ECO550 Week 7 Discussion Board 7

Predicting Price-Setting Strategies

• FromthescenarioforKatrina?sCandies,determinetheimportanceofpredictingthepricingstrategiesofrivalfirmsinanindustrycharacterizedbymutualinterdependence.Examinethecommonpricesettingstrategiesofairlinesthatusegametheory.Predictthepotentialeffectsofsuchpricingstrategiesonthedemandforseats,andconcludetheresultingimpactontheprofitabilityoftheairlines.

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During the Weekly Scenarios Herb Jones, a graduate student and part-time data analyst, together with other key members of Katrina's Candies will work together on projects related to managerial economics and globalization. ECO550 Week 7 Scenario Script: Best-Practice Tactics, Game Theory, and Pricing Techniques and Analysis Slide # Scene # Narrations Slide 1 Scene 1 An older cottage style family run business (Katrina's Candies) Slide 2 Scene 2 Gigi: Good Afternoon, Herb! In Gigi's office where Herb explains to Gigi why a large company like Katrina's Candies cannot ignore industry rivals and why predicting rival responses is an important determinant of decisions Katrina's Candies makes. Herb: Hello, Gigi. Gigi: I called you into my office today to talk about rival behaviors in our chocolate market. I had a couple of questions pertaining to this subject. My first question is, based on your time with Renee, what kind of market structure does Katrina's Candies operate in? Herb: Renee and I determined that its Chocolates operate within an Oligopolistic market structure, and we noted that there are only three firms in our market that are larger than Katrina's Candies. Gigi: This market classification means that the market has consolidated over the past fifteen years. When I started working here, there were a lot of other candy manufacturers and the market seemed to feature more monopolistic competition. Herb: Perhaps the trend towards healthier life-styles was too much for those firms that left the market; Felicia Dixon 10/31/2016 9:08 PM Formatted: Left especially burdensome is the higher cost associated with innovating products just to be able to stay in the market. Therefore, it's good Katrina's Candies was able to survive the adjustment that took place in the market. Gigi: I couldn't agree more, Herb. All of its employees have helped maintain our competitive posture so farfrom management to employees working on the manufacturing side of the operation. We'll just have to repeat the effort we organized.. We ignored all of the other chocolate manufacturers and focused our efforts on making good chocolate. We should implement a similar strategy now. Slide 3 Scene 3 In Gigi's office where Herb explains to Gigi why a large company like Katrina's Candies cannot ignore industry rivals and why predicting rival responses is an important determinant of decisions it makes. Herb: The narrowly focused strategy Katrina's Candies used previously to survive in the market might have worked with a larger number of manufacturers than what is present in today's market. However, today, given the information that the market has a few dominant firms, the strategy of ignoring other firms will not work. Katrina's Candies has to be aware of these markets and consider the reactions of other firms. Gigi: I'll defer to your opinion on this one, Herb. We brought you on the team because you have the most current information about best practices, so with that being said, how should Katrina's Candies proceed? Herb: The simple answer to your question is that we now need to focus attention on its competitors. We can develop a matrix of how competitors might respond if Katrina's Candies expands into the international market. Gigi: How can we create a matrix of Dr. Blue 1/10/2014 1:15 AM Comment [1]: This%is%not%clear.% other firms' reactions? We can't survey our competitors to ask what they will do if we expand; I think that would violate U.S. anti-trust laws prohibiting collusion amongst firms. Herb: That's correct! We cannot directly engage competitors by telephoning firms and asking questions. However, we can build a matrix of hypothesized reactions based upon theories that attempt to explain the behavior of oligopolistic firms. There are several theories we can review and use such as: The Kinked Demand Curve theory; The Price Leadership Theory; and Game Theory. The common assumption among these theories is that firms operating in oligopolistic markets are \"interdependent\" meaning that the level of profit each firm earns depends upon the behavior of other firms within the market. Gigi: Can you elaborate on this connection between interdependence and Katrina's Candies profit? Herb: Yes. It works like this. Remember how overall profit is defined as the difference between total revenue and total cost? Gigi: Yes, I remember. Herb: Also recall that Total Revenue is derived by multiplying Price times the Quantity sold. In the market Katrina's Candies is in, the price we set depends upon the price our competitors set; and vice versa. That's the reason the three oligopoly theories assume interdependence. Slide 4 Scene 4 In Gigi's office where Herb explains to Gigi why a large company like Katrina's Candies cannot ignore industry rivals and why predicting rival responses is an important determinant of decisions it makes. Gigi: