SuperSavings - Assignment Example

Assumptions for Questions to 6. SellItAll is represented by SIA SuperSavings is represented by SS All the figures in the pay off matrix are in Million Euros. Ans 1) Please refer to the below figure for question 1. Company and strategy SuperSavings ( Normal Price) SuperSavings ( Price cut) SellItAll ( Normal Price) A .1 .1 B 1.5 .03 SellItAll ( Price cut) C .03 1.5 * D .05 .05 Figure 1 Payoff matrix for the firms for various strategy combinations. Cell A represents the strategy combination such that SIA and SS both keep the prices as normal. Cell B represents the strategy combination such that SIA keeps the price as normal and SS cuts the price. Cell C represents the strategy combination such that SS keeps the price as normal and SIA cuts the price. Cell D represents the strategy combination such that both SIA and SS cut the price. Ans 2) Considering the given two assumptions SS will have to consider what SIA would do in order to decide the best strategy for itself but since there is no way to exactly find that out, it will have to make a guess. Apart from this looking at the payoffs of various strategies, It realizes that choosing to reduce price will offer it a higher payoff than the payoff it would get if it were to choose keeping the prices same, in response to the two potential strategies open to SIA. Which means if SS chooses reducing the price it gets 1.5 and .05, when SIA chooses to either keeping the price constant or reducing it. The payoff for SS will be .1 and .03, if it chooses to reduce the price in conjunction with two different strategies by SIA. SS will think that SIA would also apply the same logic and thus would consider reducing the prices and for that strategy of SIA the best strategy for SS will be to reduce the prices. Ans 3) Yes there exists Nash equilibrium (Non-cooperative equilibrium) as the firms will not cooperate or collude as there can be no legally binding contract among them to keep the prices same and in absence of which each firm would fear that even if keeping price normal offers highest pay out overall and higher than what they would get in case they don’t cooperate, the other firm may cut the price an take the market share away from the firm keeping price normal. Thus both firm fearing this would play safe and reduce the price. The combination of these two price cutting strategy by both the firm will entail a Nash equilibrium which is represented in cell D. Ans 4) No they are not likely to achieve their best outcome which would have been in cell C and B for SIA and SS respectively. In fact they would have been happier in cell A also but the irony is, fearing that they might be suckered by their competitor, they will avoid reaching such outcome and settle for the one that offers them utmost safety and not payoff. Ans 5) Repeated games can be classified in two categories finitely repeated and infinitely repeated. In the former case the number of games is fixed and each player is aware of such number, while in the latter the number of such repetition is not known. In repeated games the firms may achieve cooperative equilibrium as each firm can punish the other one for suckering it in the next game and thus “Tit for tat” plays out which leads to cooperation in repeated games. Each firm over a period builds a reputation and they start trusting each other. But in case of finite games the theoretical understanding says they will not cooperate as in the last game both would like to defect and since in the last game no cooperation is expected in the second last game both would also like to defect and working backwards in similar fashion we can see that in the first game also they will defect. But in the infinitely repeated games this will not hold as the firm may not know that it is going to play again and thus would fear punishment of defecting and hence would cooperate. But the theoretical concept of finite games having non cooperative strategies has not been empirically proven in fact the opposite has been proven empirically i.e. even in finite games players do compete. Ans 6) The rational strategy in this situation is again to compete. Since both of them know that they can’t be punished in the 6th round as there is no 6th round, they will likely defect in the 5th game. Since they expect to defect in the 5th game they will realize there is no use in cooperating in 4th also as they know the other will defect in 5th game. The similar rational can be brought back and we can come to 1st round where they will compete as they know they open to defefction in the 2nd game because they know they risk defection by the other party in the third game and so on. Q 2) James H and Johnson D (2000) said “We assert that the only relevant economic standard of any regulatory policy should be whether the particular regulation or policy regime is market-enhancing or market-debilitating over time.” Thus the major focus of the policy should be on whether the policy brings in efficiency in the market both in the short and long run or it does the otherwise. But the focus should be on both the customers and the businesses as in a society the customer and businesses can be separated. If a decision hurts businesses it will have its negative impact on customers on. If a policy enables businesses to reduce their cost, innovate continually, increase product variety, and improve quality. Thus policy should also focus on properly structured property rights, reduced transaction and information costs and development of core competencies and economies of scale and scope. Conduct regulation may also restrict the ability of firms to exploit core competencies or to lower costs by capitalizing on potential economies of scale and scope, particularly in the case of behavioral prescriptions The SCP model The SCP model suggests that in any industry the ultimate outcome is determined by the structure of it and the conduct of the firms in the industry. In other words it is the structure of the industry, determined by concentration and barriers to entry that determines the conduct i.e. pricing and other behavior of the firms in the market. And the conduct of the firms ultimately determines the performance of the industry which is defined in terms of how much efficiency and technological progress does it generate, which are the determinants of contribution of an industry towards society. The allocative efficiency is the result of producer’s and consumer’s surplus. When the producer sells the product at a price above its MC it enjoys surplus and when customers are willing to pay Price P for a product while they can purchase them at a lower price then it leads to consumers’ surplus. In a perfectly competitive market since MC has to be equal to AR (P), as profit maximization condition requires MC = MR and for a perfectly competitive firm given it inelastic demand curve MR =AR = P. Thus MC = P ensures that producer does not get any surplus but it creates a huge amount of surplus for