1 00:00:00,000 --> 00:00:12,550 [SQUEAKING] [RUSTLING] [CLICKING] 2 00:00:12,550 --> 00:00:15,940 JONATHAN GRUBER: OK, I want to talk today about-- 3 00:00:15,940 --> 00:00:18,490 continue our discussion of oligopoly. 4 00:00:18,490 --> 00:00:21,980 Last time, we talked about non-cooperative equilbria, 5 00:00:21,980 --> 00:00:24,100 but in the start, we said, gee, life would just 6 00:00:24,100 --> 00:00:25,630 be better off if everyone would just cooperate. 7 00:00:25,630 --> 00:00:27,160 And someone even asked me, "Well, why don't they 8 00:00:27,160 --> 00:00:28,240 just cooperate?" 9 00:00:28,240 --> 00:00:29,530 So let's talk about that. 10 00:00:29,530 --> 00:00:31,690 Let's talk about cartels. 11 00:00:31,690 --> 00:00:34,960 What happens when firms try to cooperate-- 12 00:00:34,960 --> 00:00:38,260 achieve the cooperative equilibrium in oligopolies? 13 00:00:38,260 --> 00:00:40,400 Now, clearly, this is going to be the best outcome. 14 00:00:40,400 --> 00:00:41,920 So the fixed examples-- 15 00:00:41,920 --> 00:00:45,430 let's go back to our example of last time, American United. 16 00:00:45,430 --> 00:00:47,880 Recall, last time, we said that demand was in the form 17 00:00:47,880 --> 00:00:53,290 339 minus Q. Price is 339 minus Q. 18 00:00:53,290 --> 00:00:58,850 And that the marginal cost was 147, OK? 19 00:00:58,850 --> 00:01:02,960 Now, we talked about the fact that if American 20 00:01:02,960 --> 00:01:07,220 was a monopoly in this market, they would simply 21 00:01:07,220 --> 00:01:09,620 solve the monopolist's problem. 22 00:01:09,620 --> 00:01:15,050 They would set marginal revenue, which is 339 minus 2Q, 23 00:01:15,050 --> 00:01:18,920 equal to marginal cost, which is 147, 24 00:01:18,920 --> 00:01:25,580 and they would get that the optimal Q would be 96. 25 00:01:25,580 --> 00:01:27,530 And then reading back off the demand curve, 26 00:01:27,530 --> 00:01:34,220 that would imply an optimal quantity of $243, OK? 27 00:01:34,220 --> 00:01:37,250 So that was what we got last time. 28 00:01:37,250 --> 00:01:39,800 Now, imagine that American is not a monopoly, 29 00:01:39,800 --> 00:01:42,145 but American United cooperate. 30 00:01:42,145 --> 00:01:44,270 What if they got together and said, "You know what? 31 00:01:44,270 --> 00:01:48,290 Let's behave as if we're one monopolist, flying 96 flights 32 00:01:48,290 --> 00:01:49,790 and just splitting them equally. 33 00:01:49,790 --> 00:01:52,070 We'll do 48, you do 48. 34 00:01:52,070 --> 00:01:53,900 So let's cartelize. 35 00:01:53,900 --> 00:01:55,930 Let's achieve the monopoly outcome, 36 00:01:55,930 --> 00:02:00,140 and we'll also share 50-50 the fruits of that outcome." 37 00:02:00,140 --> 00:02:04,730 So in that case, each firm would fly 48 flights 38 00:02:04,730 --> 00:02:08,810 at a price of $243, OK? 39 00:02:08,810 --> 00:02:10,639 And total profits in the market-- 40 00:02:10,639 --> 00:02:14,270 each firm would then make profits of 48 times-- 41 00:02:14,270 --> 00:02:16,910 price minus average cost, which is marginal cost, because it's 42 00:02:16,910 --> 00:02:17,630 flat-- 43 00:02:17,630 --> 00:02:22,140 times 243 minus 147-- 44 00:02:22,140 --> 00:02:25,010 or since I'm not like you guys, I can't do that in my head-- 45 00:02:25,010 --> 00:02:29,690 4,608 per firm, OK? 46 00:02:29,690 --> 00:02:31,790 So each firm would achieve profits of-- 47 00:02:31,790 --> 00:02:34,070 take the 96 flights, split them in 1/2, 48 00:02:34,070 --> 00:02:37,640 and then each achieve profits of 4,608. 49 00:02:37,640 --> 00:02:40,250 Now, what we can see is that these profits 50 00:02:40,250 --> 00:02:42,470 are much higher than what they got 51 00:02:42,470 --> 00:02:44,460 in the non-cooperative equilibrium. 52 00:02:44,460 --> 00:02:46,350 Remember, the non-cooperative equilibrium, 53 00:02:46,350 --> 00:02:50,085 they were each doing 64 flights at a price of-- 54 00:02:50,085 --> 00:02:52,970 they were each doing 64 flights at a price of 211. 55 00:02:52,970 --> 00:02:54,650 We saw that last time. 56 00:02:54,650 --> 00:02:58,240 So what were their non-cooperative profits? 57 00:02:58,240 --> 00:03:00,910 Their non-cooperative profits for each firm 58 00:03:00,910 --> 00:03:06,470 was 64 times the 211 they were charging, minus the 147 59 00:03:06,470 --> 00:03:13,800 in marginal costs, or their former profits were 4,096. 60 00:03:13,800 --> 00:03:16,400 So their profits used to be 4,096 61 00:03:16,400 --> 00:03:17,910 when they weren't cooperating. 62 00:03:17,910 --> 00:03:23,700 They've gone up by 12.5% to 4,608 by cooperating. 63 00:03:23,700 --> 00:03:26,730 So simply by getting together, saying, "Don't be an asshole. 64 00:03:26,730 --> 00:03:27,810 Let's cooperate. 65 00:03:27,810 --> 00:03:30,030 Let's figure how to make the most money." 66 00:03:30,030 --> 00:03:32,280 Getting together, they solve the prisoner's dilemma, 67 00:03:32,280 --> 00:03:36,300 get to the best outcome, and make a lot more money, OK? 68 00:03:36,300 --> 00:03:38,790 So the question is, why don't they always do 69 00:03:38,790 --> 00:03:42,180 this in oligopolistic markets? 70 00:03:42,180 --> 00:03:43,838 And fundamentally, there's two reasons. 71 00:03:43,838 --> 00:03:46,380 Now, normal people-- you'll see when I'm done-- normal people 72 00:03:46,380 --> 00:03:48,422 will teach them in a different order than I will. 73 00:03:48,422 --> 00:03:50,838 But let me start with the two reasons the other economists 74 00:03:50,838 --> 00:03:51,780 would teach them. 75 00:03:51,780 --> 00:03:54,810 The first reason why cartels don't form 76 00:03:54,810 --> 00:03:58,740 is that they're fundamentally unstable. 77 00:03:58,740 --> 00:04:00,570 Cartels are fundamentally unstable as long 78 00:04:00,570 --> 00:04:03,750 as firms are self-interested. 79 00:04:03,750 --> 00:04:08,420 Each individual firm in a cartel has an incentive to cheat, 80 00:04:08,420 --> 00:04:11,180 and that's because they essentially 81 00:04:11,180 --> 00:04:14,040 can solve the monopoly problem of poisoning by cheating. 82 00:04:14,040 --> 00:04:15,290 Let me explain how that works. 83 00:04:15,290 --> 00:04:17,420 It's best to see this through numbers. 84 00:04:17,420 --> 00:04:20,709 Let's imagine that we start in this cooperative equilibrium, 85 00:04:20,709 --> 00:04:23,330 48 flights each and profits of 4,608. 86 00:04:23,330 --> 00:04:26,720 And now let's imagine, that quietly, American 87 00:04:26,720 --> 00:04:29,875 increased its number of flights from 48 to 50. 88 00:04:29,875 --> 00:04:32,250 American says, "Well, I know I agreed 48, but on the sly, 89 00:04:32,250 --> 00:04:33,240 I'm going to fly two more flights 90 00:04:33,240 --> 00:04:34,530 and hope they don't catch me." 91 00:04:34,530 --> 00:04:35,250 OK? 92 00:04:35,250 --> 00:04:38,380 Well, what's American's profits? 93 00:04:38,380 --> 00:04:41,140 Well, their quantity is 50. 94 00:04:41,140 --> 00:04:43,942 Q sub A is now 50. 95 00:04:43,942 --> 00:04:44,650 What's the price? 96 00:04:46,893 --> 00:04:49,060 If they're going to do 50 flights, what's the price? 97 00:04:52,850 --> 00:04:54,620 Yeah? 98 00:04:54,620 --> 00:04:56,000 I'm sorry? 99 00:04:56,000 --> 00:04:58,805 It's 280-- the price is-- let's see if you got that right. 100 00:04:58,805 --> 00:04:59,930 I've got to check my notes. 101 00:05:02,930 --> 00:05:07,550 No, if the price was 243 when they're a monopoly, 102 00:05:07,550 --> 00:05:08,990 now they do two more flights. 103 00:05:08,990 --> 00:05:12,260 Remember, they're adding two flights to the total. 104 00:05:12,260 --> 00:05:14,330 There used to be 96 flights. 105 00:05:14,330 --> 00:05:15,960 Now it goes to 98 flights. 106 00:05:15,960 --> 00:05:18,608 So the price falls to 241, OK? 107 00:05:18,608 --> 00:05:20,900 So you were thinking about them as alone, but remember, 108 00:05:20,900 --> 00:05:22,490 there's still United doing the flights too. 109 00:05:22,490 --> 00:05:23,930 They're still doing 48 flights. 110 00:05:23,930 --> 00:05:25,640 So there were 96 flights total. 111 00:05:25,640 --> 00:05:26,720 Now it goes to 98. 112 00:05:26,720 --> 00:05:29,360 So the price falls to 241, OK? 113 00:05:29,360 --> 00:05:31,160 So what's their profits? 114 00:05:31,160 --> 00:05:42,660 Their profits are now 50 times 241 minus 147, or 4,700. 115 00:05:42,660 --> 00:05:44,420 Their profits have gone up. 116 00:05:44,420 --> 00:05:47,613 OK, let me back up and do it again because I went fast, OK? 117 00:05:47,613 --> 00:05:49,530 They say they're going to do two more flights. 118 00:05:49,530 --> 00:05:51,030 We have to respect the demand curve. 119 00:05:51,030 --> 00:05:52,697 So there's going to be two more flights. 120 00:05:52,697 --> 00:05:54,210 The price has to fall. 121 00:05:54,210 --> 00:05:59,070 If the price falls, then the price has to fall to 241. 122 00:05:59,070 --> 00:06:02,640 They now make profits of 4,700, OK? 123 00:06:02,640 --> 00:06:05,010 Well, if United is caught with their pants down 124 00:06:05,010 --> 00:06:07,980 and continues to do 48 flights, what does United make? 125 00:06:07,980 --> 00:06:10,200 Well, United's still doing 48 flights, 126 00:06:10,200 --> 00:06:24,250 so the profits of United are 48 times 241 minus 147, or 4,512. 127 00:06:24,250 --> 00:06:26,590 So American's profits are up and United's profits 128 00:06:26,590 --> 00:06:30,240 are down through American cheating. 129 00:06:30,240 --> 00:06:32,190 What happened? 130 00:06:32,190 --> 00:06:34,950 How by cheating did they drop? 131 00:06:34,950 --> 00:06:40,350 What's the intuition of why them cheating drove their profits up 132 00:06:40,350 --> 00:06:41,940 and United's down? 133 00:06:41,940 --> 00:06:43,790 And in fact, if you add these up, 134 00:06:43,790 --> 00:06:47,210 lowered total profits in the market. 135 00:06:47,210 --> 00:06:48,560 What's going on? 136 00:06:48,560 --> 00:06:49,492 Yeah. 137 00:06:49,492 --> 00:06:51,430 AUDIENCE: It's in the quantity. 