Friday, April 15, 2016

OPEC Oil Cartel and Game Theory

In Principles of Microeconomics and a few other courses that I teach I use a simple game to examine the incentives of players to behave cooperatively and non-cooperatively.  In the classic Prisoner's Dilemma, both players have an incentive to play cooperatively together in the sense that they will earn more than if they each play non-cooperatively.  Yet, we would expect each to play non-cooperatively - hence the dilemma.  The Wall Street Journal has a good article on exactly that within the oil production output decisions by the members of OPEC.  If all the members agree to restrict output, then profits to the members will be higher than if all the members increase their output beyond the proposed agreement, since as output increases prices fall.  This is exactly what was happening at the time the article linked above was published.

Monday, February 22, 2016

Chinese Price Ceilings and Prescription Drugs

The Wall Street Journal reports that China will be removing price controls on prescription drugs.  As demonstrated in Prin. of Microeconomics, price controls (price ceilings) result in a decrease in output produced by firms and while they may increase consumer welfare (depending on the impact of the difference between the gains consumers receive from lower prices and the losses consumers face from less consumption); price ceilings are welfare (i.e. economic well-being to society) reducing.  The article above points this out as competition will likely increase due to the removal of price ceilings and thus put downward pressure on drug prices.

Tuesday, February 2, 2016

India's Diesel Pricing Policy Change

The Wall Street Journal reports that India has changed their diesel fuel pricing policy and moved from a pricing policy that is essentially a per unit subsidy to letting diesel prices being determined by market forces.  In Principles of Microeconomics I examine the economic welfare of a per unit subsidy and show that while producers and consumers are better off in terms of surplus that the government is worse off, and that the loss to the government is greater than the aggregate gains to the consumers and the producers.  Given the substantial expenditures that the government of India is incurring, the policy is changing from government administered pricing to market driven pricing.

Saturday, January 30, 2016

Cotton Prices Fall due to Changes in Demand and Supply

The Wall Street Journal reported that cotton prices were falling due to changes in demand and supply.  Specifically, decreased cotton demand by China and increased US cotton supply pushed prices down as predicted with the demand and supply model presented in Principles of Microeconomics.

Tuesday, November 3, 2015

Ownership Changes and Pricing

One of the topics in Industry Analysis revolves around horizontal mergers and also the incentive that exist in firms acquiring other firms in the same industry.  In many instances expected gains in profits are unrealized as demonstrated in class.  Here is an alternative example, where firms in the same industry are acquiring rival firms and simultaneously making a profit by changing the prices of the products.  Pharmaceutical companies are raising prices on acquired firms products and this is increasing the profits of the purchasing firms.  It is cheaper than developing new pharmaceutical drugs and thus more profitable.

Thursday, October 22, 2015

Iron Ore Mining

The Wall Street Journal reports that even though iron ore prices are falling and the demand for iron ore to slow that the three largest iron ore miners are increasing production.  This seems inconsistent with the profit maximizing model - and it is.  Yet it is also strategic and is consistent with the limit output model of Cournot oligopoly.

Basically the limit output model looks at whether a firm (or group of firms such as in this case) can increase output such as to limit the amount of output that their rivals produce (in the extreme case drive the rival firms out of the market).  Since the firms are choosing the amount of output to produce this is consistent with the Cournot oligopoly model.

For this to work, the incumbent (or in this case the larger firms) have to have greater economies of scale than their rivals - which seems to be true as the larger firms have lower average variable costs than smaller iron ore mining firms.  Thus as discussed in class - here is an excellent example of firms trying to increase their profits by increasing production such that other firms decrease their production.  Having lower average variable costs can still result in greater profit even with falling prices due to increases in the firms production offsetting the decline in margins.

Friday, October 2, 2015

Rubber Cartel

OPEC is the most famous cartel, but there is also a cartel for rubber.  In February 2014 this group urged members to restrict output due to low rubber prices but by November of 2014 the agreement had broken down due and prices started to fall again.  This is a classic example of the prisoners dilemma.  It would be more profitable if collectively all the producers would restrict output as opposed to all the producers to increase output.  Yet, if only one were to increase output and all the others were to reduce output, then profits for the "player" who increased output would increase even more than if they reduced output; and this is true for all the players.

Thus firms can collectively increase profits if all agree to the output restriction, but individually each has an incentive to break the pledge as their profits will be greater independent of what their rival does.