The Cornell Queens Executive MBA

Managerial Economics and Industry Analysis MBUS 881/NCCB 505 Summary of Discussions Session 4 Bo Pazderka

Session 4 Slide # 9
Q 1: Calculation of price elasticity of demand Apply the definition of price elasticity percentage change in quantity demanded divided by percentage change in price: P,Q = (% in Q) / (% in P) = 15 / (-3) = - 5

Session 4 Slide # 9 (cont.)

Q 2: Calculation of optimal markup and price Apply the markup formula from slide #7 (also in Course Notes p. 149), where MC = 120 and Q,P = -5.

From this, P = 120 { 1 / [ 1 - ( 1/5)] } = 120 { 1 / [ 4/5 ] = 120 x 5/4 = $150. Thus, the optimal markup over cost is $ 30 (=150-120), i.e. 25% (since 30/120 = 25%).
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Session 4 Slide # 13
Q 1: Legal definition of predatory pricing (selling at prices unreasonably low Definition of unreasonably low: Price below avoidable cost. Translation: price below AVC (economic logic is similar to the shut-down decision, pp. 102-103 in Course Notes) Intent: Eliminate a competitor, or reduce competition substantially. The term substantially is typically interpreted by answering two questions: (a) is the practice widespread? (b) is it practiced by a dominant firm?
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Session 4 Slide # 13 (cont.)

Q 2: Economic logic of predatory pricing Selling below cost and losing money in the hope that a rival will be eliminated and prices raised afterwards However, there are risks: No guarantee that losses will be recovered in reasonable period of time The monopoly position of the predator may be undermined by new technology, new entry, etc. It may be cheaper to buy (take over) the potential victim

Session 4 Slide # 13 (cont.)

Q 3: Legal difficulties in proving predatory pricing Demonstration that the accused sold at prices unreasonably low Demonstration that the policy had the effect or tendency of substantially lessening competition or eliminating a competitor, or designed to have that effect It has to be a policy (not just a single event)

Session 4 Slide # 13 (cont.)

Q 3 (cont.): Evidence needed to prove illegal agreement Paper trail (smoking gun) rarely available Proof by inference from information about Attempts to intimidate competitors who try to engage in price cutting Activities of industry associations actively encouraging the imitation of pricing of some leading companies Identical bids on some contracts

Session 4 Slide # 22
Q 1: Recent Canadian government policies toward the environment Canada ratified the Kyoto Agreement U.S. did not However, emissions have been growing in Canada The policies of some provinces are ahead of the federal government The Obama administration opted in favour of the capand-trade policy (although 85% of permits were given away, rather than auctioned off) Canadian goods exported to the U.S. face the problem of equivalency of Canadian pollution taxes with the analogous U.S. charges
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Session 4 Slide # 22 (cont.)

Q 2: Recent U.S. government policies toward the environment One of President Obamas key policy priorities Preference for cap-and-trade system over pollution tax However, strong opposition: Skepticism about global warming Fear of loss of competitiveness (if China and India do not implement similar measures) Lobbying from coal-mining states Recession is not a good time to impose additional taxes or charge for pollution permits
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Session 4 Slide # 22 (cont.)

Q 3: Tradable permits as a licence to pollute Their application does reduce pollution They provide continuing incentive for abatement and can achieve abatement at lower overall cost Efficiency is further enhanced when trading is international But perception of licence to pollute remains

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Session 4 Slide # 27
Q 1: Should government subsidize R&D performed by profitable corporations? Theoretically justified if Social Benefits > Private Benefits This is generally the case because of incomplete appropriability of the results of R&D However, controversy exists about the specific methods, programs, and government management Perception that rich, profitable corporations should not get government handouts

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Session 4 Slide # 27 (cont.)

Q 2: Should only certain types (stages) of R&D activities be subsidized? Which ones? Basic R&D is unlikely to yield patentable results, hence Social Benefits > Private Benefits This is the reason why basic R&D is mostly performed at universities and government-funded research institutions Problems with promoting R&D in selected industries or firms (difficulty of picking winners)

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Session 4 Slide # 27 (cont.)

Q 3: Should governments fund business education in full? The cost of education in some fields (business, medicine, engineering, etc.) are quickly recovered. Thus, full funding is less justified in fields (e.g. Humanities) where the salaries make the rate of return low, or even negative (see text box in Course Notes, p. 175) Assuming the society values the positive externalities generated by graduates in humanities and similar fields, government funding is justified

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Session 4 Slide # 32
Q 1: Are toll roads unfair (a) to poor people? (b) to longdistance commuters who live in rural areas? Points to consider: Are there alternatives (toll-free roads)? Why should taxpayers subsidize lifestyle choices (living in the country and working in the city)? Lower-income people have lower opportunity cost of time and are likely to prefer the toll-free (but slow) road Higher-income people have high opportunity cost of time and are likely to prefer the toll road (and pay for the privilege)
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Session 4 Slide # 32 (cont.)

Q 2: Are tolls effective in reducing congestion? The congestion charges in Central London (England) have been almost universally acclaimed as a success The private autoroutes in France are expensive, but very high quality four-lane highways

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Session 4 Slide # 32 (cont.)

Q 3: Other potential applications of peak-load pricing? Telephone companies Airport landing fees

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