138 00:06:51,430 --> 00:06:56,270 You're lowering the price that you can sell each unit for, 139 00:06:56,270 --> 00:07:00,042 but for American, because they're 140 00:07:00,042 --> 00:07:02,000 increasing the number of units they're selling, 141 00:07:02,000 --> 00:07:03,920 they still make a greater profit, 142 00:07:03,920 --> 00:07:07,610 whereas as United has stayed the same, because each unit is 143 00:07:07,610 --> 00:07:09,610 sold for less, then they're making less of that. 144 00:07:09,610 --> 00:07:11,152 JONATHAN GRUBER: That's almost right. 145 00:07:11,152 --> 00:07:13,173 You got most of it, but there's one key wrinkle 146 00:07:13,173 --> 00:07:15,090 that's important, which is, a monopolist would 147 00:07:15,090 --> 00:07:17,600 have the same argument. 148 00:07:17,600 --> 00:07:20,900 The key thing is, what stops the monopolist from raising 149 00:07:20,900 --> 00:07:22,830 the price from where he is? 150 00:07:22,830 --> 00:07:24,590 Yeah? 151 00:07:24,590 --> 00:07:27,230 The poisoning effect, but think about the poisoning effect. 152 00:07:27,230 --> 00:07:29,660 Who does the poisoning effect affect? 153 00:07:29,660 --> 00:07:31,340 Everyone in the market. 154 00:07:31,340 --> 00:07:34,250 Everyone sees a lower price, but only American 155 00:07:34,250 --> 00:07:35,870 gets more flights. 156 00:07:35,870 --> 00:07:37,590 So they essentially get the benefit. 157 00:07:37,590 --> 00:07:40,173 It's like you said, they get the benefit of the extra flights, 158 00:07:40,173 --> 00:07:43,010 but only 1/2 the penalty of the poisoning effect. 159 00:07:43,010 --> 00:07:45,980 So for them, it is optimal to lower the price and sell more, 160 00:07:45,980 --> 00:07:48,800 because they share the negative effect, the negative part 161 00:07:48,800 --> 00:07:51,200 with United, but they get all the positive part. 162 00:07:51,200 --> 00:07:53,270 Once again, a monopolist, when you 163 00:07:53,270 --> 00:07:54,920 try to sell more and lower the price, 164 00:07:54,920 --> 00:07:56,295 there's a positive part, which is 165 00:07:56,295 --> 00:07:58,130 sell more units, but a negative part, which 166 00:07:58,130 --> 00:07:59,440 is the poisoning effect. 167 00:07:59,440 --> 00:08:01,940 Well, here, American gets all the positive part and only 1/2 168 00:08:01,940 --> 00:08:03,230 the negative part. 169 00:08:03,230 --> 00:08:06,322 So they make money by cheating, OK? 170 00:08:06,322 --> 00:08:07,780 Well, of course, United knows this. 171 00:08:07,780 --> 00:08:09,520 They saw the price go down. 172 00:08:09,520 --> 00:08:10,840 They know American's cheating. 173 00:08:10,840 --> 00:08:14,130 So United wants to cheat, and the whole thing breaks apart. 174 00:08:14,130 --> 00:08:18,070 So cartels are unstable, because by cheating, you 175 00:08:18,070 --> 00:08:22,310 get all the benefit but only part of the cost. 176 00:08:22,310 --> 00:08:25,720 And so cheating is incentivized in a cartel, 177 00:08:25,720 --> 00:08:27,520 and therefore, cartels will break down. 178 00:08:27,520 --> 00:08:30,320 They're not stable, OK? 179 00:08:30,320 --> 00:08:32,419 So that's the primary reason economists 180 00:08:32,419 --> 00:08:33,830 say we don't see cartels. 181 00:08:33,830 --> 00:08:36,413 The other reason people like to bring up is this little thing, 182 00:08:36,413 --> 00:08:37,490 they're illegal. 183 00:08:37,490 --> 00:08:39,289 But you know, we don't let stuff like that 184 00:08:39,289 --> 00:08:41,030 bother the economists. 185 00:08:41,030 --> 00:08:42,320 But they are illegal. 186 00:08:42,320 --> 00:08:45,110 That's another reason why we don't see cartels. 187 00:08:45,110 --> 00:08:47,750 In the late 1800, cartels were quite common. 188 00:08:47,750 --> 00:08:49,880 In the late 1800s, big industries 189 00:08:49,880 --> 00:08:52,216 like oil and railroad industries came 190 00:08:52,216 --> 00:08:55,190 to be dominated by a few large firms, 191 00:08:55,190 --> 00:08:56,690 and they tried to become cartels, 192 00:08:56,690 --> 00:08:58,070 but it kept breaking down. 193 00:08:58,070 --> 00:09:01,340 So in the late 1800s, with oil companies, Standard Oil, 194 00:09:01,340 --> 00:09:03,260 and the big railroad companies, they 195 00:09:03,260 --> 00:09:06,420 kept trying to have cartels and it kept breaking down. 196 00:09:06,420 --> 00:09:08,240 So they come up with this idea. 197 00:09:08,240 --> 00:09:12,518 They basically said, "Look, we can't trust each other. 198 00:09:12,518 --> 00:09:13,310 So we're going to-- 199 00:09:13,310 --> 00:09:15,950 every firm is going to turn over all its decisions 200 00:09:15,950 --> 00:09:17,687 to a common trust. 201 00:09:17,687 --> 00:09:19,770 And there'll be a trust that's got representatives 202 00:09:19,770 --> 00:09:21,440 from every firm on the board. 203 00:09:21,440 --> 00:09:24,128 But we will publicly commit to what 204 00:09:24,128 --> 00:09:25,670 we're going to produce at what price, 205 00:09:25,670 --> 00:09:27,530 and therefore, we can make sure there's no cheating." 206 00:09:27,530 --> 00:09:29,090 So essentially, every firm's still involved. 207 00:09:29,090 --> 00:09:30,423 They're all on this trust board. 208 00:09:30,423 --> 00:09:32,917 But they're making that decision in a way that's 209 00:09:32,917 --> 00:09:35,000 at least public to them, not public to the public, 210 00:09:35,000 --> 00:09:37,625 but public to them, so they can make sure they're not cheating. 211 00:09:37,625 --> 00:09:40,610 So they formed these trusts, and essentially cartelized, 212 00:09:40,610 --> 00:09:41,540 and made huge profits. 213 00:09:41,540 --> 00:09:42,380 And it worked. 214 00:09:42,380 --> 00:09:44,570 It solved the stability problem because cheating 215 00:09:44,570 --> 00:09:46,370 could be observed more readily. 216 00:09:46,370 --> 00:09:48,830 Now, would it solve this for very long, we don't know, 217 00:09:48,830 --> 00:09:50,930 because the government-- the public got pissed, 218 00:09:50,930 --> 00:09:52,472 and the government came in and passed 219 00:09:52,472 --> 00:09:55,160 what's called antitrust laws. 220 00:09:55,160 --> 00:09:57,850 And antitrust laws are laws which 221 00:09:57,850 --> 00:10:02,830 do not permit the cartelization of oligopolistic industries 222 00:10:02,830 --> 00:10:04,220 in this way. 223 00:10:04,220 --> 00:10:07,300 So let's talk about antitrust laws and how they work 224 00:10:07,300 --> 00:10:08,490 or how they don't work. 225 00:10:08,490 --> 00:10:09,940 I want to do a couple examples. 226 00:10:09,940 --> 00:10:12,143 One example is the movie industry. 227 00:10:12,143 --> 00:10:13,560 Now, the movie industry, you know, 228 00:10:13,560 --> 00:10:16,030 is a classic oligopolistic industry. 229 00:10:16,030 --> 00:10:17,437 There's a few players. 230 00:10:17,437 --> 00:10:18,270 There's new players. 231 00:10:18,270 --> 00:10:21,902 A24 is huge now, what didn't exist 15 years ago. 232 00:10:21,902 --> 00:10:23,860 But by and large, there's sort of a few players 233 00:10:23,860 --> 00:10:27,670 you've heard of which dominate the industry, OK? 234 00:10:27,670 --> 00:10:31,050 And the way the industry works is movie companies make-- 235 00:10:31,050 --> 00:10:32,800 they produce the movies and then sell them 236 00:10:32,800 --> 00:10:34,870 to movie theaters that show the movies. 237 00:10:34,870 --> 00:10:37,340 They show a variety of movies at any one time. 238 00:10:37,340 --> 00:10:40,150 But what happened was in the '30s and '40s, 239 00:10:40,150 --> 00:10:43,552 the production companies started buying up the movie theaters. 240 00:10:43,552 --> 00:10:45,760 And what they do when they bought the movie theaters, 241 00:10:45,760 --> 00:10:47,718 they said to the movie theater, "We now own you 242 00:10:47,718 --> 00:10:49,695 and you will only show our movies." 243 00:10:49,695 --> 00:10:51,070 So they say to the movie theater, 244 00:10:51,070 --> 00:10:54,840 "We now own you, movie theater on the corner of Lincoln 245 00:10:54,840 --> 00:10:56,970 and Kennedy streets, and we're MGM, 246 00:10:56,970 --> 00:10:59,190 and you'll only show MGM movies." 247 00:10:59,190 --> 00:11:02,490 And essentially, what that meant was essentially, 248 00:11:02,490 --> 00:11:06,870 they were taking over, monopolizing, 249 00:11:06,870 --> 00:11:09,990 a given distribution network. 250 00:11:09,990 --> 00:11:11,620 And they essentially carved it up. 251 00:11:11,620 --> 00:11:13,620 They agreed, OK, you get these theaters. 252 00:11:13,620 --> 00:11:15,390 We'll take these theaters. 253 00:11:15,390 --> 00:11:17,970 And essentially, that was the way they formed their cartel, 254 00:11:17,970 --> 00:11:19,770 was through distribution. 255 00:11:19,770 --> 00:11:21,480 And the federal government jumped in 256 00:11:21,480 --> 00:11:23,820 and said that that was an antitrust violation. 257 00:11:23,820 --> 00:11:26,050 The federal government sued and won. 258 00:11:26,050 --> 00:11:30,560 And so that industry, that was broken up. 259 00:11:30,560 --> 00:11:32,310 But did that mean-- that didn't mean folks 260 00:11:32,310 --> 00:11:33,477 stopped trying to cartelize. 261 00:11:33,477 --> 00:11:35,980 It just meant they stopping being so obvious about it. 262 00:11:35,980 --> 00:11:37,980 So later moves to cartelize were more hidden. 263 00:11:37,980 --> 00:11:41,455 So for example, in the early 2000s, 264 00:11:41,455 --> 00:11:43,080 airline industries were in big trouble, 265 00:11:43,080 --> 00:11:45,247 because oil prices were going way up due to the Iraq 266 00:11:45,247 --> 00:11:46,860 war and other factors. 267 00:11:46,860 --> 00:11:49,260 Oil prices were going way up, and the airline industry 268 00:11:49,260 --> 00:11:50,640 was in trouble. 269 00:11:50,640 --> 00:11:53,310 So in 2004, British Airlines and Virgin Atlantic 270 00:11:53,310 --> 00:11:55,950 had secret talks about essentially 271 00:11:55,950 --> 00:12:00,360 cartelizing the cross Atlantic market from the East Coast 272 00:12:00,360 --> 00:12:03,090 to London. 273 00:12:03,090 --> 00:12:06,710 And what they did is they said, "Look, if we sort of obviously 274 00:12:06,710 --> 00:12:09,463 set our prices together, people are going to notice. 275 00:12:09,463 --> 00:12:10,880 So to do this instead, we're going 276 00:12:10,880 --> 00:12:12,980 to add fuel surcharges to the bill. 277 00:12:12,980 --> 00:12:15,350 We're going to say, 'Oh, oil is getting more expensive. 