globalization, technology, and real-world competition chapter 14

Globalization, Technology, and Globalization, Technology, and Real-World Competition Real-World Competition


Chapter 14Chapter 14

The Goals of Real-World Firms

• Is it reasonable to assume that all firms are profit maximizers?

• Firms care about both short-run and long-run profit.

The Goals of Real-World Firms

• They must be profit maximizers in the short run as well as the long run.

• Any expenditures on good will and good reputation can increase long-run profits but reduce short-run profits.

The Problem With Profit Maximization

• Problems with the profit maximization model when applied to the real world:– Decision-makers’ income is often a cost

to the firm.– Most real-world production takes place

in large corporations rather than in owner-operated businesses.

Manager’s Incentives

• Managers' incentives are not always to maximize the firm's profit.

• Self-interested decision makers have little incentive to hold down their pay unless someone sees to it that they do.

Manager’s Incentives

• Just because the firm ostensibly is profit maximizing does not mean that individuals hired by the firm are also profit maximizing.

• Most firms put pressure on managers to make at least a predesignated level of profit.

Need for Monitoring

• Economists recognize that individuals hired by the firm may not have an incentive to maximize the firm's profit.

• Economists call it the monitoring problem – the need to oversee employees to see that their actions are in the best interest of the firm.

Need for Monitoring

• The monitoring problem is now a central problem focused on by economists who specialize in industrial organization.

Need for Monitoring

• Economists who specialize in industrial organization study the internal structures of firms and look for incentive-compatible contracts.– Incentive-compatible contract – a

contract in which the incentives of each of the two parties to the contract correspond as closely as possible.

Need for Monitoring

• Self-interested managers are only interested in maximizing the firm’s profit if the structure of the firm requires them to do so.

Need for Monitoring

• High-level managers can pay themselves very well when appropriate monitoring is not in place.

– American managers receive significantly more than their Japanese counterparts but less than rock and sports stars.

What Do Real-World Firms Maximize?

• Some real-world firms focus on maximizing profits while others emphasize growth in sales or cost-reductions to increase long-run profits.


• Other firms do nothing at all.

– Joan Robinson called these firms lazy monopolists – firms that do not push for efficiency, but merely enjoy the position they are already in.


• When Robinson coined the term “lazy monopoly,” firms faced mostly domestic competition.

• Today they are a bit less lazy because they face global competition.

The Lazy Monopolist and X-Inefficiency

• Lazy monopolists are not profit maximizers.

• They see to it that they make enough profit so that the stockholders won’t complain, but do not push as hard as they could to keep their costs down.


• The result is what economists call X-inefficiency – firms operating far less efficiently than they could technically.


• Such firms have monopoly positions, but they do not make large monopoly profits.

• They simply make a normal level of profit because inefficiencies cause their costs to rise.


• Competitive pressures faced by lazy monopolies places a limit on their laziness.


• If all firms in the industry are inefficient, they can remain profitable.

• If a new firm aggressively challenges the status quo, or if the industry is opened up to international competition, they must quickly make themselves competitive by restructuring.


• Corporate takeovers, or simply the threat of a takeover, can improve a firm’s efficiency.

– A corporate takeover occurs when another firm or a group of individuals issues a tender offer to gain control and to install it own managers.


• The threat of a corporate takeover provides competitive pressure on firms to maximize profits.


• Nonprofit organizations (hospitals, universities, libraries, and jails) often display lazy monopolist tendencies.

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Motivations for Efficiency Other Than the Profit Motive

• Some individuals derive pleasure from efficiently run organizations.

• Employees in some nonprofit organizations build their success on their employees’ pride in their jobs, not on their profit motive.

Motivations for Efficiency Other Than the Profit Motive

• Economists generally believe that holding down costs without the profit motive takes stronger willpower than most people have.

Fight between Competitive and Monopolistic Forces

• Self-seeking individuals do not like competition for themselves although they love it for others.

• When competitive pressures get strong, individuals often fight back through social and political pressures.

• This is none other than rent-seeking behavior.

Fight between Competitive and Monopolistic Forces

• Real-world competition is a process.

• It is a fight between the forces of monopolization and the forces of competition.

How Monopolistic Forces Affect Perfect Competition

• Monopolistic forces affect perfect competition..

• Laws have been enacted that prevent firms from charging too low a price!


• The U.S. has a myriad of laws, regulations, and programs that prevent agricultural markets from working competitively.


• U.S. laws and social mores simply do not allow perfect competition to work because government emphasizes other social goals besides efficiency.

Economic Insights and Real-Word Competition

• Economics provide insights to real-word competition.