Okay, I believe I understand the interdependence assumption now. Herb: Let's now review Kinked Demand Theory. Assume there are two firms considering two decisions about price. Decision one is to raise prices and decision two is to lower prices. According to kinked demand curve theory, if one firm chooses to lower prices, the other firm will also lower their prices. However, if one firm raises prices, the other firm may not raise prices. Gigi: Why would a firm ignore a price increase? Wouldn't an increase in price increase the firm's total revenue? Herb: An increase in the price of an oligopolist's product would increase total revenue only if the other firm reacted by also increasing the price of its product. However, if firm A were to increase price and firm B did not react by increasing price, consumers would switch from consuming firm A's product to consuming firm B's product because both sell the same type of product. Gigi: Is this all there is to kinked demand curve theory? Herb: Almost. Although the theory states that firms would follow price cuts, oligopolists avoid using price to compete. Instead, oligopolists engage in lots of non-price competition; for example, spending on advertising as a way to compete. Gigi: Is there a reason firms behave differently than theorists predict? Herb: Yes, by using price to compete this can sometimes cause a price war for the best prices. To avoid that outcome, it's best for firms to compete in ways that don't affect price. Let's look at an example of the Kinked Demand Curve Theory. Slide 5 Scene 5 Interaction Slide Ipad will be showcasing the video: Slide 6 Kinked Demand Oligopoly: The lack of price competition. o http://www.youtube.com /watch?v=HT9t-zjYi_A Scene 6 In Gigi's office with Herb briefly commenting on Kinked demand curve theory and preparing to view other presentations Slide 7 Scene 7 Interaction Slide Ipad will be showcasing these videos: Price Leadership 1 o http://www.youtube.com /watch?v=AtH4_lU_T8k Price Leadership 2 o http://www.youtube.com /watch?v=GeD2fwjJ8_U Gigi: That was a very interesting explanation of Kinked demand theory. The example brought everything into perspective. Herb: Fantastic! The next concept I want to cover is Price Leadership theory. I found two short videos that will give you a basic overview of the basic assumptions of this theory. Slide 8 Scene 8 In Gigi's office where Herb talks about Price Leadership Theory and Game Theory with Gigi Gigi: Thank you for showing me those videos Herb; they were a great overview! I now understand the difference between a firm's behavior in a kinked demand curve environment and in a price leadership environment. Initially, I thought the uncertainty in the kinked demand curve outcome was restrictive. After learning the basics of price leadership theory, the kinked demand scenario seems more attractive. Herb: I agree. The price leadership scenario does not theorize a good outcome for Katrina's Candies Chocolates, even though they are the fourth largest firm in the chocolate industry. Gigi: So, what can we here at Katrina's Candies do in this type of market? Herb: Katrina's Candies must be very strategic with its decisions! All decisions must be based upon the assumption that its nearest competitors will respond to the decisions they make. Gigi: So, that's your recommendation? Let the competitors react to our decisions? Herb: Yes, I feel we should go along with that assumption and also look into a foundation involving \"Game Theory.\" Game Theory is a theory that provides a model for predicting the behavior of rivals. It looks at strategic decision making! Gigi: How do we apply this model to make a prediction? Herb: Here, take a look at this video. The video will give you an idea of how we need to be rational throughout various scenarios. Slide 9 Scene 9 Interaction Slide Ipad will be showcasing the video: Slide 10 Game theory in real life o http://www.youtube.com /watch?v=2o3H0AtEylg Scene 10 Gigi: (laughter) That skit is hilarious!! In Gigi's office where Herb talks about Game Theory with Gigi Herb: Yes, it is! Every time I view it, it makes me laugh! Gigi: I can see why! However, it's a great way to summarize the game theory method. Did you hear how many times they used the word \"probably\"? Herb: Yes. Can you imagine how we're going to sound speculating about the reactions of Katrina's Candies rivals! Gigi: (Laughter) I hadn't thought about that! However, we need to stop here for today because I have an appointment with a client in a few minutes. Herb: Before you go I think it would be best if we did a review since we covered so many new topics today. Therefore, I would like for you to participate in a review activity I put together based on the key items we discussed. Gigi: Good thinking Herb. I will go through your review activity and then we will have a final review to finish up our time together today. Slide 11 Scene 11 Interaction Slide Ipad will be showcasing the video: Slide 12 Micro 4.8 Oligopolies and Game Theory o http://www.youtube.com /watch?v=AOEbJF0k8v M Scene 12 Check Your Understanding Answer the following questions based on the payoff matrix for a one quarter time-period, for Katrina's Candies and Gooey's. The numbers in the matrix indicate the profit in billions of dollars for an international or national