278 00:12:15,350 --> 00:12:17,850 Your price haven't changed, but there's now a fuel surcharge 279 00:12:17,850 --> 00:12:18,770 on your bill.' 280 00:12:18,770 --> 00:12:21,950 And that fuel surcharge is going to be something people 281 00:12:21,950 --> 00:12:23,960 won't pay attention to because they won't notice 282 00:12:23,960 --> 00:12:25,530 that we're rising it together." 283 00:12:25,530 --> 00:12:29,240 And these fuel surcharges rose quickly from $10 to $120 284 00:12:29,240 --> 00:12:31,935 per flight, and essentially rose in lockstep. 285 00:12:31,935 --> 00:12:33,560 They essentially coordinated, but tried 286 00:12:33,560 --> 00:12:35,030 to hide it by making the coordination not 287 00:12:35,030 --> 00:12:36,710 over the sticker price, but over this thing that's 288 00:12:36,710 --> 00:12:38,502 sort of at the bottom of your ticket, which 289 00:12:38,502 --> 00:12:40,057 is the fuel surcharge. 290 00:12:40,057 --> 00:12:42,140 So this worked for awhile, but then what happened? 291 00:12:42,140 --> 00:12:44,410 Well, what happened was the prisoner's dilemma. 292 00:12:44,410 --> 00:12:48,670 Was it lawyers for-- 293 00:12:48,670 --> 00:12:51,580 lawyers for Virgin Airlines started worrying 294 00:12:51,580 --> 00:12:53,570 they were to get busted. 295 00:12:53,570 --> 00:12:57,020 And they said, "Well, if we go to the feds first and bust 296 00:12:57,020 --> 00:13:00,000 British airlines, maybe we'll get a better deal." 297 00:13:00,000 --> 00:13:02,420 So they were essentially the prisoner that ratted. 298 00:13:02,420 --> 00:13:05,238 So Virgin Atlantic was the prisoner that ratted, 299 00:13:05,238 --> 00:13:06,530 and the whole thing broke down. 300 00:13:06,530 --> 00:13:08,488 There were penalties, more on British Airlines, 301 00:13:08,488 --> 00:13:10,248 because Virgin Atlantic ratted on them. 302 00:13:10,248 --> 00:13:12,290 But just like the prisoner's dilemma breaks down, 303 00:13:12,290 --> 00:13:13,723 it broke down in reality. 304 00:13:13,723 --> 00:13:16,140 And so that was something not where the law really worked, 305 00:13:16,140 --> 00:13:19,827 but where the cartel was unstable. 306 00:13:19,827 --> 00:13:21,410 And the end result was Virgin Atlantic 307 00:13:21,410 --> 00:13:24,650 paid no fees, paid no penalty, and British Airlines 308 00:13:24,650 --> 00:13:26,612 paid more than $500 million. 309 00:13:26,612 --> 00:13:28,070 So British Airlines clearly did not 310 00:13:28,070 --> 00:13:29,930 study the prisoner's dilemma, and did not 311 00:13:29,930 --> 00:13:32,420 realize that they should have gone first 312 00:13:32,420 --> 00:13:35,360 in ratting out Virgin Atlantic. 313 00:13:35,360 --> 00:13:39,170 Now, that said, sometimes cartels 314 00:13:39,170 --> 00:13:43,590 operate openly in the public and get away with it, OK? 315 00:13:43,590 --> 00:13:47,610 Let's talk about probably the biggest open cartel 316 00:13:47,610 --> 00:13:51,940 perhaps in America today, the National Football League, OK? 317 00:13:51,940 --> 00:13:53,190 The National Football League-- 318 00:13:53,190 --> 00:13:54,607 football is the most popular sport 319 00:13:54,607 --> 00:13:56,768 in America, the most profitable sport in America. 320 00:13:56,768 --> 00:13:58,560 There are 32 teams, and they're essentially 321 00:13:58,560 --> 00:14:03,450 32 businesses whose job it is to produce football wins, OK? 322 00:14:03,450 --> 00:14:05,880 Now, these businesses have a huge incentive 323 00:14:05,880 --> 00:14:07,690 to collude with their fellow business, 324 00:14:07,690 --> 00:14:10,260 however, because they can-- 325 00:14:10,260 --> 00:14:12,690 because of television rights. 326 00:14:12,690 --> 00:14:15,890 So if the New York Giants and the New York Jets 327 00:14:15,890 --> 00:14:19,350 competed over the television rights for their area, 328 00:14:19,350 --> 00:14:20,810 they would compete away the profits 329 00:14:20,810 --> 00:14:23,150 that could be made by getting a big contract. 330 00:14:23,150 --> 00:14:25,820 If they collude and say, "No, you can only-- 331 00:14:25,820 --> 00:14:29,580 we will only agree to a contract together," 332 00:14:29,580 --> 00:14:31,680 they could get a higher price for that contract, 333 00:14:31,680 --> 00:14:32,880 because it's either you give them the contract 334 00:14:32,880 --> 00:14:33,463 or you're out. 335 00:14:33,463 --> 00:14:35,460 If they competed, TV companies would 336 00:14:35,460 --> 00:14:38,315 compete against each other and fight the price down, OK? 337 00:14:38,315 --> 00:14:40,440 And in general, actually, this goes more than this. 338 00:14:40,440 --> 00:14:45,220 The League sells the rights to televise games as a package. 339 00:14:45,220 --> 00:14:47,640 So in fact, the National Football League literally 340 00:14:47,640 --> 00:14:52,140 sells, explicitly says, "We have a cartel of 32 teams. 341 00:14:52,140 --> 00:14:55,140 We are selling the monopoly right to televise these games." 342 00:14:55,140 --> 00:14:56,070 Somebody's got Sunday. 343 00:14:56,070 --> 00:14:56,880 Somebody's got Thursday. 344 00:14:56,880 --> 00:14:58,505 Somebody's got Monday night, et cetera. 345 00:14:58,505 --> 00:15:00,530 But it's a monopoly product they're selling. 346 00:15:00,530 --> 00:15:02,280 Now, how did they get away with that? 347 00:15:02,280 --> 00:15:05,328 Well, basically, actually 1957, they were busted. 348 00:15:05,328 --> 00:15:07,620 That's a long time ago, I think even before I was born, 349 00:15:07,620 --> 00:15:08,600 that long ago. 350 00:15:08,600 --> 00:15:11,220 OK, they were busted and the court 351 00:15:11,220 --> 00:15:15,600 ruled that the NFL was violating antitrust laws, OK? 352 00:15:15,600 --> 00:15:17,130 Now, that was 1957. 353 00:15:17,130 --> 00:15:18,670 That was 60 years ago. 354 00:15:18,670 --> 00:15:21,120 The NFL still makes about $40 billion 355 00:15:21,120 --> 00:15:22,830 on its television contract. 356 00:15:22,830 --> 00:15:23,850 What happened? 357 00:15:23,850 --> 00:15:25,840 Congress just exempted them. 358 00:15:25,840 --> 00:15:27,480 Congress said, "Well, you know what?" 359 00:15:27,480 --> 00:15:28,630 We know they violate antitrust, but we're 360 00:15:28,630 --> 00:15:31,005 going to pass a law which exempts them from antitrust law 361 00:15:31,005 --> 00:15:31,937 and let them do it. 362 00:15:31,937 --> 00:15:34,270 So it proves basically that Americans like football more 363 00:15:34,270 --> 00:15:37,300 than free markets, and basically, we now 364 00:15:37,300 --> 00:15:41,230 have a cartelized football industry that-- 365 00:15:41,230 --> 00:15:43,910 because Congress basically exempted them from the laws, 366 00:15:43,910 --> 00:15:45,440 OK? 367 00:15:45,440 --> 00:15:46,730 So those are some examples. 368 00:15:46,730 --> 00:15:47,265 Yeah? 369 00:15:47,265 --> 00:15:49,910 AUDIENCE: Is this also true for other sports teams? 370 00:15:49,910 --> 00:15:52,310 JONATHAN GRUBER: Other sports teams, it is not as-- 371 00:15:52,310 --> 00:15:55,430 they are-- it's largely true for other sports leagues. 372 00:15:55,430 --> 00:15:57,670 It's largely true. 373 00:15:57,670 --> 00:15:59,420 Some of it aren't as explicit as football, 374 00:15:59,420 --> 00:16:01,575 but it's largely true for the other sports leagues as well. 375 00:16:01,575 --> 00:16:03,575 AUDIENCE: What about on the international level, 376 00:16:03,575 --> 00:16:05,043 with things like soccer, that are-- 377 00:16:05,043 --> 00:16:06,710 JONATHAN GRUBER: I don't know, actually. 378 00:16:06,710 --> 00:16:07,550 I presume it's-- 379 00:16:07,550 --> 00:16:10,400 I mean, I don't know they have international antitrust laws. 380 00:16:10,400 --> 00:16:12,692 I'm not sure how that works with international leagues. 381 00:16:12,692 --> 00:16:14,890 It's a good question. 382 00:16:14,890 --> 00:16:17,338 OK, now, another form of cartels-- 383 00:16:17,338 --> 00:16:19,255 we talked about cartels and how companies have 384 00:16:19,255 --> 00:16:20,650 incentive to put them together. 385 00:16:20,650 --> 00:16:23,940 Actually, sometimes, the government can make a cartel. 386 00:16:23,940 --> 00:16:24,506 Yeah? 387 00:16:24,506 --> 00:16:26,440 AUDIENCE: How well [INAUDIBLE] working? 388 00:16:26,440 --> 00:16:26,890 JONATHAN GRUBER: How's what? 389 00:16:26,890 --> 00:16:28,480 AUDIENCE: How well is OPEC working? 390 00:16:28,480 --> 00:16:29,640 JONATHAN GRUBER: OPEC? 391 00:16:29,640 --> 00:16:31,930 So OPEC is, as I mentioned in the first lecture, 392 00:16:31,930 --> 00:16:34,370 a series of countries that get together to produce oil. 393 00:16:34,370 --> 00:16:36,640 It's not working as well as it was when I was a kid. 394 00:16:36,640 --> 00:16:37,557 It worked really well. 395 00:16:37,557 --> 00:16:40,060 Because more countries-- A, more countries are cheating, 396 00:16:40,060 --> 00:16:41,602 and more countries-- there's more oil 397 00:16:41,602 --> 00:16:42,850 being found outside OPEC. 398 00:16:42,850 --> 00:16:43,720 But it still works. 399 00:16:43,720 --> 00:16:45,598 It's sort of a partially functioning cartel, 400 00:16:45,598 --> 00:16:47,140 is I think the way to think about it. 401 00:16:49,830 --> 00:16:53,780 OK, so let me actually-- 402 00:16:53,780 --> 00:16:56,140 let me go on and talk about-- let's 403 00:16:56,140 --> 00:16:57,950 do one more example about a time when 404 00:16:57,950 --> 00:16:59,660 a government made a cartel. 405 00:16:59,660 --> 00:17:01,820 Here's one more interesting example. 406 00:17:01,820 --> 00:17:04,490 So in the early 1980s, before the early 1980s, 407 00:17:04,490 --> 00:17:07,170 the US dominated the car production business. 408 00:17:07,170 --> 00:17:10,170 Starting in the late '70s, Japan started making huge inroads 409 00:17:10,170 --> 00:17:12,450 into car production, and by the early 1980s, 410 00:17:12,450 --> 00:17:14,140 we're in recession and car manufacturers 411 00:17:14,140 --> 00:17:16,710 in the US were really pissed that Japan was 412 00:17:16,710 --> 00:17:18,300 taking so much of our market. 413 00:17:18,300 --> 00:17:19,380 And we'll talk in a couple of lectures 414 00:17:19,380 --> 00:17:21,030 about international trade and all those sort of issues, 415 00:17:21,030 --> 00:17:22,212 but put those issues aside. 