• The move away from perfectly competitive markets could have been predicted by economic theory.

Economic Insights and Real-Word Competition

• Suppliers introducing restrictions on entry seldom claim that the reason for the restrictions is to increase their income.

• Usually they couch their arguments for restrictions in terms of the public’s good.

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How Competitive Forces Affect Monopoly

• Although perfect competition does not exist in the real world, it does not mean that competition does no exist.

• Competition is fierce.


• Competition is so strong that it makes perfect monopolies as rare as pure competition.


• Competitive forces work to break down monopoly.

• It is almost impossible to prevent other firms from entering the market.


• Would-be monopolists try to break down the monopoly through political or economic forces.


• For example, potential competitors will get around the patent by developing a slightly different product or by working on a new technology that avoids the monopoly but satisfies the relevant need.


• Establishing an initial presence in a market can be more effective than obtaining a permit when trying to extract monopoly profit.


• Another way competitors gather information about competing products is reverse engineering.


• Reverse engineering means the buying another firm’s product, disassembling it, figuring out what is so special about it, and then copying it within the limits of the law.

Competition and Natural Monopolies

• In some industries it is less costly for one firm to operate than for more than one firm to operate.– Such industries are called natural

monopolies – industries that enjoy strong economies of scale so average costs are continually falling.


• It can be demonstrated graphically that as the number of firms in a natural monopoly increases, the average cost of producing a fixed number of units also increases.


• Since these industries can make large profits, there are calls for government regulation of these monopolies to prevent their "exploitation" of the consumer.

Regulating Natural Monopolies

• Many natural monopolies are regulated.

• In the past, pressure to regulate these natural monopolies has been stronger than competitive pressure to lower prices.


• Regulated natural monopolies have been given the exclusive right to operate in the industry.

• In return, they have had to agree to have the price they charge and the services they provide regulated by regulatory boards.


• Regulatory boards control the price that natural monopolies charge so it will be a fair price.

• A fair price is defined as one that includes all costs plus a normal return on capital investment (a normal profit, but no excess profit).


• When firms are allowed to pass on all cost increases to earn a normal profit on those costs, they have little or no incentive to hold down costs.


• To fight the tendency to pass on every cost, regulatory boards must screen every cost and determine which costs are appropriate and which are not.


• Once regulation gets so specific that it is scrutinizing every cost, the regulatory process becomes extremely bureaucratic, which itself increases the cost.

Deregulating Natural Monopolies

• Some economists argue that even in the case of natural monopolies, no regulation is desirable, and that society would be better served by direct competition.


• Many former natural monopolies are being deregulated.


• In the 1980 and 1990s deregulation and competitive supply of both electric and phone service grew.

• Many states have adopted provisions to open their electricity markets to multiple providers.


• To say that the electric power industry has been deregulated is not quite correct.

• Only the portions of the market where competition is likely to exist are being deregulated.

How Firms Protect Their Monopolies

• Firms do not sit idly by and accept competition – they fight it.

• Firms protect their monopolies by advertising and lobbying, producing products as nearly unique as possible, or by charging low prices.

Cost-Benefit Analysis of Creating and Maintaining Monopolies

• Cost-benefit analysis can be used to decide to create and/or maintain monopolies.


• Economic theory suggests that if firms have to spend money to create and protect their monopoly, the higher the cost, the less monopoly they will “buy”.

• They will buy monopoly until marginal cost equals marginal benefit.


• Examples of firms spending money to protect or create monopolies are in the news every day.


• Farm lobbies fight to keep quotas and farm support programs.

• Drug companies spend a of money researching drugs they can patent.

• Owens-Corning spends millions to promote its pink fiberglass.

Establishing Market Position

• Establishing market position is important in today's economy.

• Some economists argue that today's economy is becoming more and more like a monopoly because of the importance of brand names.

Establishing Market Position

• Modern competition can be a "winner take all" competition.

• Because of brand loyalty, patent protection, or simply consumer laziness, the winner who achieves a monopoly can charge significantly higher prices without facing competition.

Driving Forces in Today’s Economy

• Modern competition is different because of globalization and technology.

Globalization

• Globalization has two effects on the competitive process.

• It increases the size of the gain for the winner and it makes it much harder to win.

Globalization

• The rewards for winning globally are much larger than the rewards for winning domestically.

– This is a positive effect.

• Globalization increases competition in an economy.– This is a negative effect.

Globalization

• Globalization increases competition by allowing greater specialization and division of labor, which, in turn, increases growth and improves the standard of living for everyone.

Globalization

• Globalization can lower costs by allowing firms to move operations to countries with a comparative advantage in a production process.

