What to Consider in Structure-Conduct-Performance Model - Essay Example

Economics 319 Part A Question SA de s Sell it All and SS de s Super Savings, L = lower prices, U= unchanged SA\SS L U L 50000,50000150000, 30000 U 30000,150000 100000, 100000 If SA plays L and SS plays L too, the profits for each would be 50000 only. However, if one of them decides to lower the prices then the one that lowers will earn 150000 while the other who does not change will suffer by earning only 30000. If both SS and SA don’t do anything they get a regular profit of 100000. Question 2 If it is a simultaneous move game, then both SS and SA are not aware of the payoffs of each other. Since SS is not aware of the payoff of SA, SS will prefer playing L over U. This is because SS’s strategy L dominates U. (The payoffs are higher) Question 3 If SS plays L, then SA will choose L, 50000> 30000 If SS plays U, them SA will choose U, 150000> 100000 If SA plays L, then SA will choose L, 50000> 30000 If SA plays U, them SA will choose U, 150000> 100000 Hence the Nash equilibrium is L, L with a payoff of (50000, 50000) At this point both SS and SA have no incentive to deviate. Question 4 The best possible outcome for SA is when it plays L while SS plays U and the best possible outcome for SS is when it plays L, and the other plays U. These outcomes (L, U) and (U, L) are difficult to achieve. This is because these strategies are not dominant for both. There is an incentive for one player to deviate. Question 5 If the prices are decided every week then the strategy would change in terms of the components. For the repeated games, the Nash equilibriums of all the sub games are the same as the equilibrium of each one shot game. The number of components in the strategy would increase because of the repetition of the game (both would still play L, L) however the pay off associated with the game would be increase by times of the number of weeks in the case. For example if this process is carried out for three weeks, then the payoffs associated with the game for SS and SA would be 3*50000,3*50000= 150000, 150000 Question 6 The rational strategy that they would play would be to not lower the prices. This way none of them would have any incentive to deviate. Plus they would accumulate the maximum possible profit for each of the firm. If they both play L then the profits would be half of what they would earn if they do not change. Part B The purpose of this essay is to critically analyze the extent to which the efficiency and equity considerations should be taken into account in the Structure-Conduct-Performance Model when it comes to deciding policies for the mergers between large firms. Firstly, the paper talks briefly about the Structure-Conduct-Performance Model and then moves onto discuss the importance of equity and efficiency in policy making for mergers. Introduction According to the Structure-Conduct-Performance Model, the performance of any industry depends on the firms’ conducts in the industry. The Conduct of the firms in turn depends on the structure of the market. The structure of the market may include factors like the overall competitiveness, the number of buyers and sellers in the market, and the barriers to entry and exit. The conduct of the firms on the other hand includes things like the price behaviour, the research and development and the contracts etc. The performance of the industry can be determined by the equity and efficiency etc. Since the paper deals with the use of the Structure-Conduct-Model for mergers, now it is important to discuss the performance and the conduct of the mergers. Mergers A merger exists when two or more firms come together and jointly produce and supply output so as to take over the market share and the number of buyers, as Shelton (1997) relates. This way they can earn higher profits and reduce their per-unit costs. Other benefits that may arise for the firms include more control of the determination of the prices, and the control over the general competitiveness of the market. Mergers can affect the barriers to entry and exit and so in order to reduce the competitiveness of the market; they can ensure that no new firm enters the market. Mergers and collusions can be beneficial for the economy; in the way that they can help reduce the negative externalities that are created as a result of the competitive behaviour of the firms (Benefits of Mergers and Acquisitions) Firms in order to compete with each other spend a lot of resources on the advertising of the differentiated products. These costs may not exist for mergers because there is no need for the companies to advertise or make attempts to win over the market share in the economy. The reduction of such costs and the merging of the output produced leads to cost efficiency. This is because the mergers are more likely to enjoy economies of scale. The average costs are lower and the merger firms produce at a point where the Average cost equals the Marginal Cost. With lower prices there is a chance that the mergers would charge lower prices (they do not need to charge higher prices to cover up for their higher costs); however, this is not what happens normally. The need for considering efficiency Although the mergers may be beneficial for the industry and the economy in many