416 00:17:22,212 --> 00:17:23,670 Right now, you just have this issue 417 00:17:23,670 --> 00:17:28,500 that car manufacturers wanted to limit 418 00:17:28,500 --> 00:17:30,720 the amount of Japanese cars to come into America. 419 00:17:30,720 --> 00:17:32,553 Now, you guys have been reading in the paper 420 00:17:32,553 --> 00:17:35,100 about international trade and why economists typically 421 00:17:35,100 --> 00:17:38,130 don't like limiting international trade. 422 00:17:38,130 --> 00:17:40,920 And Reagan was a standard Republican, 423 00:17:40,920 --> 00:17:42,570 the party of free trade. 424 00:17:42,570 --> 00:17:44,430 So Reagan said, "Well, we're not going 425 00:17:44,430 --> 00:17:47,010 to limit the cars that Japan wants to send in, 426 00:17:47,010 --> 00:17:49,290 but we're going to tell Japan, if you guys were 427 00:17:49,290 --> 00:17:53,700 willing to agree to a voluntary export restraint, 428 00:17:53,700 --> 00:17:55,575 we wouldn't mind." 429 00:17:55,575 --> 00:17:56,950 So we said to Japan, they imposed 430 00:17:56,950 --> 00:17:59,750 what they called a voluntary export constraint, which 431 00:17:59,750 --> 00:18:03,320 basically said, we won't negotiate a deal with you. 432 00:18:03,320 --> 00:18:06,170 You will voluntarily agree to reduce the number of cars 433 00:18:06,170 --> 00:18:08,392 you send to America, OK? 434 00:18:08,392 --> 00:18:09,600 It's not a government policy. 435 00:18:09,600 --> 00:18:10,890 This isn't big government. 436 00:18:10,890 --> 00:18:13,320 This is negotiations of a private company, 437 00:18:13,320 --> 00:18:14,850 voluntary agreement. 438 00:18:14,850 --> 00:18:16,440 OK. 439 00:18:16,440 --> 00:18:20,340 Japan happily agreed to this, why? 440 00:18:20,340 --> 00:18:21,665 Yeah. 441 00:18:21,665 --> 00:18:22,540 AUDIENCE: [INAUDIBLE] 442 00:18:22,540 --> 00:18:24,780 JONATHAN GRUBER: No. 443 00:18:24,780 --> 00:18:26,300 AUDIENCE: Sold cars at higher price. 444 00:18:26,300 --> 00:18:28,490 JONATHAN GRUBER: Because? 445 00:18:28,490 --> 00:18:30,110 Because you made a cartel. 446 00:18:30,110 --> 00:18:32,700 The Japanese companies used to have to compete with each other 447 00:18:32,700 --> 00:18:33,530 to sell the cars in America. 448 00:18:33,530 --> 00:18:34,910 Now it's like, OK, you guys get together 449 00:18:34,910 --> 00:18:36,552 and limit how many cars you send. 450 00:18:36,552 --> 00:18:38,510 They're like, great, you've given us an ability 451 00:18:38,510 --> 00:18:40,343 to form a cartel, by essentially telling us, 452 00:18:40,343 --> 00:18:42,510 get together and figure out how you're going to sell 453 00:18:42,510 --> 00:18:43,600 this many cars to America. 454 00:18:43,600 --> 00:18:46,100 So essentially, this voluntary export constraint essentially 455 00:18:46,100 --> 00:18:50,192 cartelized, and no company could cheat. 456 00:18:50,192 --> 00:18:52,400 So if you had a cartel, and a company tried to cheat, 457 00:18:52,400 --> 00:18:53,530 they couldn't sell the cars to US. 458 00:18:53,530 --> 00:18:55,250 US wouldn't let them come into the US. 459 00:18:55,250 --> 00:18:57,140 So essentially, the US provided them a way 460 00:18:57,140 --> 00:18:58,940 of enforcing their cartel. 461 00:18:58,940 --> 00:19:00,050 What happened? 462 00:19:00,050 --> 00:19:03,230 Well, the average price of a Japanese car in America 463 00:19:03,230 --> 00:19:06,500 went up by $1,200, OK? 464 00:19:06,500 --> 00:19:10,070 US auto profits did go up, but US consumers 465 00:19:10,070 --> 00:19:12,312 lost out by way more than producers gained. 466 00:19:12,312 --> 00:19:14,270 And on net, the estimates are that US consumers 467 00:19:14,270 --> 00:19:15,380 were about three billion-- 468 00:19:15,380 --> 00:19:19,070 overall, US was about $3 billion worse because of this policy. 469 00:19:19,070 --> 00:19:21,680 Just examples of how different government policies 470 00:19:21,680 --> 00:19:25,680 can interact with the cartelization of industries. 471 00:19:25,680 --> 00:19:26,870 Yeah. 472 00:19:26,870 --> 00:19:29,000 AUDIENCE: Company price matches, isn't that sort 473 00:19:29,000 --> 00:19:31,035 of like making a cartel? 474 00:19:31,035 --> 00:19:32,660 Because the other company would see it. 475 00:19:32,660 --> 00:19:33,300 They're going to price match. 476 00:19:33,300 --> 00:19:35,390 They wouldn't want to set a price lower than what the-- 477 00:19:35,390 --> 00:19:37,265 JONATHAN GRUBER: Well, it's a great question, 478 00:19:37,265 --> 00:19:39,440 and you're pointing out this is not a solid line. 479 00:19:39,440 --> 00:19:42,800 And in some sense, the question is, if it's true 480 00:19:42,800 --> 00:19:45,230 that-- so for many years, tobacco industry 481 00:19:45,230 --> 00:19:46,080 worked this way. 482 00:19:46,080 --> 00:19:47,830 There was one large player, Philip Morris. 483 00:19:47,830 --> 00:19:49,622 Philip Morris would sort of raise the price 484 00:19:49,622 --> 00:19:50,930 that everyone would match. 485 00:19:50,930 --> 00:19:53,990 Now, as long as there's no evidence 486 00:19:53,990 --> 00:19:57,103 that they agreed to do that, that is not illegal. 487 00:19:57,103 --> 00:19:59,520 If there is evidence they agreed to do that, it's illegal. 488 00:19:59,520 --> 00:20:01,040 But as long as it's just like, no, 489 00:20:01,040 --> 00:20:04,080 this is the way it's going to work, then that's not illegal. 490 00:20:04,080 --> 00:20:06,720 So basically, that's sort of an implicit cartel. 491 00:20:06,720 --> 00:20:08,640 Now, once again, what's holding it together? 492 00:20:08,640 --> 00:20:09,330 Nothing. 493 00:20:09,330 --> 00:20:12,000 A company could cheat and try to charge less. 494 00:20:12,000 --> 00:20:13,665 But basically, that essentially-- they 495 00:20:13,665 --> 00:20:15,540 figured they were working better as a cartel, 496 00:20:15,540 --> 00:20:16,915 and essentially, it was hard to-- 497 00:20:16,915 --> 00:20:18,350 there was no way to bust it. 498 00:20:18,350 --> 00:20:18,870 Yeah. 499 00:20:18,870 --> 00:20:21,120 AUDIENCE: I mean, if a company says to consumers like, 500 00:20:21,120 --> 00:20:22,578 "If you can bring in a lower price, 501 00:20:22,578 --> 00:20:23,925 we'll sell it for that price." 502 00:20:23,925 --> 00:20:25,800 JONATHAN GRUBER: That's sort of a different-- 503 00:20:25,800 --> 00:20:28,780 I mean, you could imagine you would need every company 504 00:20:28,780 --> 00:20:29,280 to do that. 505 00:20:29,280 --> 00:20:30,780 That would be a cartel enforcing way 506 00:20:30,780 --> 00:20:33,000 if every company had that deal in a market. 507 00:20:33,000 --> 00:20:34,375 But if one company had that deal, 508 00:20:34,375 --> 00:20:35,940 it doesn't enforce the cartel. 509 00:20:35,940 --> 00:20:37,650 Every company needs to have that deal. 510 00:20:37,650 --> 00:20:40,600 And so the question is, if every company on their own, OK, 511 00:20:40,600 --> 00:20:41,190 we've decided we're going to have 512 00:20:41,190 --> 00:20:42,630 that deal, that would essentially 513 00:20:42,630 --> 00:20:44,280 be a way of trying to bring-- 514 00:20:44,280 --> 00:20:45,947 enforce a cartel, but I think that would 515 00:20:45,947 --> 00:20:49,780 be hard to say it was an antitrust violation. 516 00:20:49,780 --> 00:20:50,780 Good questions. 517 00:20:50,780 --> 00:20:52,280 Other questions? 518 00:20:52,280 --> 00:20:55,340 OK, so now, let's ask why do we care about all this. 519 00:20:55,340 --> 00:20:58,545 We care about all this because it matters for ultimately 520 00:20:58,545 --> 00:21:00,170 what matters to us in this class, which 521 00:21:00,170 --> 00:21:02,360 is economic welfare, OK? 522 00:21:02,360 --> 00:21:04,500 So now, let's go to a second thing I want to cover, 523 00:21:04,500 --> 00:21:06,100 which is comparing the equilbria. 524 00:21:10,520 --> 00:21:13,310 We've now covered three types of market structures, 525 00:21:13,310 --> 00:21:16,870 perfect competition, monopoly, and oligopoly. 526 00:21:16,870 --> 00:21:18,526 Now, let's compare them, and I want 527 00:21:18,526 --> 00:21:23,320 to compare them in two ways, quantity sold 528 00:21:23,320 --> 00:21:32,590 and profits per firm, profits earned per firm. 529 00:21:32,590 --> 00:21:35,260 And we're going to stick with the United, American market, 530 00:21:35,260 --> 00:21:35,980 OK? 531 00:21:35,980 --> 00:21:39,550 We know, if this is a monopoly, if this is a monopoly, 532 00:21:39,550 --> 00:21:42,640 if they can perfectly cartelize, then 533 00:21:42,640 --> 00:21:47,300 there'll be 96 flights total. 534 00:21:47,300 --> 00:21:52,330 Each will fly 48 flights, and profits per firm will be 4,608. 535 00:21:52,330 --> 00:21:53,600 OK, we solved that already. 536 00:21:53,600 --> 00:21:55,790 That's the cartel outcome. 537 00:21:55,790 --> 00:21:57,970 The non-cooperative outcome, which 538 00:21:57,970 --> 00:22:02,990 we call the oligopoly outcome, is they each sell 64 flights. 539 00:22:02,990 --> 00:22:04,535 We solved that last time. 540 00:22:04,535 --> 00:22:12,263 And as we solved here, they each make profits of 4,096. 541 00:22:12,263 --> 00:22:14,180 What's the competitive outcome in this market? 542 00:22:18,093 --> 00:22:20,010 What's the competitive outcome in this market? 543 00:22:20,010 --> 00:22:21,300 First of all, what's the price? 544 00:22:21,300 --> 00:22:22,350 Somebody raise their hand and tell me. 545 00:22:22,350 --> 00:22:23,700 If this is a perfectly competitive market, 546 00:22:23,700 --> 00:22:24,850 what would the price be? 547 00:22:24,850 --> 00:22:26,353 And then what would the quantity be? 548 00:22:26,353 --> 00:22:26,696 Yeah. 549 00:22:26,696 --> 00:22:27,040 AUDIENCE: 147. 550 00:22:27,040 --> 00:22:28,080 JONATHAN GRUBER: Price would be 147, 551 00:22:28,080 --> 00:22:29,830 because in a perfectly competitive market, 552 00:22:29,830 --> 00:22:31,380 price would be marginal cost. 553 00:22:31,380 --> 00:22:32,855 So profits would be? 554 00:22:32,855 --> 00:22:33,480 AUDIENCE: Zero. 555 00:22:33,480 --> 00:22:35,160 JONATHAN GRUBER: Zero. 556 00:22:35,160 --> 00:22:43,050 And quantity would be 339 minus 147, or 192, OK? 557 00:22:43,050 --> 00:22:44,550 So here we have, for a given market, 558 00:22:44,550 --> 00:22:46,950 a nice table which lets us compare 559 00:22:46,950 --> 00:22:50,170 the three different possible outcomes. 