strategy. The profit outcome cells are A, B, C, and D. (insert matrix picture for question) Question: Which strategies are the dominate ones for Katrina's Candies and Gooey's? Choices: International National Demand theory Game theory Correct Answer: Slide 13 The dominant strategy for Katrina's Candies and Gooey's is to always choose the international strategy. Scene 13 Summary Concluding scene taking place in conference room Herb: Gigi, I hope the review activities were helpful! Gigi: They were great, Herb! Thank you for sharing these review materials with me; they were a great review tool. Can we now complete a review of what we accomplished today so I can be prepared for my next meeting with Ken? Herb: Sure thing! We first established that Katrina's Candies is operating in an oligopolistic market, meaning that at least three chocolate manufacturing firms dominate the market. I also mentioned that currently Katrina's Candies is number four in this market. Gigi: I also remember you talking about the primary characteristic of firms in oligopolistic markets is mutual interdependence. Herb: That is correct, and I'm glad you remembered that! I also explained three theories that offered explanations for the behavior of oligopolistic firms. Gigi: I believe those three theories were the Kinked Demand Curve theory, Price Leadership Theory, and Game Theory. You also provided me with videos that really helped solidify these three theories. Herb: I'm glad that those videos were helpful for you! I believe you will be very well prepared for your next meeting with Ken to discuss the future of Katrina's Candies. Gigi: That is fantastic and I believe that is all for our meeting today. Until we meet again, don't forget to complete your weekly threaded discussions based on the key concepts we covered this week. Herb: Thanks Gigi and have a great day! % ECO 550 - Managerial Economics and Globalization COURSE DESCRIPTION Applies relevant economic theory to develop a framework of analysis and techniques that business managers can use in deciding how to allocate a firm's scarce resources to achieve its objectives. Uses economic analysis to support business strategy decisions that promote competitiveness in an environment of changing domestic and international market conditions, government regulations, trade policies, and resource availability. Systematically analyzes how global economic integration affects the production, input sourcing, and pricing decisions of firms operating in different market structures. INSTRUCTIONAL MATERIALS Required Resources McGuigan, J. R., Moyer, R. C., & Harris, F. H. deB. (2014). Managerial economics: applications, strategies and tactics (13th ed.). Stamford, CT: Cengage Learning. Microsoft Excel (2003 version or newer) [Computer software]. Redmond, Washington. Supplemental Resources MBA Primer Note: The MBA Primer is designed to help students with little or no educational background in business to prepare for the rigors of an MBA program. The MBA Primer is also a useful tool for students who have the business background but might need a refresher. It is a way to help you prepare for the types of activities and concepts that will be covered in the MBA program, so you can feel more comfortable and confident as you progress into higher level courses. Students are emailed an access code for this product when they purchase MBA Primer from the Strayer Bookstore, accessible through iCampus. Board of Governors of the Federal Reserve System. (2013). General format. Retrieved from http://www.federalreserve.gov excelcentral.com. Learn Excel 2010 Essential Skills with the Smart Method. (2013). Retrieved from http://www.excelcentral.com/?gclid=CK3zisSC1rkCFcE7OgodLlEA_g fundamentalfinanace.com. (2013). Excel. Retrieved from http://www.fundamentalfinance.com/excel/ Wall Street Journal (2013). General format. Retrieved from http://online.wsj.com COURSE LEARNING OUTCOMES 1. Assess how managerial economics is used in business decision making. 2. Analyze how production and cost functions in the short run and long run affect the strategy of individual firms. 3. Apply the concepts of supply and demand to determine the impact of changes in market conditions in the short run and long run, and the economic impact on a company's operations. 4. Analyze business and economic forecasting techniques utilized by managers. 5. Analyze short-run and long-run production and cost functions. 6. Apply macroeconomic concepts to changes in global and national economies and how they affect economic growth, inflation, interest rates, and wage rates. 2015 Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University. ECO 550 Student Version 1158 (8-13-2015) Page 1 of 6 ECO 550 - Managerial Economics and Globalization 7. Evaluate the profit-maximizing price and output level for given operating costs for monopolies and firms in competitive industries. 8. Propose how differences in demand and elasticity lead managers to develop various pricing strategies. 9. Analyze the economic impact of contracting, governance and organizational form within organizations. 10. Evaluate how government regulation is constraining and enabling for managerial decisions related to maximizing shareholder wealth. 