Hierachies, incentives and firm structure ECOS3003
Tutorial 1
1. Question 3-14 in Brickley et al (2009), p. 101.
At Locust Hill Golf club upgrade costs $6000. If benefit from better playing > $6000, then a member will vote yes
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At Salt lake Golf Club cost is $6000. Benefit is better course plus better resale price to new members; hence more likely to get a yes vote at Salt Lake.
2. What do you think will happen to the price and quantity of DVD players if:
(a) The availability of good movies to play on DVD players increases?
(b) Personal income increases?
(c) The price of inputs used to produce DVD players decreases?
(d) Ticket prices at local movie theatres decline substantially?
a. Price rise; quantity rise b. price rise; quantity rise c. price fall, Q rise
d. price fall, Q fall
3. At the time, many film makers argued that the advent of video would harm the film making industry. Assess this argument. Do you think your arguments apply to DVDs? What about more recent technological developments (relating to the delivery of content) in this industry?
Video introduced a new platform for viewing movies. Possible effects include
This could increase demand for movies, increasing qty demanded for each movie
Could allow for price discrimination; even without increasing market size could increase revenue for a movie
Decrease demand for cinema watching, as people wait for video release (two platforms substitutes for many viewers) – this could reduce overall revenue. That is, it might be difficult to credibly commit not to release a video or only to do so at a high price – like a durable goods monopoly problem.
Could increase opportunities for piracy
There is a general lesson here about technological change and need to continuously adapt to a changing environment. Due to competition, firms cannot ignore technological change. Moreover, the pressure to stay in front of rivals and capture market share (and profits) can drive firms to implement innovation and adopt new technologies. Technological change brings both opportunities for firms and potential downsides. Technological changes can render old technologies and products obsolete; but it can also create opportunities. For example, new technologies in the film industry can provide new ways of marketing films and related products.
4. (a) (b) (c)
What are contracting costs?
Give a few examples of contracting costs.
What effect does the existence of contracting costs have on market economies?
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a. Contracting costs – costs of developing, writing and enforcing a contract. Could include opportunity cost to extent that inefficiencies arise. Contracting costs include; search, information costs, bargaining & decision costs and enforcement.
b. In a mkt – discovering supplier and negotiating a price
In a firm – making timely decisions, motivating and monitoring employees
c. There is pressure to organize production in a market economy so as to minimize contracting costs – version of the basic principle of value maximization; it is in the interests of all parties to a contract to organize production so as to minimize contracting costs as when more value is created, ore can be share among the contracting parties.
Production will be conducting inside the firm or through the market so as to minimise contracting (transactions) costs – idea of Coase (1937). (Note – we will come back to the make-or-buy decision for a firm later in the course.)
5. Consider an externality between a beekeeper (and her bees) and almond production from an almond orchard. It costs the beekeeper $25 to maintain each beehive. If the beekeeper places her hives near the almond orchard almond production increases by $10 per hive. The benefit to the beekeeper from placing her hives near the almond orchard is $50 for the first hive, $40 for the second hive, $30 for the third hive, $20 for the fourth hive, $10 for the fifth hive and $0 for any subsequent hives. If the almond orchard buys the beekeeping operation (that is, the two activities are performed by the same firm) what is the number of hives that will be placed near the almond orchard?
Explain your answer in context of the literature on market mechanisms to deal with externalities.
D; participants to trade have an incentive to maximise surplus (if they can) because with larger surplus at least one person can be made better off without making anyone worse off (or everyone can be made better off) – refer to Coase theorem
6. What is a firm?
A firm is a focal point for a set of contracts
7. Give examples of incentive conflicts between:
(a) shareholders and managers
(b) co-workers on teams
a. Shareholders wish to maximize profit over long term; manager wants to maximize perks/ short term profit
b. Co-workers want to max own utility (possibly leisure); team wants to max team output
8. What is asymmetric information? How can it limit contracts from solving incentive conflicts?
Asymmetric information – one party to a contract has private information that cannot be observed by the other contracting parties – it means that the parties cannot write a contract on that information that is private.
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9. Explain how US insider-trading laws can be thought of as a prisoners’ dilemma. Can you think of any other examples in which the designer of the game (the government, regulator etc) tries to set up a prisoners’ dilemma for the participants.
Insider trading law – first person gets immunity and others get severely punished; tries to give all conspirators a dominant strategy to report
A similar mechanism applies to immunity from prosecution for collusion in Australia
A tendering process (with private information about the sale price) can be like a prisoners’ dilemma – all bidder have an incentive to reduce their bid as the cheapest bid wins the contract.
10. Consider the following entry game. Virgin Blue can enter the market (E) or decide to not enter (NE). If they choose NE Qantas gets a profit of 20 and Virgin gets a profit of 5. If Virgin chooses to E, Qantas can then choose to either punish (P) or accommodate (A). If Qantas choose P the payoffs are 7 for Qantas and -5 for Virgin. If Qantas opts to A the payoffs are 8 to each party.
(a) Draw the game tree of this game
(b) How do you get the subgame perfect equilibrium in a game? What is it here?
(c) Change the payoff to Qantas when Virgin enters and Qantas accommodates to 5. All other
payoffs remain the same. What is the subgame perfect equilibrium now?
b SPE – backwards induction – is (E, A) c. (NE, P)
11. Give an example of a coordination game.
For example, see lecture notes
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