560 00:22:50,170 --> 00:22:52,950 And what you see is essentially, the more you 561 00:22:52,950 --> 00:22:56,970 can monopolize, the higher your profits but the smaller 562 00:22:56,970 --> 00:23:00,110 the market, OK? 563 00:23:00,110 --> 00:23:03,390 So basically, three lessons here. 564 00:23:03,390 --> 00:23:05,240 First of all, generally speaking, 565 00:23:05,240 --> 00:23:06,680 the oligopoly outcome is somewhere 566 00:23:06,680 --> 00:23:08,972 between the monopoly and perfectly competitive outcome. 567 00:23:08,972 --> 00:23:12,040 Where in between, take 14, 12. 568 00:23:12,040 --> 00:23:13,790 If 14, 12 was bad, it's how you figure out 569 00:23:13,790 --> 00:23:16,040 where in between this outcome comes between these two. 570 00:23:16,040 --> 00:23:17,832 It's all about game theory, OK? 571 00:23:17,832 --> 00:23:19,790 So that's what's exciting about game theory is, 572 00:23:19,790 --> 00:23:21,820 this is a wide range, and game theory 573 00:23:21,820 --> 00:23:23,360 is a set of sophisticated tools that 574 00:23:23,360 --> 00:23:25,350 let us pin down where in this range 575 00:23:25,350 --> 00:23:28,340 companies will end up in a realistic case. 576 00:23:28,340 --> 00:23:30,650 0.2 is, the more you can monopolize, 577 00:23:30,650 --> 00:23:33,040 the higher your profits will be. 578 00:23:33,040 --> 00:23:34,660 But let us come to welfare. 579 00:23:34,660 --> 00:23:37,420 Now, I haven't computed social surplus here. 580 00:23:37,420 --> 00:23:40,270 But here's the cheat, I don't really need to. 581 00:23:40,270 --> 00:23:43,390 I don't need to because essentially, roughly speaking, 582 00:23:43,390 --> 00:23:47,380 social welfare is proportional to the quantity sold. 583 00:23:47,380 --> 00:23:50,920 In other words, we know that in a perfectly competitive market, 584 00:23:50,920 --> 00:23:54,520 this is-- the welfare-maximizing quantity is 192. 585 00:23:54,520 --> 00:23:57,010 We know that there's 192 flights that maximize welfare, 586 00:23:57,010 --> 00:23:59,230 because that's the competitive outcome. 587 00:23:59,230 --> 00:24:00,670 What we're saying is the more-- 588 00:24:00,670 --> 00:24:01,712 Oh, this shouldn't be 64. 589 00:24:01,712 --> 00:24:02,700 It should be 128. 590 00:24:02,700 --> 00:24:04,160 That's my bad. 591 00:24:04,160 --> 00:24:04,960 128. 592 00:24:04,960 --> 00:24:07,060 It's each doing 64. 593 00:24:07,060 --> 00:24:11,680 We know that as we monopolize the market, 594 00:24:11,680 --> 00:24:14,440 there are fewer and fewer flights. 595 00:24:14,440 --> 00:24:18,420 Therefore, we're creating a deadweight loss. 596 00:24:18,420 --> 00:24:21,480 Essentially, deadweight loss is proportional-- 597 00:24:21,480 --> 00:24:24,450 actually, it's sort of exponentially proportional-- 598 00:24:24,450 --> 00:24:27,030 to the gap between the quantity sold 599 00:24:27,030 --> 00:24:29,790 and the competitive quantity. 600 00:24:29,790 --> 00:24:31,780 Welfare is maximized here by definition. 601 00:24:31,780 --> 00:24:33,188 We proved that. 602 00:24:33,188 --> 00:24:35,730 So any reduction for that means it increased deadweight loss. 603 00:24:35,730 --> 00:24:38,770 So the more you reduce quantity, the more you lower welfare. 604 00:24:38,770 --> 00:24:41,460 So essentially, as we go down the column, 605 00:24:41,460 --> 00:24:44,010 we lower profits but raise social welfare. 606 00:24:44,010 --> 00:24:45,478 Yeah. 607 00:24:45,478 --> 00:24:47,270 AUDIENCE: When we're-- I'm not really sure. 608 00:24:47,270 --> 00:24:48,850 Are we talking about an oligopoly 609 00:24:48,850 --> 00:24:50,170 that acts like a monopoly? 610 00:24:50,170 --> 00:24:54,300 JONATHAN GRUBER: Yeah, cartel/monopoly. 611 00:24:54,300 --> 00:24:55,800 AUDIENCE: So there's [INAUDIBLE]---- 612 00:24:55,800 --> 00:24:57,690 JONATHAN GRUBER: Yes. 613 00:24:57,690 --> 00:25:01,030 But otherwise, you do 96, your profits would be twice that. 614 00:25:01,030 --> 00:25:03,330 But the bottom line is that essentially, you've 615 00:25:03,330 --> 00:25:07,830 got essentially more profits in this market. 616 00:25:07,830 --> 00:25:08,830 OK? 617 00:25:08,830 --> 00:25:11,340 Other questions about that? 618 00:25:11,340 --> 00:25:15,180 So the bottom line is, the more competitive the market, 619 00:25:15,180 --> 00:25:19,370 the higher the welfare, but the lower the profits, OK? 620 00:25:19,370 --> 00:25:21,180 So that's kind of our bottom line 621 00:25:21,180 --> 00:25:22,630 of how we think about this. 622 00:25:22,630 --> 00:25:24,490 Questions about that? 623 00:25:24,490 --> 00:25:26,780 OK, next I want to cover-- 624 00:25:26,780 --> 00:25:30,680 we've only covered the case of two firms. 625 00:25:30,680 --> 00:25:32,720 What if there are many firms? 626 00:25:35,750 --> 00:25:39,200 After all, most oligopoly markets are not just two firms. 627 00:25:39,200 --> 00:25:43,040 We've talked about cars and movie producing studios. 628 00:25:43,040 --> 00:25:45,970 There are many firms, OK? 629 00:25:45,970 --> 00:25:50,825 Well, the Cournot model is super hard to do when there's more 630 00:25:50,825 --> 00:25:52,450 firms, but there's no reason you can't. 631 00:25:52,450 --> 00:25:55,090 It literally just becomes three equations and three unknowns 632 00:25:55,090 --> 00:25:56,590 or four equations and four unknowns. 633 00:25:56,590 --> 00:25:58,990 Literally, as you can see, you could simply see, 634 00:25:58,990 --> 00:26:01,240 if you take that model and add more firms, 635 00:26:01,240 --> 00:26:02,680 it just expands the state space. 636 00:26:02,680 --> 00:26:05,440 It becomes impossible the graph, but you could solve it. 637 00:26:05,440 --> 00:26:10,120 Eventually, you've got n equations and n unknowns. 638 00:26:10,120 --> 00:26:13,810 The key bottom line result is that as the Cournot-- 639 00:26:13,810 --> 00:26:16,530 as the number of firms gets large, 640 00:26:16,530 --> 00:26:19,270 the Cournot equilibrium approaches 641 00:26:19,270 --> 00:26:21,130 the competitive equilibrium. 642 00:26:21,130 --> 00:26:22,840 That is mathematically, if you solve 643 00:26:22,840 --> 00:26:24,382 this-- you don't have to solve this-- 644 00:26:24,382 --> 00:26:29,850 but the bottom line condition is, the markup that firms earn 645 00:26:29,850 --> 00:26:36,270 is equal to minus 1 over n times the elasticity. 646 00:26:36,270 --> 00:26:37,405 In sort of a market-- 647 00:26:37,405 --> 00:26:39,780 this is sort of in a symmetric Cournot market of the kind 648 00:26:39,780 --> 00:26:43,100 we've been working with. 649 00:26:43,100 --> 00:26:46,490 The markup is 1 over the number of firms 650 00:26:46,490 --> 00:26:49,745 times the elasticity of demand. 651 00:26:49,745 --> 00:26:51,120 So think about this for a second. 652 00:26:51,120 --> 00:26:54,800 Imagine there is one firm. 653 00:26:54,800 --> 00:26:57,050 Then this equation says the market is equal to minus 1 654 00:26:57,050 --> 00:26:58,490 over the elasticity of demand. 655 00:26:58,490 --> 00:27:01,660 Where have we seen that before? 656 00:27:01,660 --> 00:27:03,220 That's the monopoly condition. 657 00:27:03,220 --> 00:27:04,870 That's the monopoly market condition. 658 00:27:04,870 --> 00:27:07,360 So when n equals 1, this is an equation we've seen before, 659 00:27:07,360 --> 00:27:09,400 the monopoly market condition. 660 00:27:09,400 --> 00:27:14,040 When n equals 2, the firms are making 1/2 as much. 661 00:27:14,040 --> 00:27:15,870 When n equals 3, a third-- 662 00:27:15,870 --> 00:27:18,420 it goes a fact-- factor third, et cetera. 663 00:27:18,420 --> 00:27:21,360 What this says is n approaches infinity, 664 00:27:21,360 --> 00:27:24,590 we approach a competitive outcome. 665 00:27:24,590 --> 00:27:26,490 We'll never get there, but we're asymptoting 666 00:27:26,490 --> 00:27:29,618 towards a competitive outcome, which basically says-- 667 00:27:29,618 --> 00:27:32,160 you know, it's sort of like my point about contested markets. 668 00:27:32,160 --> 00:27:35,090 You get a market that's sort of competitive enough, 669 00:27:35,090 --> 00:27:38,340 you're going to shrink the markup as more and more firms 670 00:27:38,340 --> 00:27:40,080 enter, OK? 671 00:27:40,080 --> 00:27:43,740 So that's sort of a general condition that we could derive, 672 00:27:43,740 --> 00:27:49,920 that shows that as more firms are in, 673 00:27:49,920 --> 00:27:53,130 then you get a lower markup. 674 00:27:53,130 --> 00:27:54,060 Now, I want to make-- 675 00:27:54,060 --> 00:27:54,810 there's actually-- 676 00:27:54,810 --> 00:27:58,340 But this actually understates the case, 677 00:27:58,340 --> 00:28:00,410 for an important strategic reason, 678 00:28:00,410 --> 00:28:04,100 which is, more firms lowers the markup in a-- 679 00:28:04,100 --> 00:28:08,060 more firm lowers the markup in a Cournot non-cooperative model. 680 00:28:08,060 --> 00:28:12,080 But more firms also makes a cooperative model harder. 681 00:28:12,080 --> 00:28:14,025 So this is for the non-cooperative model. 682 00:28:14,025 --> 00:28:15,650 The non-cooperative model, your profits 683 00:28:15,650 --> 00:28:17,060 fall as there more firms. 684 00:28:17,060 --> 00:28:18,770 But it also gets harder to cooperate 685 00:28:18,770 --> 00:28:21,090 as there are more firms, because there 686 00:28:21,090 --> 00:28:23,030 are more people you have to trust, 687 00:28:23,030 --> 00:28:24,590 more people you have to keep hold of. 688 00:28:24,590 --> 00:28:28,580 So a great example of this, actually, for a long time, 689 00:28:28,580 --> 00:28:31,760 mercury, the stuff we use in thermometers and such, 690 00:28:31,760 --> 00:28:34,040 only was found in Italy and Spain, 691 00:28:34,040 --> 00:28:35,660 in the mines in Italy and Spain. 692 00:28:35,660 --> 00:28:38,270 And they had a cartel between the two countries 693 00:28:38,270 --> 00:28:40,100 to sell mercury. 