Download Globalization, Technology and Real

Globalization, Technology, and
Real-World Competition
Chapter 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 owneroperated 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 costreductions to increase long-run profits.
What Do Real-World Firms Maximize?
• 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.
What Do Real-World Firms Maximize?
• 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 Lazy Monopolist and
X-Inefficiency
• The result is what economists call Xinefficiency – firms operating far less
efficiently than they could technically.
The Lazy Monopolist and
X-Inefficiency
• 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.
The Lazy Monopolist and
X-Inefficiency
• Competitive pressures faced by lazy
monopolies places a limit on their
laziness.
The Lazy Monopolist and
X-Inefficiency
• 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.
The Lazy Monopolist and
X-Inefficiency
• 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 Lazy Monopolist and
X-Inefficiency
• The threat of a corporate takeover
provides competitive pressure on firms
to maximize profits.
The Lazy Monopolist and
X-Inefficiency
• Nonprofit organizations (hospitals,
universities, libraries, and jails) often
display lazy monopolist tendencies.
True Cost Efficiency and the Lazy
Monopolist
Cost
per unit
MC
PM
CLM
ATC
(Producing
efficiently)
B
A
CM
MR
0
ATC
(Producing
inefficiently)
QM
D
Quantity
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!
How Monopolistic Forces Affect Perfect
Competition
• The U.S. has a myriad of laws,
regulations, and programs that prevent
agricultural markets from working
competitively.
How Monopolistic Forces Affect Perfect
Competition
• 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.
Movement Away From Competitive
Markets
Price
S
PL
A
PM
B
C
D
0
L
M
Quantity
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.
How Competitive Forces Affect Monopoly
• Competition is so strong that it makes
perfect monopolies as rare as pure
competition.
How Competitive Forces Affect Monopoly
• Competitive forces work to break down
monopoly.
• It is almost impossible to prevent
other firms from entering the
market.
How Competitive Forces Affect Monopoly
• Would-be monopolists try to break down
the monopoly through political or
economic forces.
How Competitive Forces Affect Monopoly
• 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.
How Competitive Forces Affect Monopoly
• Establishing an initial presence in a
market can be more effective than
obtaining a permit when trying to
extract monopoly profit.
How Competitive Forces Affect Monopoly
• Another way competitors gather
information about competing products is
reverse engineering.
How Competitive Forces Affect Monopoly
• 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.
Competition and Natural Monopolies
• 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.
Competition and Natural Monopolies
• 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.
Regulating Natural Monopolies
• 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.
Regulating Natural Monopolies
• 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).
Regulating Natural Monopolies
• 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.
Regulating Natural Monopolies
• 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.
Regulating Natural Monopolies
• 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.
Deregulating Natural Monopolies
• Many former natural monopolies are
being deregulated.
Deregulating Natural Monopolies
• 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.
Deregulating Natural Monopolies
• 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.
Cost-Benefit Analysis of Creating and
Maintaining 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.
Cost-Benefit Analysis of Creating and
Maintaining Monopolies
• Examples of firms spending money to
protect or create monopolies are in the
news every day.
Cost-Benefit Analysis of Creating and
Maintaining Monopolies
• 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.
Surviving in a Global Economy
• Firms may keep production within the
company, but parcel out portions of the
production process to different parts
of the world.
Surviving in a Global Economy
• Or they may simply out-source that part
of production that can be done more
cheaply by firms in other companies.
Surviving in a Global Economy
• Global competition helps to keep down
relative prices and wages paid to the
factors of production.
Surviving in a Global Economy
• 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.
Does Globalization Eliminate 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.
Does Globalization Eliminate Jobs?
• 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.
Technology, Efficiency, and Market
Structure
• Globalization of the economy provides
an even greater incentive to develop new
technology since a world market is
infinitely larger than a domestic one.
Technology, Efficiency, and Market
Structure
• 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.
Technology, Efficiency, and Market
Structure
• The supply/demand framework does not
consider technological issues.
• It assumes technology is unchanging or
unaffected by market structure.
Technology, Efficiency, and 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.
Technology, Efficiency, and Market
Structure
• 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.
Oligopoly and Technology
• 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.
Oligopoly and Technology
• 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.
Network Externalities, Standards, and
Technological Lock-in
• A network externality occurs when
greater use of a product increases the
benefit of that product to everyone.
Network Externalities, Standards, and
Technological Lock-in
• Network externalities are important to
market structure because they can lead
to the development of industry
standards.
Network Externalities, Standards, and
Technological Lock-in
• 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.
Standards and Winner-Takes-All
Industries
• As network externalities broaden the
use of the product, the need for a
single standard becomes more important
and eventually one standard wins out.
Standards and Winner-Takes-All
Industries
• 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.
Technological Lock-In
• QWERTY is a metaphor for
technological lock-in – when prior use of
a technology make the adoption of
subsequent technology difficult.
Technological Lock-In
• The QWERTY debate is part of a larger
debate about the competitive process
and government involvement in that
competitive process.
Technological Lock-In
• 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.
Technological Lock-In
• 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.
Globalization, Technology, and
Real-World Competition
End of Chapter 14