consumers. In the above figure the surplus for the customer, when the price is perfectly competitive (Pc) will be given by APcE. While there will be no producer’s surplus. But in case of monopoly price Pm the surplus of the customer will be just triangle PmAB while producer’s surplus would emerge and will be blue rectangle PmPcGB. While the area reflected by red Triangle GBE will be a net loss to the society (APcE – PmPcGB). Thus a monopoly reduces efficiency in an economy. The net loss is called as deadweight loss. The SCP as a basis of “Antitrust policy” The SCP model is static in nature and thus does not fully recognize the market-enhancing or market-debilitating effects of many regulations over time. It takes a static view of the economy where technology, macro product markets, and the cost-minimizing productivity choices of firms are stable and either will not change, or will change in predicted ways, as a result of regulatory initiatives. According to the structure-conduct-performance (SCP)model, a concentrated industry will either be caused by , or cause , the anticompetitive behavior of firms within the industry, which ultimately results in to restricted output, higher prices, and the possibility of excessive profit rates for the industrys dominant firms, thus reducing efficiency from the economy. The merger guidelines which were based on SCP paradigm, followed by the Justice Department in enforcing the Sherman and Clayton Antitrust Acts, for example, presumed that market structure i.e. market power, and thus the expected conduct of firms with significant market power, can be estimated by concentration ratios and other measures of industry structure (Mueller, 1996). As a basis for evaluating antitrust policies, the SCP model, emphasizing on concentration ratios, relevant markets, and other structural measures, often leads to contradictory conclusions about long run behavior of the market. The reasons are first, that there is no common definition of the boundaries of a market as suggested by White (1999), which is crucial in evaluating the presence of market power and in identifying the nature and extent of market failure. Second, even when the first problem is taken care of, concentration ratios and other structural market measures may not be meaningful in dynamic environment which is characterized by fast changing organizational and technological landscapes as Williamson (1968) proposed. In rather dynamic environments, the development and extension of production capabilities and the innovation of new products and process innovations continually alter the nature of entry and exit barriers. Thus the policy proposals essentially based on SCP paradigm are inflexible and not conducive to cross-substitutability. While regulating the business conduct through antitrust policies, based on SCP model that aims to prohibit behaviors which can, under certain situations, be justified on efficiency grounds, and also fails to allow taking advantage of technological advancements and exploiting core competencies in new or expanding markets. Harold Demsetz (1973) also argued that there are many risks of decreasing efficiency through the use of anti merger policies. The risks may be reducing efficiency either by the penalties that are placed on innovative success by such policies or by shifting the output from larger to smaller, higher cost firms that are brought about by anti-merger policies. This would seem to be a distinct possibility if large firms in concentrated industries earn higher rates of return than small firms. Thus in his view such antitrust, anti merger policies have more potential for reducing the efficiency rather than enhancing it in the economy. Schumpeter through his theory of innovation also suggested that in any market, innovation is possible only when a firm gains sufficient market power and is able to generate revenues in excess to its cost and the difference is sufficiently large for it to plough back it in to R&D to innovate. These innovations that a monopolist will bring about in the market will help in increasing efficiency in the market. For example if a drug company is not assured of monopoly power over the drug market for some time, it will not spend on R&D and thus would not innovate. Thus by reducing innovation we may be depriving the society of its deserved new improved goods and services, which could have brought about more efficiency in the market. Putting the case of GE – Honeywell failed merger in to above discussion. The decision taken by EC seems to be highly based on SCP paradigm. The view that GE-Honeywell after merger would become such a big entity that it will restrict competition in the European market is not in line with what economists today suggest. The SCP model has already drawn so much criticism. The EC’s preoccupation with keeping competition alive may actually deprive European people from enjoying the lower cost and innovative products that GE-Honeywell would have produced due to its massive strengths. Although we see in the above discussion of SCP model that a monopolist would keep the prices high will generate his own surplus at a much higher cost( than monopolist’s gain) to the consumers and thus will ultimately reduce efficiency in the economy. But this model, as discussed above fails to take in to consideration the dynamic nature of the aerospace industry and thus discount the innovation potential of such a big firm. It also fails to recognize the fact that this anti merger diktat on GE – Honeywell also precludes the cost reduction by GE- Honeywell and later enjoyed by the industry and consumers. It would have brought about further efficiency in the market. Conclusion – The consideration of efficiency and/or equity to complement the policy prescriptions of the Structure-Conduct-Performance model as a guide to policy decisions about mergers between large firms is not bad per se. The problem lies in the static and narrow view of the SCP model itself that it fails to consider the other positive effects of a merger which could be innovation, reduction in cost etc which also have great potential to enhance efficiency in an economy. In fact regulators must employ some other better framework like BCA regulation James H Johnson D (2000) to evaluate such anti merger policies. References Demsetz H. (1973) ‘Industry Structure, Market Rivalry, and Public Policy’, Journal of Law and Economics, Vol. 16, No. 1. pp. 1-9. James H. and Johnson D. (2000) ‘Understanding Regulatory Environments and their Impact on Economic Change’ pp. 1-19 Mueller, Dennis C., (1996) ‘Lessons from the United States Antitrust History,’ International Journal of Industrial Organization, 14, 415-445 White, Lawrence J., (1999) ‘Wanted: A Market definition Paradigm for Monopolization,’ working paper #CLB-99-002, Center for Law and Business, New York University Williamson, Oliver E., (1968) "Economies as an Anti-trust Defense: The Welfare Trade-offs," American Economic Review, 58, 18-36. Read More