694 00:28:40,100 --> 00:28:42,598 What happened, other countries discovered mercury, 695 00:28:42,598 --> 00:28:44,390 and they couldn't keep the cartel together, 696 00:28:44,390 --> 00:28:46,130 and the price of mercury fell a lot. 697 00:28:46,130 --> 00:28:48,170 With the question about OPEC, similar thing-- 698 00:28:48,170 --> 00:28:51,980 OPEC was much more successful in the 1970s, when essentially, 699 00:28:51,980 --> 00:28:55,460 the only source of oil were basically these Arab nations 700 00:28:55,460 --> 00:28:56,658 that form OPEC. 701 00:28:56,658 --> 00:28:58,700 What happened over time is we discovered more oil 702 00:28:58,700 --> 00:29:02,690 around the world, in particular, in Russia and in the US, which 703 00:29:02,690 --> 00:29:06,050 has sort of broken the power of this cartel to a large extent. 704 00:29:06,050 --> 00:29:09,110 So the reason why a bigger market moves us 705 00:29:09,110 --> 00:29:10,580 towards a competitive equilibrium 706 00:29:10,580 --> 00:29:15,110 is that it makes it harder to maintain a cartel, OK? 707 00:29:15,110 --> 00:29:19,940 Now, let's actually-- the other issue I want to cover here 708 00:29:19,940 --> 00:29:22,820 is, I want to talk about what does all this teach us 709 00:29:22,820 --> 00:29:27,495 about a key policy issue, which is the issue of mergers? 710 00:29:27,495 --> 00:29:29,120 What does everything we've learned here 711 00:29:29,120 --> 00:29:32,660 tell us about thinking about mergers? 712 00:29:32,660 --> 00:29:33,890 OK, we know about mergers. 713 00:29:33,890 --> 00:29:34,890 It happens all the time. 714 00:29:34,890 --> 00:29:36,460 Two companies merge. 715 00:29:36,460 --> 00:29:38,270 Well, it turns out when companies merge 716 00:29:38,270 --> 00:29:40,310 and they're large enough, the federal government 717 00:29:40,310 --> 00:29:42,018 regulates that. 718 00:29:42,018 --> 00:29:43,560 The federal government gets a vote on 719 00:29:43,560 --> 00:29:44,700 whether that merger is going to be allowed 720 00:29:44,700 --> 00:29:47,130 to go forward, either the Department of Justice 721 00:29:47,130 --> 00:29:48,880 or the Federal Trade Commission, depending 722 00:29:48,880 --> 00:29:50,810 on what industry it is. 723 00:29:50,810 --> 00:29:52,700 So the federal government has to decide 724 00:29:52,700 --> 00:29:56,600 how to evaluate whether two firms merging is a good idea 725 00:29:56,600 --> 00:29:59,540 or not, and essentially, what it comes down to 726 00:29:59,540 --> 00:30:07,750 is a simple trade-off, economies of scale versus market power. 727 00:30:12,110 --> 00:30:15,700 The benefit of two firms merging is economies of scale. 728 00:30:15,700 --> 00:30:18,580 If two firms have sort of redundant production processes 729 00:30:18,580 --> 00:30:21,130 and they merge, they can be more efficient. 730 00:30:21,130 --> 00:30:24,070 There can be positive economies of scale for merging firms. 731 00:30:26,720 --> 00:30:28,900 So it's cost efficiencies, basically. 732 00:30:28,900 --> 00:30:31,310 Economies of scale deliver cost efficiencies. 733 00:30:31,310 --> 00:30:34,220 On the other hand, the more firms merge, 734 00:30:34,220 --> 00:30:37,340 the more this n goes down, and the more markets go up, 735 00:30:37,340 --> 00:30:39,960 and the worse it is for consumers. 736 00:30:39,960 --> 00:30:42,150 So the trade-off is, do you want to reduce-- 737 00:30:42,150 --> 00:30:45,900 is reducing n worth it in terms of the economies of scale? 738 00:30:45,900 --> 00:30:48,870 Or in other words, does the producer efficiency 739 00:30:48,870 --> 00:30:51,900 go up enough to make up for the potential loss 740 00:30:51,900 --> 00:30:56,420 to consumers of this less competitive market, OK? 741 00:30:56,420 --> 00:30:58,607 People understand that? 742 00:30:58,607 --> 00:31:00,190 Now an interesting case of this, which 743 00:31:00,190 --> 00:31:02,950 has got very big implications for all of us in America, 744 00:31:02,950 --> 00:31:05,440 is hospital mergers. 745 00:31:05,440 --> 00:31:07,980 During the decade of the 2000s, there 746 00:31:07,980 --> 00:31:11,110 was a rash of hospital mergers, where hospitals said, look, 747 00:31:11,110 --> 00:31:13,210 here's a classic case for economies of scale, 748 00:31:13,210 --> 00:31:16,360 because hospitals have what's called a peak load problem. 749 00:31:16,360 --> 00:31:17,950 They have to have empty beds. 750 00:31:17,950 --> 00:31:19,570 Hospitals can't be full all the time, 751 00:31:19,570 --> 00:31:22,400 because there might be a car accident, and people need beds. 752 00:31:22,400 --> 00:31:24,400 So by definition, it's inefficient for hospitals 753 00:31:24,400 --> 00:31:26,170 to be 100% capacity. 754 00:31:26,170 --> 00:31:28,150 Hospitals want to have excess capacity. 755 00:31:28,150 --> 00:31:29,530 The problem with that, there's two hospitals 756 00:31:29,530 --> 00:31:31,540 next to each other, each with excess capacity, 757 00:31:31,540 --> 00:31:32,840 that's inefficient. 758 00:31:32,840 --> 00:31:34,840 It'd be more efficient to have one hospital, one 759 00:31:34,840 --> 00:31:37,173 merged hospital, then they just manage the proper amount 760 00:31:37,173 --> 00:31:39,015 of excess capacity. 761 00:31:39,015 --> 00:31:40,390 And hospitals made this argument, 762 00:31:40,390 --> 00:31:42,910 and we basically approved any hospital merger 763 00:31:42,910 --> 00:31:45,330 that they wanted in the 2000s. 764 00:31:45,330 --> 00:31:46,620 Well, what happened? 765 00:31:46,620 --> 00:31:48,940 What happened is the hospitals lied. 766 00:31:48,940 --> 00:31:51,690 They kept both hospitals open, kept all the empty beds, 767 00:31:51,690 --> 00:31:53,920 and just raised prices. 768 00:31:53,920 --> 00:31:55,420 So essentially, the hospital mergers 769 00:31:55,420 --> 00:31:57,295 did not deliver any of the economies of scale 770 00:31:57,295 --> 00:31:59,950 they promised, but did deliver a lot of the market power 771 00:31:59,950 --> 00:32:01,540 we feared. 772 00:32:01,540 --> 00:32:04,090 So a huge cause of the increase in medical spending 773 00:32:04,090 --> 00:32:06,940 in the 2000s was these hospital mergers, 774 00:32:06,940 --> 00:32:10,840 which essentially took a lot of the competitive pressure out 775 00:32:10,840 --> 00:32:13,870 of the medical market and didn't really deliver 776 00:32:13,870 --> 00:32:15,690 economies of scale. 777 00:32:15,690 --> 00:32:17,820 And this is the hard part of being a regulator. 778 00:32:17,820 --> 00:32:20,820 Most of what public policy economists do in the world 779 00:32:20,820 --> 00:32:22,410 is regulate. 780 00:32:22,410 --> 00:32:24,035 All over the world, there are thousands 781 00:32:24,035 --> 00:32:26,368 of economists employed all over the world, hundreds of-- 782 00:32:26,368 --> 00:32:27,930 tens of thousands, whose job it is 783 00:32:27,930 --> 00:32:30,280 to make regulatory decisions of this nature, 784 00:32:30,280 --> 00:32:31,950 and they're really hard. 785 00:32:31,950 --> 00:32:35,340 Because we've drawn nice, clean theoretical models here, 786 00:32:35,340 --> 00:32:38,300 but we have to know what's epsilon. 787 00:32:38,300 --> 00:32:40,320 You know, how much-- 788 00:32:40,320 --> 00:32:42,570 what's epsilon, to figure out the effect to consumers. 789 00:32:42,570 --> 00:32:43,903 What are the economies of scale? 790 00:32:43,903 --> 00:32:46,570 Will they exploit those economies of scale, et cetera? 791 00:32:46,570 --> 00:32:49,460 So these are really hard and interesting decisions. 792 00:32:49,460 --> 00:32:52,680 Now, let's go on to the last topic I want to cover today, 793 00:32:52,680 --> 00:32:54,876 which is price competition. 794 00:33:03,310 --> 00:33:05,080 Price competition. 795 00:33:05,080 --> 00:33:09,220 Now, the models we've been discussing so far 796 00:33:09,220 --> 00:33:12,730 have been what we call quantity competition, that United 797 00:33:12,730 --> 00:33:16,940 and American compete on how many flights to send, 798 00:33:16,940 --> 00:33:20,080 and then the demand curve tells them what they can charge. 799 00:33:20,080 --> 00:33:22,670 But in fact, in many markets, that's not how firms compete. 800 00:33:22,670 --> 00:33:23,920 In fact, we even mentioned it. 801 00:33:23,920 --> 00:33:26,770 Someone mentioned about best price offers, et cetera. 802 00:33:26,770 --> 00:33:30,880 They don't compete on quantity, they compete on price, 803 00:33:30,880 --> 00:33:32,980 and that's a different model, named 804 00:33:32,980 --> 00:33:35,260 after another French economist. 805 00:33:35,260 --> 00:33:40,553 A model of Bertrand competition is 806 00:33:40,553 --> 00:33:42,220 a model of price competition, is a model 807 00:33:42,220 --> 00:33:45,260 we call Bertrand competition. 808 00:33:45,260 --> 00:33:49,700 This model says that basically, two firms compete over 809 00:33:49,700 --> 00:33:52,690 what price to set, and then the quantity 810 00:33:52,690 --> 00:33:55,830 is determined by the price that results from that competition. 811 00:33:55,830 --> 00:33:57,330 So they don't compete over quantity. 812 00:33:57,330 --> 00:33:59,460 They compete over price, and the demand curve then 813 00:33:59,460 --> 00:34:03,120 tells you the quantity, OK? 814 00:34:03,120 --> 00:34:05,970 Now, in this case, what's really striking about Bertrand 815 00:34:05,970 --> 00:34:10,469 competition is that unlike the Cournot model, 816 00:34:10,469 --> 00:34:12,600 under Bertrand competition, two firms 817 00:34:12,600 --> 00:34:16,389 can be enough to get us to the competitive equilibrium. 818 00:34:16,389 --> 00:34:17,572 Why? 819 00:34:17,572 --> 00:34:19,280 Why do we only potentially need two firms 820 00:34:19,280 --> 00:34:20,270 to get to the competitive equilibrium? 821 00:34:20,270 --> 00:34:20,770 Yeah. 822 00:34:20,770 --> 00:34:21,937 AUDIENCE: I'll do you lower. 823 00:34:21,937 --> 00:34:24,478 JONATHAN GRUBER: Why don't you explain a little bit more what 824 00:34:24,478 --> 00:34:25,150 you mean? 825 00:34:25,150 --> 00:34:28,159 AUDIENCE: One firm [INAUDIBLE] the other one what price are 826 00:34:28,159 --> 00:34:29,097 lower, and like-- 827 00:34:29,097 --> 00:34:30,139 JONATHAN GRUBER: Exactly. 