Surviving in a Global Economy

• Firms are breaking down the production process in order to survive in the global economy.


• Firms may keep production within the company, but parcel out portions of the production process to different parts of the world.


• Or they may simply out-source that part of production that can be done more cheaply by firms in other companies.


• Global competition helps to keep down relative prices and wages paid to the factors of production.


• The high prices U.S. lawyers charge are hard to attack in a global market because there is virtually no uniformity in the laws nations have.

• On the other hand, manufacturing is quite susceptible to foreign competition.

Does Globalization Eliminate Jobs?

• To some degree globalization eliminate jobs in the U.S. – but technology also creates jobs.


• U.S. firms, even small ones, see themselves as global companies and are structuring themselves to compete in the global market thus putting them in a better position to sell their products.


• Expanding global markets increase demand for those aspects of production that are still U.S. based.

• This has helped keep demand high for U.S. goods, and hence has increased the demand for U.S. labor.

Technology

• The second major driving force in the economy in recent years has been technological development.

• Technological development – the discovery of new or improved products or methods of production.

Technology

• Technological advances and globalization go together.

• Technological advances require large investments of time and money in very specialized areas.

Technology

• Globalization allows for that specialization and the possibility of large revenues to fund research.

Technology

• Specialization allows producers to learn more about the particular aspects of production in which they specialize.

Technology, Efficiency, and Market Structure

• What causes technology to grow?• Technological advance requires

market incentives.


• Globalization of the economy provides an even greater incentive to develop new technology since a world market is infinitely larger than a domestic one.


• Are some market structures more conducive to growth than others?

• Perfect competition leads to efficient outcomes.

• All other market structures lead to dead-weight loss.


• The supply/demand framework does not consider technological issues.

• It assumes technology is unchanging or unaffected by market structure.


• If market structure does affect technology, another type of efficiency must be considered.

• This is called dynamic efficiency – the market's ability to promote technological change.


• Viewed in this manner, oligopoly provides the best structure for technological advance.

Perfect Competition and Technology

• Perfectly competitive firms have no incentive to develop new technologies.

• They earn no profits to fund research.• Even if they did innovate, competitors

would gain from the new technology without having to pay for it.

Monopolistic Competition and Technology

• Monopolistic competition is somewhat more conducive to technological change since they have some market power.

• But they also lack long-term profits.

Monopolistic Competition and Technology

• Easy entry would limit their ability to recoup their investment in technological innovation.

• Through its support of patents, the U.S. does provide some incentive to innovate.

Monopoly and Technology

• Monopolists have the profits but seldom have the incentive to innovate.

• Their market is protected from entry, so the easiest path is the lazy monopolist path.

Monopoly and Technology

• Since nearly all pure monopolies are created by government action, monopolists do not face the threat of new competitors.

Oligopoly and Technology

• Oligopoly is the market structure most economists feel is most conducive to technological change.


• Oligopolists realize ongoing economic profit thus they have the money to carry out research and development.

• The belief that its competitors are innovating, forces them to do so as well.


• Not all economists agree that oligopoly is conducive to technological change.

Network Externalities, Standards, and Technological Lock-in

• Network externalities, standards, and technological lock-in support the view that technology determines market structure.


• A network externality occurs when greater use of a product increases the benefit of that product to everyone.


• Network externalities are important to market structure because they can lead to the development of industry standards.


• Standards become important because network externalities involves the interaction among individuals and processes.

Standards and Winner-Takes-All Industries

• Network externalities increase the likelihood that an industry becomes a winner-takes-all industry.


• As network externalities broaden the use of the product, the need for a single standard becomes more important and eventually one standard wins out.


• The firm that gets its standard accepted as the industry standard gains an enormous advantage over other firms - it dominates the market.

First Mover Advantage

• First-mover advantage is important when standards are important.

• There is a strong incentive to be first in the market since their standard may be the standard for the industry.

First Mover Advantage

• Firms are willing to take huge losses initially since the future payoff may be huge.

Technological Lock-In

• Technological lock-in is the result of network externalities.

• Economists debate how standards can be inefficient and yet be maintained by the first-mover advantage.


• QWERTY is a metaphor for technological lock-in – when prior use of a technology make the adoption of subsequent technology difficult.


• The QWERTY debate is part of a larger debate about the competitive process and government involvement in that competitive process.


• Those who emphasize the standard economic framework see government involvement as necessary to protect the economy and the consumer.

• This is called the nudging hand approach.


• Those who see the competitive process as central are less likely to support such a role for government.

• Each case must be decided on its own merits.



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globalization, technology, and real-world competition chapter 14

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