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.
One should differentiate between the demand for a good generally and the demand for a good from a particular producer. Think about the market for holiday apartments in Upper Styria (at some time of the year). As we discussed before we would expect that the demanded number of apartments will depend on the price of these apartments, the lower the price the more people would be interested in renting a holiday apartment. I don’t quite know what the slope (or shape) of this demand function is exactly, but we would expect to be properly downward sloping (as a function of the price).
Suppose you observe different prices for the same good at different times. Why would that be? How can we explain this? In fact there are lots of possible explanations for this, but they can mostly be grouped into two categories of explanations: explanations based on changes of the demand(function) for the good and explanations based on changes of the supply(function) for the good. [Another explanation could be that there are changes in the market structure, which is a point I will get to in a later lecture.] Let me give you what I believe are good examples for the two cases. First, Styrian white wine in different years. Second, Upper Styrian hotel rooms and apartments in winter versus summer.
Consider a pop music concert. For reasons that we do not necessarily have to go into, pop music stars do not always want to charge the highest possible (single-concert profit-maximizing) prices for tickets to their concerts. In fact ticket prices are often so “low” (I still find them rather expensive) that many more people would like to go to the concert (at these prices) than there are tickets. The economic term for this is that tickets are being “rationed”. What is the result of such rationing?
If tickets are sold offline in a single “brick-and-mortar”, as people like to say, ticket booth, then we get long queues and people starting to queue at 2am of the morning of the day ticket sales begin or they even get there earlier and camp out with sleeping bags. If the selling is done online, then you have about one second in which you can buy your ticket, with many people with a slower internet connection missing out. Is the final ticket allocation in such cases of rationing Pareto-efficient? Think about it.
When people say that markets are efficient then they mean the notion of Pareto efficiency I provided in a previous post: An allocation is Pareto efficient if there is no other allocation that is a Pareto improvement. An allocation is a Pareto improvement over another allocation if the former is at least as good as the latter for everyone involved and strictly better for at least one person. As we saw, Pareto efficiency has nothing to do with fairness. If I have everything there is to be had in the world and I want to have all this stuff then this is Pareto efficient. Because any other allocation would require me to give up something and, as I do not like to do this, this other allocation is not a Pareto improvement because I am not as happy as before.
This is a joke that I heard many times and once on a big stage at the 2014 annual meeting of the Verein für Socialpolitik where some supposedly important person from a supposedly important central bank (if I recall correctly) used it as a criticism of current economic methodology (as this person understood it) and generalizing it to mean it as a criticism of any economic methodology that uses math (if I understood this person correctly).