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Economics of Markets and Organizations Week 7 Summary
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Economics of Markets and Organizations Week 7 Summary including readings
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Week 7:Preparation: Chap 16: The value of
commitment.
In a Principal-Agent setting, the principal may establish commitment by signing a
binding contract with the agent in which she ensures the agent that he will
obtain a bonus if he works hard.
In markets, early entrants may establish first-mover advantages allowing them
to commit to aggressive behavior once a newcomer enters. First movers can
benefit from:
- Building overcapacity: because the costs of overcapacity are sunk at the
point of entry, the incumbent has no reason to withdraw. (Stackelberg
model)
- Technology leadership: sustainable comparative advantage in technology
makes unit production cost falling or make difficult to catch the advances
in product or process technology.
- Preemption of assets: preventing rivals from acquiring scarce assets.
- Buyer witching costs.
Despite that, there is numerous disadvantages that can mitigate or even reverse
the positive net gain that the incumbent might derive:
- Imitation costs are usually lower than innovation costs.
- Late movers can gain an edge through resolution of the market or
technological uncertainty.
- First movers may also suffer from inertia, might appear to be locked into a
specific set of fixed assets, may be reluctant to cannibalism, or become
organizationally inflexible.
The Stackelberg model is a dynamic game consisting of two stages:
- The first firm decides on its production capacity q s
- The second entrant decides on its production capacity q C after having
observed the first firm’s choice qS;
Commitment can also be important in bilateral trade.
“Hold-up”: if a party engages in an action to exploit his trading partner’s
dependence.
In general, it arises if two trading partners refrain from establishing an efficient
outcome because one of the parties fears being forced to accept
disadvantageous terms.
Chap 17: Make or
Buy
Firms in the vertical chain of production may prefer vertical integration over
vertical separation for several reasons:
- Integrating vertically may avoid double marginalization: in the case of two
monopolies, both will add a profit margin to MC, resulting in a higher price
than if the two firms were integrated: they can increase their joint profits
by merging into one firm.
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