ways, a merger does not increase the overall welfare of the society. In a perfectly competitive market, the firm is likely to charge at a point where the price equals the marginal cost. According to Sameulson et al. (1995), the operating of the firm at this particular point means that the industry is squeezing the maximum output out of the limited and scarce resources that are available to the firms. When the price equals the marginal cost in an industry the welfare is maximized. The consumer surplus and the producer surplus are also the maximum and there is no dead weight loss. For a monopoly (a merger in this case), things are different. A merger prices the output in such a manner that the marginal revenue earned equals the marginal cost. At MC= MR, the profit of the merger firms is maximized. Since the marginal revenue curve is steeper than the average revenue curve, pricing at this point means that the merger firms cut down on their outputs in order to increase the profits. Since MR is not equal to the Price level, this means that the industry as a whole does not utilize the resources available to their fullest. Since efficiency is not achieved by the mergers, the welfare of the society as a whole is not maximized. This is also the point when the market is not in equilibrium. In fact the merger firms in this case operate at an output that is below the equilibrium level of output. Operating at MC=MR has various consequences. The first and foremost is the fact that the customers are exploited. The prices for the mergers are generally higher for the mergers. This is because the merger firms have a larger market share and are able to affect the market prices easily unlike the firms in the competitive market that have to take the prices as given. This fact was also observed in Wenden et al.’s (2006) study about the merger of two American airlines. According to him, the merger of TWA and Ozark, two airline companies, led to an increase in the fares and so the customers felt that they had to pay more than what they used to pay before. MC=MR pricing also affects the consumer surplus and the producer surplus in the market. While the price increase leads to the increase in the producer surplus, there is a decrease in the consumer surplus as they are charged more for every unit purchased. The increase in the producer surplus is usually high for mergers but the decrease in the consumer surplus is higher than the increase in the producer surplus. As a result, there is a dead weight loss in the market. In case of efficiency, as mentioned above, this is not the case. The market structure of mergers also means that there are increased barriers to entry. The mergers in order to retain their market share increase the barriers to entry so that it is difficult for new firms to enter. This again affects the overall efficiency of the market and the industry. Restrictions to entry means that the firms cannot enter and cannot increase the overall output produced in the industry. The reduction from the total efficient output means that the resources are not fully used in the production process. As a result, efficiency cannot be achieved in the industry. Although cost efficiency is prevalent in the merger market structure, it does not ensure efficiency in terms of the total resources exhausted. Importance of equity and efficiency consideration It is very important that while designing policies for mergers of large firms, the equity and efficiency are taken into account. Equity consideration would mean that the mergers are not allowed to accumulate as much wealth as they want. If a limit is put on the equity and so the total profits earned in a particular time period, there is a better chance of the mergers exploiting the consumers less instead of charging sky high prices. The lower prices would result in the increase of the consumer surplus and the reduction (if not removal) of the dead weight loss and hence would affect the efficiency of the market. If efficiency of the market is taken into account before designing of the policies, it is likely that the total output produced would be higher. Increased output would mean there is a more efficient allocation of resources, the consumers are not exploited and there are lesser barriers to entry. Conclusion To conclude, it is extremely important to take into account the efficiency and equity of the merger market structure before designing of policies of mergers between large firms in the Structure-Conduct-Performance Model. Taking these two into account reduces the monopolistic power of the mergers and ensures a more appropriate allocation of resources in the industry. References Samuelson P. & Nordhaus, W. (1995). Economics. UK. Mac- Graw Hill. Shaffer, S. (1994). Structure, Conduct, Performance, and Welfare. Netherlands. Kluwer Academic Publishers Shelton, L. (1997).Merger market dynamics: insights into the behavior of target and bidder firms. USA. University of Illinois Site editor. (2009). Benefits of Mergers and Acquisitions [Internet] Available from < http://finance.mapsofworld.com/merger-acquisition/benefits.html> [Accessed 29 April 2010] Wenden, G. Joskow, A & Johnson, R. (2006).The effects of mergers on price and output: Two case studies from the airline industry. USA. Department of Justice Read More