11. Analyze capital budgeting decisions and the related impact to productivity, cost efficiency, diversification of asset base, and impact to future cash flows of the firm. 12. Use technology and information resources to research issues in managerial economics and globalization. 13. Write clearly and concisely about managerial economics and globalization using proper writing mechanics. WEEKLY COURSE SCHEDULE The standard requirement for a 4.5 credit hour course is for students to spend 13.5 hours in weekly work. This includes preparation, activities, and evaluation regardless of delivery mode. Certain discussions are tied to scenarios. Please view these scenarios prior to participating in the related discussions. Week 1 Preparation, Activities, and Evaluation Points Preparation Reading(s) o Chapter 1: Introduction and Goals of the Firm o Chapter 2: Fundamental Economic Concepts Scenario (See Faculty Notes for more details) Activities Discussion 20 Evaluation None Supplemental Resources Note: All supplemental resources are available in Blackboard in the weeks in which they are listed in the course guide. \"How to Calculate Equilibrium Price and Quantity (Demand and Supply)\" (6 min 7 s) \"Demand Elasticities: Price Elasticity, Cross- Price Elasticity, and Income Elasticity\" (8 min 23 s) \"Demand and Supply and Market Equilibrium\ECO550- Summer 2015 Midterm Exam Part 1 Question 1 4 out of 4 points Shirking of one's duties is often encountered in team production settings because Answer Selected Answer: teammates face a dilemma posed by a dominant strategy to shirk Correct Answer: teammates face a dilemma posed by a dominant strategy to shirk Question 2 4 out of 4 points To reduce Agency Problems, executive compensation should be designed to: Answer Selected Answer: create incentives so that managers act like owners of the firm. Correct Answer: create incentives so that managers act like owners of the firm. Question 3 4 out of 4 points Income tax payments are an example of ____. Answer Selected Answer: explicit costs Correct Answer: explicit costs Question 4 4 out of 4 points The moral hazard in team production arises from Answer ECO550- Summer 2015 Midterm Exam Part 1 Selected Answer: a conflict between tactically best interest and one's duty Correct Answer: a conflict between tactically best interest and one's duty Question 5 4 out of 4 points Economic profit is defined as the difference between revenue and ____. Answer Selected Answer: total economic cost Correct Answer: total economic cost Question 6 4 out of 4 points Possible goals of Not-For-Profit (NFP) enterprises include all of the following EXCEPT: Answer Selected Answer: maximize total costs Correct Answer: maximize total costs Question 7 4 out of 4 points The primary difference(s) between the standard deviation and the coefficient of variation as measures of risk are: Answer Selected Answer: Correct Answer: the coefficient of variation is a measure of relative risk whereas the standard deviation is a measure of absolute risk the coefficient of variation is a measure of relative risk whereas the ECO550- Summer 2015 Midterm Exam Part 1 standard deviation is a measure of absolute risk Question 8 4 out of 4 points The ____ is the ratio of ____ to the ____. Answer Selected Answer: coefficient of variation; standard deviation; expected value Correct Answer: coefficient of variation; standard deviation; expected value Question 9 4 out of 4 points The level of an economic activity should be increased to the point where the ____ is zero. Answer Selected Answer: net marginal benefit Correct Answer: net marginal benefit Question 10 4 out of 4 points Generally, investors expect that projects with high expected net present values also will be projects with Answer Selected Answer: high risk Correct Answer: high risk Question 11 4 out of 4 points ECO550- Summer 2015 Midterm Exam Part 1 The standard deviation is appropriate to compare the risk between two investments only if Answer Selected Answer: the expected returns from the investments are approximately equal Correct Answer: the expected returns from the investments are approximately equal Question 12 4 out of 4 points A change in the level of an economic activity is desirable and should be undertaken as long as the marginal benefits exceed the ____. Answer Selected Answer: marginal costs Correct Answer: marginal costs Question 13 4 out of 4 points The factor(s) which cause(s) a movement along the demand curve include(s): Answer Selected Answer: decrease in price of the good demanded Correct Answer: decrease in price of the good demanded Question 14 4 out of 4 points An increase in each of the following factors would normally provide a subsequent increase in quantity demanded, except: Answer Selected Answer: level of competitor advertising ECO550- Summer 2015 Midterm Exam Part 1 Correct Answer: level of competitor advertising Question 15 4 out of 4 points Which of the following would tend to make demand INELASTIC? Answer Selected Answer: the proportion of the budget spent on the item is very small Correct Answer: the proportion of the budget spent on the item is very small Question 16 4 out of 4 points A price elasticity (ED) of 1.50 indicates that for a ____ increase in price, quantity demanded will ____ by ____. Answer Selected Answer: one percent; decrease; 1.50 percent Correct Answer: one percent; decrease; 1.50 percent Question 17 