Marketing #5

Economic Rent

Economic rent is the difference in the amount of money that an individual would be willing to work for, and the amount that they are actually paid. Consider a rock star, or a sports figure who earns, say, a million dollars each year, but would actually be willing to work for $100,000/year. Economic rent, then, equals $900,000 which is a payment provided to the individual (or any type of input) due to their "uniqueness". Another way of thinking about this concept is that an increase in wages will not increase the quantity of labor supplied because the equilibrium wage (which ultimately determines economic rent) is primarily a function of DEMAND for an individual input since supply is relatively fixed.

Marketing #4

Backward-bending Labor Supply

An individual's labor supply curve will have an upward-sloping range and then eventually will start to bend backward.

Consider this question:  When you get a pay raise, does the raise cause you to work more hours, or less hours? (With respect to this question, assume that you have the ability to choose how many hours you'd like to work.)

[Note:  Refer to the graph below.]

The labor supply curve begins at point A with what's referred to as a "reservation wage" (i.e., the lowest wage you would be willing to give up your leisure time for).  In the upward-sloping range, as the wage increases, the quantity of labor hours supplied also increases.  (Digression:  W and L are positively related here because the substitution effect between labor and leisure exceeds the income effect of the wage increase.)

However, at a particular wage (and this wage is different for different individuals), the income effect will dominate the substitution effect, and as the wage increases, the quantity of labor supplied will start to decrease.  W and L are inversely related in this region because when the wage rises, the individual feels "richer", and chooses to work less, not more.

Marketing #3

Kinked Demand Curve

The kinked demand curve model shows that oligopolists tend to keep prices stable, and use other means (increased advertising, rebates, and other incentives, etc.) to generate business.

The KDC model comes from analyzing two separate demand curves that the oligopolist faces --- a flat D curve (more elastic) and a steep D curve (more inelastic), and using the relevant portion of each demand curve for potential price increases or decreases.

Consider the idea of "mutual interdependence" among rival firms A, B, and C.  The idea behind this model is that when one of the competing firms (say, Firm A) raises its price, the other firms do NOT follow that action.  Firms B and C intend to increase their own sales and market share by being the lower-priced competition. 

Alternatively, if Firm A lowers its price, then that price decrease will be matched by the other rival firms also with the intent of increasing sales and market share.

[Note:  Show the graph here.]

The "kinked" demand curve gets its name from the fact that for price increases, Firm A's relevant demand curve is "elastic" but for price decreases, the relevant demand curve is "inelastic".  Since TR will fall in either case*, the model concludes that mutually interdependent firms are very likely to keep prices stable.

* Recall that when P rises and demand is elastic, TR will fall and also when P falls and demand is inelastic, TR will also fall.

Marketing #2

Concentration Ratio

One of the characteristics of this model is that of a "high" concentration ratio defined as the percentage market share belonging to the top 4 (top 8, top 20, or top 50) firms in the industry. For example, the CR4 measures the market share of the largest 4 firms in their respective industry, the CR8 measures the market share of the largest 8 firms, and so on .......

The term "high" CR4 is relative (as is the term "few" which measures the number of firms in the industry). In fact, whether an industry is considered "oligopolistic" or not, depends on the combination of two concepts interacting together --- the number of firms in the industry as well as the industry's concentration ratio.

Hypothetically, suppose there are 7 firms in the Chewing Gum Industry (listed in alphabetical order) where the percentage market share of each firm is as follows:

Firm A = 40%
Firm B = 5%
Firm C = 20%
Firm D = 6%
Firm E = 25%
Firm F = 2%
Firm G = 2%

Find the CR4. Find the CR8.

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Answers:  CR4 = 91%, CR8 = 100% and with only 7 firms in the industry (combined with a relatively very high CR4), we can conclude that the Chewing Gum Industry is indeed oligopolistic.

Marketing #1

Long Run Scale of Production

Economies of Scale = Increasing Returns to Scale
Diseconomies of Scale = Decreasing Returns to Scale
Also Constant Returns to Scale --- a very important assumption in economics, in general.

Something to note is that "The Law of Diminishing Marginal Returns" is a short run, not a long run concept, and doesn't apply to the topic of Economies/Diseconomies of Scale.

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Let's assume that a firm doubles its inputs. Instead of L = 1 and K = 1, let's suppose that L = 2 and K = 2. [Note that since all inputs are now "variable", this is a long run, not a short run, situation!]

When inputs (L and K) double, one of three things will potentially happen to output:

Output more than doubles (Q > 2) then AC will fall .... called Economies of Scale
Output less than doubles (Q < 2) then AC will rise ... called Diseconomies of Scale
Output exactly doubles (Q = 2) then AC is constant ... called Constant Returns to Scale

To confirm what happens to AC, first determine why TC rises when inputs double. Remember that AC = TC/Q.

[Note:  Show graph of LRAC here.]