In the last few days, I watched the British news a bit about Boris Johnson forming the new UK government. There was of course a lot of talk about the Brexit negotiations. I was a bit puzzled at one point about some of Boris Johnson’s statements. On the one hand there is a lot of talk about being prepared for a hard Brexit and on the other I also heard him say something like that “the chance of a hard Brexit is one in a million” a little while back. So why prepare for some contingency that you do not expect to happen under essentially any circumstances? Also you get the feeling that Boris Johnson, despite having said that, would not so much mind a hard Brexit. In this short post, I explore why all this might actually all make good game theoretic sense (and why perhaps, at least for this matter, his UK opponents should get on board with his strategy if they care about the UK unless, of course, they think they can still stop Brexit).
In what sense does Google “hold back” its products?
In this series of short posts I give you my personal opinion (as it is at the moment) and my reasons for this opinion about how good or bad I believe different monopolies to be. I am planning six mini-case studies of monopolies. When I talk about a monopoly in this post I simply mean a firm that has some power over its price: it can choose a lower price and sell a bit more (but not super much more) or a higher price and sell a bit less (but not super much less). A firm with such a power will typically – see a previous post – choose a higher price and sell less than would be Pareto-efficient. And this way such a firm will typically make “abnormally” high profits. While all this is probably true in all six cases, I am, for various reasons, in fact not equally worried about every one of these. I want to discuss the following six “monopoly” cases: Coca-Cola (or Red Bull), Google, Facebook, Scientific Publishers such as Elsevier (possibly also publishers of €100 textbooks such as Pearson), the OPEC cartel of a set of oil producers, and pharmaceutical companies (such as Novartis). This one is about Coca-Cola, and applies equally to Red Bull.
Economists tend to think that competition between firms is a good thing. In fact most countries (all?) have some anti-trust regulation in some form or another. Anti-trust means against “trusts”, where trusts are here meant to be cartels (groups of firms) that collude especially by determining prices together and thus avoid competitive pricing. But how would competition improve matters in the first place?
What if you, as a producer or at least seller of some good, face a “flat” demand function? With “flat” demand function I mean any demand function that has a non-infinite slope, that is any demand function where you can vary the price a bit and this does not immediately lead to a demand of more than you can provide (at a slightly lower price) or a demand of zero (at a slightly higher price). This means that in such a case you could choose a price, and different prices will have different consequences for you but also for your consumers.
To fix ideas consider the following situation. You are in charge of a student organization and you are trying to do a bit of fundraising. You are thinking of showing a movie in a university lecture hall at reasonable ticket prices to students. You have convinced the university that they let you have a largish lecture hall with 500 seats for free. You only have to pay for the cleaning cost, which say amounts to €200. You also have to pay for the right to show a movie, which say amounts to €500. You have otherwise convinced some of the other members of the student organization to help with ticket sales, advertising, and other matters, for free. The key question for you is now, what to charge the students for the tickets?
My students have played a short supply and demand experiment in class this year. The experimental design goes back to the work of Chamberlin (1948, JPE) and Vernon Smith (1962, JPE). I have used the beautiful online design developed by Heinrich Nax, Diego Gabriel Nunez Duran, and Bary Pradelski at the ETH Zürich. I ran three sessions and had 60 students participating in each. I am afraid I did not pay any money, so if you are interested in the experiment you may want to go back to the original Vernon Smith (1962) experiments and the literature that followed, in which subjects are almost always given (some) monetary incentives. The results I got with my students were not that different, however, to what researchers found with monetarily incentivized students.
This is to demonstrate the usefulness of the ideas from the last post. When Air Berlin went out of business in 2017 the prices for Lufthansa flights increased substantially (up to 30%). I have this from a news article from the ORF from the 26th of November 2017. Lufthansa, according to this article, claimed that this has nothing to do with them, it is simply a question of an increase of demand and as a consequence that their automated ticket booking system simply more quickly leads to higher price categories. Apparently Lufthansa uses up to 26 price categories (for the same seats). Which category you get depends on when you book your ticket and how full the plane is already and possibly some other things. This is actually a topic for another class – on price discrimination. But let me here only explain in which sense Lufthansa’s statement is right and wrong at the same time, or at the least on how one should perhaps read their statement.