4 out of 4 points When demand is ____ a percentage change in ____ is exactly offset by the same percentage change in ____ demanded, the net result being a constant total consumer expenditure. Answer Selected Answer: unit elastic; price; quantity Correct Answer: unit elastic; price; quantity Question 18 ECO550- Summer 2015 Midterm Exam Part 1 4 out of 4 points Those goods having a calculated income elasticity that is negative are called: Answer Selected Answer: inferior goods Correct Answer: inferior goods Question 19 4 out of 4 points Producers' goods are: Answer Selected Answer: raw materials combined to produce consumer goods Correct Answer: raw materials combined to produce consumer goods Question 20 4 out of 4 points In regression analysis, the existence of a high degree of intercorrelation among some or all of the explanatory variables in the regression equation constitutes: Answer Selected Answer: multicollinearity Correct Answer: multicollinearity Question 21 4 out of 4 points In which of the following econometric problems do we find Durbin-Watson statistic being far away from 2.0? Answer Selected Answer: ECO550- Summer 2015 Midterm Exam Part 1 autocorrelation Correct Answer: autocorrelation Question 22 4 out of 4 points In testing whether each individual independent variables (Xs) in a multiple regression equation is statistically significant in explaining the dependent variable (Y), one uses the: Answer Selected Answer: t-test Correct Answer: t-test Question 23 4 out of 4 points When two or more "independent" variables are highly correlated, then we have: Answer Selected Answer: multicollinearity Correct Answer: multicollinearity Question 24 4 out of 4 points One commonly used test in checking for the presence of autocorrelation when working with time series data is the ____. Answer Selected Answer: Durbin-Watson test Correct Answer: Durbin-Watson test ECO550- Summer 2015 Midterm Exam Part 1 Question 25 4 out of 4 points The standard deviation of the error terms in an estimated regression equation is known as: Answer Selected Answer: standard error of the estimate Correct Answer: standard error of the estimate Discussion Response Sometime you need to wait until you determine the pricing of competitors. The reason why is simply because you do not know their pricing structure. For example, you could consider Pepsi and Coca-Cola, they do not predict the pricing of each other. They observe in one week what the prices of the competitor is and the following week they reduce the prices in a similar way. This is in large why you see alternative sales over the week for each Pepsi and Coca-Cola. Watch it and you will be amazed how this works perfectly. The challenge here comes to mind is who would be the first mover for the price reduction? What I mean is assume that you have a 4th of July weekend and both have reduced their prices for the event, how can you determine who would be the first mover the following week? Explanation Business firms reduce the price of products to gain competitive advantage over their rival firms and to increase their customer base. The price leadership theory suggests that the dominant firm sets the prices. It is applicable both ways, i.e. in increasing the price as well as in reducing the price. The dominant business firm tends to increase its market share and use price reduction as tool to increase its customers thereby decreasing the customers of its competitor. Be it Wal-Mart Stores, Inc., or Coca-Cola or any other multinational giant, this strategy is used by most of the big companies operating globally. For example, when a company establishes its business in new country or in new region it starts selling goods at low price so as to gain market share. Discussion Response Sometime you need to wait until you determine the pricing of competitors. The reason why is simply because you do not know their pricing structure. For example, you could consider Pepsi and Coca-Cola, they do not predict the pricing of each other. They observe in one week what the prices of the competitor is and the following week they reduce the prices in a similar way. This is in large why you see alternative sales over the week for each Pepsi and Coca-Cola. Watch it and you will be amazed how this works perfectly. The challenge here comes to mind is who would be the first mover for the price reduction? What I mean is assume that you have a 4th of July weekend and both have reduced their prices for the event, how can you determine who would be the first mover the following week? Explanation Business firms reduce the price of products to gain competitive advantage over their rival firms and to increase their customer base. The price leadership theory suggests that the dominant firm sets the prices. It is applicable both ways, i.e. in increasing the price as well as in reducing the price. The dominant business firm tends to increase its market share and use price reduction as tool to increase its customers thereby decreasing the customers of its competitor. Be it Wal-Mart Stores, Inc., or Coca-Cola or any other multinational giant, this strategy is used by most of the big companies operating globally. For example, when a company establishes its business in new country or in new region it starts selling goods at low price so as to gain market share