828 00:34:30,139 --> 00:34:32,090 As long as there's profits to be made, 829 00:34:32,090 --> 00:34:34,520 it's like our entry/exit decision, right? 830 00:34:34,520 --> 00:34:36,409 As long as there's profits to be made, 831 00:34:36,409 --> 00:34:38,750 I'm going to come in at a price one penny below you, 832 00:34:38,750 --> 00:34:41,210 make one penny less profits, and steal all the business 833 00:34:41,210 --> 00:34:42,780 from you. 834 00:34:42,780 --> 00:34:45,030 So if there's perfect competition between firms 835 00:34:45,030 --> 00:34:47,800 in a Bertrand sense, then you only 836 00:34:47,800 --> 00:34:50,110 need two firms to get to the competitive equilibrium 837 00:34:50,110 --> 00:34:52,510 in theory, OK? 838 00:34:52,510 --> 00:34:55,159 So it's a very different idea. 839 00:34:55,159 --> 00:34:57,520 Cournot competition, we need many, many firms 840 00:34:57,520 --> 00:34:59,770 to get close to this competitive outcome. 841 00:34:59,770 --> 00:35:02,110 With price competition, because firms are always 842 00:35:02,110 --> 00:35:04,370 kind of competing on one penny below each other, 843 00:35:04,370 --> 00:35:07,090 in a market that's otherwise competitive, 844 00:35:07,090 --> 00:35:10,167 you can actually drive the price to competitive price through-- 845 00:35:10,167 --> 00:35:12,250 essentially, you can actually drive the price down 846 00:35:12,250 --> 00:35:13,743 to marginal cost. 847 00:35:13,743 --> 00:35:15,910 It's sort of like I talked about contestable markets 848 00:35:15,910 --> 00:35:18,370 and as long as there's profit to be made, someone would enter. 849 00:35:18,370 --> 00:35:19,570 Here, as long as there's profit to be made, 850 00:35:19,570 --> 00:35:21,362 someone will lower their price, and that'll 851 00:35:21,362 --> 00:35:24,570 keep happening until price equals marginal cost. 852 00:35:24,570 --> 00:35:26,730 So in Bertrand competition, you actually 853 00:35:26,730 --> 00:35:30,030 can get close to or at-- to the competitive outcome 854 00:35:30,030 --> 00:35:32,170 with a small number firms. 855 00:35:32,170 --> 00:35:34,620 Now, two points to make about this. 856 00:35:34,620 --> 00:35:37,800 Your first point is, well, holy shit, 857 00:35:37,800 --> 00:35:40,082 how do I say which one of these to use? 858 00:35:40,082 --> 00:35:41,040 You've just taught me-- 859 00:35:41,040 --> 00:35:43,373 you've just spent a lecture and 1/2 on this fancy model, 860 00:35:43,373 --> 00:35:45,978 spent 37 seconds on this model. 861 00:35:45,978 --> 00:35:47,270 How do I know which one to use? 862 00:35:47,270 --> 00:35:48,640 You didn't write down any math, so I don't know what to do. 863 00:35:48,640 --> 00:35:49,910 I'm freaking out. 864 00:35:49,910 --> 00:35:51,740 OK, how do I know which one to use? 865 00:35:51,740 --> 00:35:53,198 Well, the bottom line is, we're not 866 00:35:53,198 --> 00:35:55,698 going to ask you to do much math about Bertrand competition, 867 00:35:55,698 --> 00:35:58,390 other than sort of the intuition about competing over price. 868 00:35:58,390 --> 00:36:00,340 The more relevant question is, how do you 869 00:36:00,340 --> 00:36:03,643 think about the situations where Cournot competition is 870 00:36:03,643 --> 00:36:05,810 more likely and Bertrand competition is more likely? 871 00:36:05,810 --> 00:36:06,770 So what do you think? 872 00:36:06,770 --> 00:36:08,570 In what types of markets do you think 873 00:36:08,570 --> 00:36:10,510 Cournot competition would be more likely, 874 00:36:10,510 --> 00:36:13,355 and what kinds of markets do you think Bertrand competition 875 00:36:13,355 --> 00:36:14,230 would be more likely? 876 00:36:16,790 --> 00:36:17,642 Yeah. 877 00:36:17,642 --> 00:36:19,350 AUDIENCE: Wouldn't the Bertrand be really 878 00:36:19,350 --> 00:36:21,387 efficient in an elastic market? 879 00:36:21,387 --> 00:36:22,470 JONATHAN GRUBER: Well, no. 880 00:36:22,470 --> 00:36:23,730 Elasticity is the same. 881 00:36:23,730 --> 00:36:26,970 So basically, elasticity is going 882 00:36:26,970 --> 00:36:28,440 to have a similar effect in both. 883 00:36:28,440 --> 00:36:31,740 It's going to basically drive the price down in both, OK? 884 00:36:31,740 --> 00:36:33,990 Because the elasticity is higher, it drove the markup. 885 00:36:33,990 --> 00:36:36,317 Bertrand, it's going to drive down in both. 886 00:36:36,317 --> 00:36:37,900 So it's not actually about elasticity. 887 00:36:37,900 --> 00:36:39,960 It's something about production processes. 888 00:36:39,960 --> 00:36:41,968 What type of production processes 889 00:36:41,968 --> 00:36:44,010 are going to lend themselves to price competition 890 00:36:44,010 --> 00:36:46,520 versus quantity competition? 891 00:36:46,520 --> 00:36:50,260 Think about it this way, if I offer a price, 892 00:36:50,260 --> 00:36:52,897 what do I have to do? 893 00:36:52,897 --> 00:36:55,230 AUDIENCE: I think the better the production is dominated 894 00:36:55,230 --> 00:36:59,362 by the capital costs, or is it [INAUDIBLE] the variable costs? 895 00:36:59,362 --> 00:37:01,320 JONATHAN GRUBER: That's roughly speaking right. 896 00:37:01,320 --> 00:37:05,550 Basically, if there's long lags in production, 897 00:37:05,550 --> 00:37:07,480 I can't do price competition. 898 00:37:07,480 --> 00:37:08,670 So if I say I'm going to compete, people would say, 899 00:37:08,670 --> 00:37:10,045 "Great, I want all your product." 900 00:37:10,045 --> 00:37:12,110 I'm like, great, you can have it in a year. 901 00:37:12,110 --> 00:37:13,870 That doesn't work. 902 00:37:13,870 --> 00:37:17,050 So things like auto companies are 903 00:37:17,050 --> 00:37:19,527 going to have a hard time with pure price competition, 904 00:37:19,527 --> 00:37:21,860 because if Toyota says, "OK, I'm $1 less," someone says, 905 00:37:21,860 --> 00:37:22,390 "OK, great. 906 00:37:22,390 --> 00:37:26,200 We want a million Toyotas tomorrow," they can't do it. 907 00:37:26,200 --> 00:37:28,420 So things which are capital-intensive lagged 908 00:37:28,420 --> 00:37:31,678 production processes it's going to be hard to have pure-- 909 00:37:31,678 --> 00:37:33,970 real life, of course, there could be some mix of these. 910 00:37:33,970 --> 00:37:36,307 But it will tend more towards quantity competition, 911 00:37:36,307 --> 00:37:38,890 because you're really going to know what you're going to sell, 912 00:37:38,890 --> 00:37:41,300 because that's sort of-- you can't just infinitely supply 913 00:37:41,300 --> 00:37:41,800 it. 914 00:37:41,800 --> 00:37:45,110 With other things like cereal sales, 915 00:37:45,110 --> 00:37:46,615 where you can sort of immediately 916 00:37:46,615 --> 00:37:48,240 crank up a million more boxes of cereal 917 00:37:48,240 --> 00:37:50,198 in like a day out of your production processes, 918 00:37:50,198 --> 00:37:52,330 there would be more likely to be price competition. 919 00:37:52,330 --> 00:37:54,723 Things with small production lags, 920 00:37:54,723 --> 00:37:56,890 then you'd be more likely to have price competition, 921 00:37:56,890 --> 00:37:58,540 because if you lower the price, all of the sudden, 922 00:37:58,540 --> 00:37:59,540 you dominate the market. 923 00:37:59,540 --> 00:38:02,520 You can meet that demand, OK? 924 00:38:02,520 --> 00:38:05,880 So essentially, we can think about price competition 925 00:38:05,880 --> 00:38:09,415 as being more likely the smaller the production lag, 926 00:38:09,415 --> 00:38:11,790 or maybe the less capital-- it's not really about capital 927 00:38:11,790 --> 00:38:13,270 intensity, because you can have a capital-- 928 00:38:13,270 --> 00:38:14,620 you can create things quickly. 929 00:38:14,620 --> 00:38:16,090 It's more about production lags. 930 00:38:16,090 --> 00:38:20,170 Now, we're never going to ask you to tell us which is right, 931 00:38:20,170 --> 00:38:22,565 and of course, in reality, it lies somewhere in between. 932 00:38:22,565 --> 00:38:24,190 But this just gives you a sense of kind 933 00:38:24,190 --> 00:38:28,720 of when one type of competition is more likely than the other. 934 00:38:28,720 --> 00:38:29,358 Yeah? 935 00:38:29,358 --> 00:38:30,900 AUDIENCE: Does it have anything to do 936 00:38:30,900 --> 00:38:33,430 [INAUDIBLE] to protect the cereal in the grocery store? 937 00:38:33,430 --> 00:38:35,120 JONATHAN GRUBER: Great segue. 938 00:38:35,120 --> 00:38:38,720 You've jumped ahead to the last point I want to make, 939 00:38:38,720 --> 00:38:41,920 which is, imagine you're in a Bertrand competition world, 940 00:38:41,920 --> 00:38:43,480 like with cereal. 941 00:38:43,480 --> 00:38:47,180 That's a pretty awful world if you're a producer, OK? 942 00:38:47,180 --> 00:38:48,972 Basically, that's where your markup's tiny, 943 00:38:48,972 --> 00:38:50,805 because any time you try to raise the price, 944 00:38:50,805 --> 00:38:51,880 you get undercut. 945 00:38:51,880 --> 00:38:53,320 What can you do? 946 00:38:53,320 --> 00:38:55,030 Well, we've already gotten the answer. 947 00:38:55,030 --> 00:38:56,740 What you can do is you can engage 948 00:38:56,740 --> 00:38:59,650 in product differentiation. 949 00:39:04,550 --> 00:39:08,820 You can engage in product differentiation. 950 00:39:08,820 --> 00:39:14,090 OK, so basically, the reason why you're in Bertrand competition 951 00:39:14,090 --> 00:39:16,530 is because you're selling the same thing. 952 00:39:16,530 --> 00:39:18,800 Once I'm selling something different, 953 00:39:18,800 --> 00:39:21,840 I take on the features of a monopolist again. 954 00:39:21,840 --> 00:39:24,500 So if I can get consumers to not think of my good 955 00:39:24,500 --> 00:39:26,630 as identical to my competitors, then I 956 00:39:26,630 --> 00:39:30,470 can price above marginal cost, and people would still buy it. 957 00:39:30,470 --> 00:39:33,260 The reason Bertrand competition drives price to marginal cost 958 00:39:33,260 --> 00:39:35,853 is because people view the goods as identical. 