrs) 10. Market research and market analysis. Auction and rings. Strategic behaviour Ch. 13 11 (8 Dec; 2 hrs ) 11. Public sector perspectiveCh. 14 12 (9 Dec; 2 hrs) 12. Revision 13. Examination 13 (11 Dec; 2 hrs) Examination

4. Topic 11 Public sector perspective Market limitations and the role of government Topic Contents 11.1 Managerial perspective 11.2 Market failure 11.3 Natural monopoly 11.4Public and merit goods 11.5 Positive and negative externalities 11.6 Knowledge and information 11.7 Other limitations of market exchange 11.8 Consumption of public goods and services 11.9Production of public goods and services 11.10 Taxation and regulation 11.11Further reading

5. 11.1 Managerial perspective mixed economyThe concept of the “mixed economy” stateThe “state” defined as the totality of legislative and executive public bodies, statutory undertakings, public agencies and enterprises State interventionState intervention in the economy takes the form of: –facilitation –facilitation of private economic activity –regulation –regulation of private markets and economic entities –direct production and consumption Case for ‘smaller government’Case for ‘smaller government’ –excessive state production (too much and wrong structure) –excessive and poorly balanced state consumption –too much taxation (also wrong tax structure) –excessive regulation (too much interference)

6. 11.2 Market failure Market failureMarket failure refers to the private sector’s inability to realise the full potential of the economy (an obvious misnomer) It arises because of: intrinsic nature –the intrinsic nature of certain goods/services and thus problems for their consumption/use technology –the technology applied in the production of some other goods/services Reasons for market failure: –natural monopolies –public goods/bads –merit goods/bads –positive and negative externalities

7. 11.3 Natural monopoly inherent tendency to decreasing average costs pervasive economies of scaleSome activities show an inherent tendency to decreasing average costs over the entire range falling within the market to be supplied (pervasive economies of scale) natural monopolistSuch activities may be undertaken by a single provider - the natural monopolist destructiveCompetition in such a case is said to be destructive, traditional example utilities. For competition to be destructive there must be large fixed and sunk costs and recurrent periods of excess capacity

8. 11.3 Natural monopoly That is, the entry of firms into a natural monopoly market is likely to reduce the overall benefits generated fore society by raising the total cost of production Most monopolies are not natural monopoliesMost monopolies are not natural monopolies public interventionNatural monopoly case for public intervention to: –protect buyers from the monopolist –protect market standards from the monopolist –protect a natural monopolist from destructive competition –promote stability in an unstable market (eg. prevent price wars)

9. Economics for Managers 11.3 Natural monopoly Costs, RevenuesDemand Monopoly profit Competitive loss Average Cost Marginal Cost MR Q m MR Q c Quantity

10. 11.4 Public and merit goods Public goodsnon-rivalrynon- excludabilityPublic goods exhibit non-rivalry in consumption and non- excludability cost recoveryfree rideThey cannot normally be supplied through the market - cost recovery is the difficult as consumers free ride club goods two-part tariffSmall degree of publicness - club goods, which could be provided through clubs with costs recovered through a “two-part tariff” (membership fee plus pay-as-you-go) multilevel governmentPublic goods may have different catchment areas - multilevel government Merit goods/bads consumer sovereigntyMerit goods/bads deemed by governments to be intrinsically desirable/undesirable, i.e., consumer sovereignty is denied

11. 11.4 Public and merit goods Merit goods have no particular economic characteristic other than government designation State interventionState intervention may take the form of: –direct provision of public and merit goods and services –regulation of providers of public goods and services –regulation of acquisition and consumption of merit bads

12. 11.5 Positive and negative externalities Externalitiesuncompensated costs an benefits interdependenciesExternalities are uncompensated costs an benefits which arise as a result of interdependencies in production and/or consumption external effects, external economies or diseconomies. property rights may not be defined or are not enforceableKnown as external effects, external economies or diseconomies. They arise because markets do not exist for certain goods, eg. clean air, that is, property rights may not be defined or are not enforceable State interventionState intervention may take the form of: –provision of free information on externalities –regulation of producers or recipients of external effects –direct production in areas where externalities are widespread (public safety, education, health)

13. 11.5 Positive and negative externalities Negative Externality Prices, Costs Demand DemandSocial Marginal CostSupply P social P Private Q social Q Private Quantity

14. 11.6 Knowledge and information Perfect knowledgePerfect knowledge in economics KnowledgeinformationKnowledge vs information Scarcity of knowledge and information InventioninnovationInvention and innovation Asymmetry of knowledgeAsymmetry of knowledge (re: previous Topics) lemonsQuality issues and economic “lemons” “Hold up” problems (ditto)

15. 11.7 Other limitations of market exchange Insurance markets Warranties Moral hazardsMoral hazards

16. 11.8 Consumption of public goods and services Definition of public goods too broadDefinition of public goods too broad Provision of merit goods tends to be arbitraryProvision of merit goods tends to be arbitrary (influence of special interest groups and politics) Packages of goods and services tend to be poorly targetedPackages of goods and services (‘education’, ‘health’, ‘defence’) tend to be poorly targeted

17. 11.8 Consumption of public goods and services Example - Over- and Underprovision Demand for and Cost of Provision Demand Underprovision Cost of provision Overprovision Q* Q free Good A

18. 11.9 Production of public goods and services Managerial controlManagerial control –Collective property rights break the nexus between the owner (taxpayer) and the manager of public assets –Political control very indirect information costly to obtain incentives to free-ride voting on packages of policies –Fusion of productive and regulatory interests Public monopolies hard to challengePublic monopolies hard to challenge –natural monopoly arguments –legal protection –lack of contestability and competition –rent seeking

19. 11.9 Production of public goods and services Producer Subsidy (re: Topic 6) Price Home supply before subsidy Home Market DemandHome supply with subsidy Cost home Subsidy P world World Supply DW loss Imports DW loss Qa Qb Quantity World price paid at home by consumers but subsidized producers produce more and replace imports of more efficiently produced world products. Net loss of national resources

20. 11.10 Taxation and regulation Excessive taxation follows from excessive government spendingExcessive taxation follows from excessive government spending Poor tax basePoor tax base –Wrong structure of incentives - middle-income employees bear the burden of income taxation –Value-added taxation preferred (e.g., VAT) –Poll tax - least distortion –Many taxes too costly to collect Excessive regulationExcessive regulation –Too much bureaucracy –Too much focus on special interest groups (subsidies, tariffs) –Poor targeting (slow to respond and inflexible) More facilitation less regulationMore facilitation less regulation

21. 11.10 Taxation and regulation Tariff (re: Topic 6) Price Home Market Demand Home Market DemandHome Supply Welfare Loss P home Tariff P world World Supply Imports Qa Qb Qc Quantity

22. 11.11Further reading Baye (2010): ch. 14