959 00:39:35,853 --> 00:39:37,770 But if they don't view the goods as identical, 960 00:39:37,770 --> 00:39:41,770 then I can keep price above marginal cost, OK? 961 00:39:41,770 --> 00:39:43,270 And the example-- breakfast cereals 962 00:39:43,270 --> 00:39:45,560 is the perfect way to illustrate this. 963 00:39:45,560 --> 00:39:47,380 So back around World War II, there 964 00:39:47,380 --> 00:39:50,680 were essentially basically like three types of cereal, OK? 965 00:39:50,680 --> 00:39:54,880 There was Cheerios, there was cornflakes, and Quaker oats. 966 00:39:54,880 --> 00:39:58,470 OK, that's basically what cereal was, not very exciting. 967 00:39:58,470 --> 00:40:03,870 Now, but by 1970, there were more than 150 breakfast cereals 968 00:40:03,870 --> 00:40:06,470 to choose from, including some which 969 00:40:06,470 --> 00:40:08,960 are variations of Cheerios and variation of cornflakes. 970 00:40:08,960 --> 00:40:10,220 In fact, you could all say in some sense, 971 00:40:10,220 --> 00:40:11,762 all cereal is variations of Cheerios, 972 00:40:11,762 --> 00:40:14,330 and cornflakes, and oats. 973 00:40:14,330 --> 00:40:18,740 And then-- and moreover now, if you go to a store today, 974 00:40:18,740 --> 00:40:22,580 you can actually buy generic versions of brand name cereal. 975 00:40:22,580 --> 00:40:24,920 You can buy Oatios or Marshmallow 976 00:40:24,920 --> 00:40:27,680 Mateys, which are Lucky Charms, or what's the other one? 977 00:40:27,680 --> 00:40:29,120 I love buying these big bags. 978 00:40:29,120 --> 00:40:30,665 You guys ever buy these generic Lucky 979 00:40:30,665 --> 00:40:31,790 Charms, Marshmallow Mateys. 980 00:40:31,790 --> 00:40:34,560 Generic Captain Crunch is like, you know, 981 00:40:34,560 --> 00:40:35,640 Ahoy Matey or something. 982 00:40:35,640 --> 00:40:36,350 I don't know. 983 00:40:36,350 --> 00:40:38,475 They've got these generic things which you can buy, 984 00:40:38,475 --> 00:40:40,770 which are really just the same. 985 00:40:40,770 --> 00:40:45,522 So essentially, what you do-- what companies 986 00:40:45,522 --> 00:40:47,730 want to always do, which are in Bertrand competition, 987 00:40:47,730 --> 00:40:49,668 is always try to product differentiate, 988 00:40:49,668 --> 00:40:51,960 always try to figure out a way they can create a market 989 00:40:51,960 --> 00:40:56,640 where they can price above marginal cost, OK? 990 00:40:56,640 --> 00:41:00,780 So for example, let's take General Mills, a company that 991 00:41:00,780 --> 00:41:03,180 makes Cheerios, OK? 992 00:41:03,180 --> 00:41:05,790 They're making Cheerios, and then 993 00:41:05,790 --> 00:41:08,040 all of a sudden, Oatios and stuff started coming along 994 00:41:08,040 --> 00:41:09,490 and they weren't making money. 995 00:41:09,490 --> 00:41:10,232 What do they do? 996 00:41:10,232 --> 00:41:11,940 They created different kinds of Cheerios, 997 00:41:11,940 --> 00:41:13,567 like Apple Cinnamon Cheerios. 998 00:41:13,567 --> 00:41:15,900 General Mills did not create Apple Cinnamon Cheerios out 999 00:41:15,900 --> 00:41:17,192 of the goodness of their heart. 1000 00:41:17,192 --> 00:41:19,067 General Mills created Apple Cinnamon Cheerios 1001 00:41:19,067 --> 00:41:21,490 because they were getting killed in the Cheerio market, 1002 00:41:21,490 --> 00:41:23,160 and so they tried to differentiate 1003 00:41:23,160 --> 00:41:26,543 by having a new product on which they 1004 00:41:26,543 --> 00:41:28,710 could charge a higher price, which is Apple Cinnamon 1005 00:41:28,710 --> 00:41:30,630 Cheerios. 1006 00:41:30,630 --> 00:41:33,240 Now, how do we feel about this? 1007 00:41:33,240 --> 00:41:34,800 Well, it's not clear. 1008 00:41:34,800 --> 00:41:39,530 On the one hand, by introducing Apple Cinnamon Cheerios, 1009 00:41:39,530 --> 00:41:42,350 General Mills was able to push its price greater 1010 00:41:42,350 --> 00:41:44,210 than marginal cost. 1011 00:41:44,210 --> 00:41:47,160 And as price pushed above marginal cost, 1012 00:41:47,160 --> 00:41:49,610 quantity sold in the market falls. 1013 00:41:49,610 --> 00:41:51,800 It created deadweight loss. 1014 00:41:51,800 --> 00:41:55,190 Quantity fell, and that's bad, OK? 1015 00:41:55,190 --> 00:41:56,940 On the other hand, Apple Cinnamon Cheerios 1016 00:41:56,940 --> 00:42:00,020 are quite good, OK? 1017 00:42:00,020 --> 00:42:02,570 So it actually ends up being much like our patent 1018 00:42:02,570 --> 00:42:05,580 discussion, which is, essentially, 1019 00:42:05,580 --> 00:42:08,340 by differentiating, they've had two effects. 1020 00:42:08,340 --> 00:42:12,300 They've lowered consumer surplus and welfare 1021 00:42:12,300 --> 00:42:15,210 by pricing above marginal cost, but raised it 1022 00:42:15,210 --> 00:42:17,760 by shifting up the demand curve, by creating a new good 1023 00:42:17,760 --> 00:42:18,480 that people want. 1024 00:42:18,480 --> 00:42:19,800 Yeah. 1025 00:42:19,800 --> 00:42:24,475 AUDIENCE: Isn't like-- doesn't like consumer [INAUDIBLE] not 1026 00:42:24,475 --> 00:42:26,850 necessarily have to happen, because then different people 1027 00:42:26,850 --> 00:42:29,150 have different demand curves, and the demand 1028 00:42:29,150 --> 00:42:32,310 curve for like Apple Cinnamon Cheerios is not-- 1029 00:42:32,310 --> 00:42:33,290 hasn't been this good. 1030 00:42:33,290 --> 00:42:34,980 JONATHAN GRUBER: No, the point is-- 1031 00:42:34,980 --> 00:42:37,170 OK, it's another way of stating my point. 1032 00:42:37,170 --> 00:42:38,430 Even if the demand curve-- 1033 00:42:38,430 --> 00:42:40,210 let's say there's a new demand curve for Apple Cinnamon 1034 00:42:40,210 --> 00:42:40,710 Cheerios. 1035 00:42:40,710 --> 00:42:42,210 It's way out, OK? 1036 00:42:42,210 --> 00:42:43,790 That's great, OK? 1037 00:42:43,790 --> 00:42:46,290 But still, the fact that they're pricing above marginal cost 1038 00:42:46,290 --> 00:42:47,280 means they'll sell fewer than they 1039 00:42:47,280 --> 00:42:48,630 would in a competitive market. 1040 00:42:48,630 --> 00:42:50,160 If they had invented Apple Cinnamon Cheerios 1041 00:42:50,160 --> 00:42:52,810 and sold it at marginal cost, they'd still be way better off. 1042 00:42:52,810 --> 00:42:54,450 So the trade-off is, essentially, 1043 00:42:54,450 --> 00:42:57,150 how far out do we shift demand by creating this new product, 1044 00:42:57,150 --> 00:42:58,920 versus how much do we restrict sales 1045 00:42:58,920 --> 00:43:01,020 by pricing it above marginal cost? 1046 00:43:01,020 --> 00:43:04,140 So essentially-- now, and now what 1047 00:43:04,140 --> 00:43:08,670 we have is a market with about five firms that dominate it, 1048 00:43:08,670 --> 00:43:11,610 and about 5,000 brands of cereal, OK? 1049 00:43:11,610 --> 00:43:14,250 So it's constant product differentiation. 1050 00:43:14,250 --> 00:43:16,962 And essentially, this is the trade-off 1051 00:43:16,962 --> 00:43:18,420 with product differentiation, which 1052 00:43:18,420 --> 00:43:21,730 is we get reduced sale-- we get deadweight loss, 1053 00:43:21,730 --> 00:43:23,730 because they're not pricing it at marginal cost, 1054 00:43:23,730 --> 00:43:26,120 but we get new products that people might like. 1055 00:43:26,120 --> 00:43:27,980 Yeah. 1056 00:43:27,980 --> 00:43:30,455 AUDIENCE: So if there's a product with like-- 1057 00:43:30,455 --> 00:43:31,830 JONATHAN GRUBER: Differentiation. 1058 00:43:31,830 --> 00:43:34,710 AUDIENCE: Yeah, differentiation. 1059 00:43:34,710 --> 00:43:37,606 Is brand loyalty between things like Adidas and Nike, 1060 00:43:37,606 --> 00:43:40,480 or like, Apple and Android, where there are various 1061 00:43:40,480 --> 00:43:42,566 [INAUDIBLE] where you feel strongly towards one, 1062 00:43:42,566 --> 00:43:44,672 is that good for both of the two things 1063 00:43:44,672 --> 00:43:45,880 That you're choosing between? 1064 00:43:45,880 --> 00:43:48,190 JONATHAN GRUBER: Well, actually, that's really interesting. 1065 00:43:48,190 --> 00:43:50,250 It depends on whether that brand loyalty is based 1066 00:43:50,250 --> 00:43:53,340 on innovation or blind faith. 1067 00:43:53,340 --> 00:43:55,835 So this is, once again, this gets 1068 00:43:55,835 --> 00:43:57,210 into the deep, interesting issues 1069 00:43:57,210 --> 00:43:58,790 of industrial organization. 1070 00:43:58,790 --> 00:44:00,300 You talk about game theory, which 1071 00:44:00,300 --> 00:44:07,270 is, if I can create brand loyalty in a way that makes you 1072 00:44:07,270 --> 00:44:11,110 slightly better off, but keeps you in my brand forever, 1073 00:44:11,110 --> 00:44:12,152 then that might be worse. 1074 00:44:12,152 --> 00:44:14,443 By creating it in a way that makes you much better off, 1075 00:44:14,443 --> 00:44:15,340 that might be better. 1076 00:44:15,340 --> 00:44:18,640 So essentially, that's why, for example, you 1077 00:44:18,640 --> 00:44:21,550 may have noticed you may be getting one or two credit card 1078 00:44:21,550 --> 00:44:24,020 mailers. 1079 00:44:24,020 --> 00:44:26,840 Are you guys getting inundated with credit card offers? 1080 00:44:26,840 --> 00:44:29,420 OK, it's not because they love you guys. 1081 00:44:29,420 --> 00:44:32,570 It's because if they hook you now, 1082 00:44:32,570 --> 00:44:35,240 then you might stick with that credit card later. 1083 00:44:35,240 --> 00:44:36,320 So trying to exploit-- 1084 00:44:36,320 --> 00:44:38,695 trying to get you, they're trying to give you a good deal 1085 00:44:38,695 --> 00:44:40,220 now to get you hooked later, so they 1086 00:44:40,220 --> 00:44:43,440 can charge up closer to monopoly price later on. 1087 00:44:43,440 --> 00:44:45,260 So essentially, there's a trade-off, 1088 00:44:45,260 --> 00:44:47,510 which is, if that loyalty is based on real differences 1089 00:44:47,510 --> 00:44:48,802 in quality, that might be good. 1090 00:44:48,802 --> 00:44:50,677 If it's not, it might not be, but the welfare 1091 00:44:50,677 --> 00:44:51,380 gets very murky. 1092 00:44:51,380 --> 00:44:52,580 It's a good question. 1093 00:44:52,580 --> 00:44:54,330 Other questions? 1094 00:44:54,330 --> 00:44:56,300 OK, so these are exciting real world topics. 1095 00:44:56,300 --> 00:44:58,710 It's more reasons to go on and study more economics. 1096 00:44:58,710 --> 00:44:59,950 But let's stop now. 1097 00:44:59,950 --> 00:45:01,800 We will come back and we'll start talking 1098 00:45:01,800 --> 00:45:05,240 about factor markets on Monday.