APPLIED ECONOMICS FOR MANAGERS SESSION 18 I REVIEW GROUP DECISION MAKING ECONOMIC OUTCOMES A COLLECTIVE CHOICE A FACT OF LIFE 1 IN PUBLIC POLICY 2 IN INTERNAL ORGANIZATIONAL DECISIONS a MANAGEMENT LABOR COMMITTEES b CHOICE OF CEO B COLLECTIVE CHOICE CHARACTERIZED BY DIFFERENT LOGIC ILLOGIC THAN INDIVIDUAL CHOICE 1 BIAS TOWARD THE STATUS QUO INDIVIDUAL UNCERTAINTY MAGNIFIED AT AGGREGATE LEVEL 2 CYCLING AND CONDORCET 3 COLLECTIVE CHOICE TO PURSUE PRIVATE INTEREST C IMPLICATIONS FOR PUBLIC POLICY 1 CAUTIOUS PUBLIC POLICY 2 ALWAYS A LARGE GROUP OF UNHAPPY VOTERS 3 DANGER OF CAPTURE D IMPLICATIONS FOR CORPORATIONS 1 CAUTIOUS POLICIES 2 ALWAYS DISGRUNTLED SPLINTER GROUP 3 DANGER OF CORRUPTION II CORPORATE ARCHICTECTURE AND VERTICAL INTEGRATION WHERE IS THE FIRM S BEGINNING AND ENDING A THE VERTICAL PRODUCTION CHAIN 1 RAW MATERIALS 2 MANUFACTURE 3 DISTRIBUTION 4 RETAIL B VERTICAL INTEGRATION VS SEPARATE FIRMS 1 SEPARATION ALLOWS a COMPETITION TO SPUR EFFICIENCY b SCALE ECONOMIES 2 INTEGRATION a AVOIDS HOLD UP PROBLEM OF FIRM SPECIFIC ASSETS b REDUCES DOUBLE MARGINALIZATION c FACILITATES PRICE DISCRIMINATION C PRODUCT COMPLEMENTARY DOUBLE MARGINALIZATION RETAIL DEMAND P 100 2Q RETAIL MARGINAL REVENUE MRD 100 4Q ASSUME MARGINAL COST WHOLESALE PRICE W RETAIL PROFIT MAXMIZATION W 100 4Q HENCE MANUFACTURER S DEMAND W 100 4Q MANUFACTURER S MARGINAL REVENUE MRU 100 8Q MANUFACTURES MARGINAL COST 12 MANUFACTURER S PROFIT MAXIMIZATION 100 8Q 12 FULL DIS INTEGRATED EQUILIBRIUM Q 11 W 56 P 88 PROFIT RETAILER 242 MANUFACTURER 484 WHAT IF FIRMS VERTICALLY INTEGRATE THEN DEMAND FACING INTEGRATED FIRM IS P 100 2Q MARGINAL REVENUE FOR INTEGRATED FIRM IS MR 100 4Q WITH MARGINAL COST 12 EQUILIBRIUM IS Q 22 P 56 PROFIT 968 242 484 FIRMS AND CONSUMERS GAIN FROM VERTICAL INTEGRATION D DOUBLE MARGINALIZATION COMPLEMENTARY GOODS MANUFACTURER AND RETAILER HARDWARE AND SOFTWARE E VERTICAL INTEGRATION VERSUS CONTRACT 1 CONSIDER A TWO PART TARIFF a SELL TO RETAILER AT MC 12 b CHARGE RETAILER A FIXED FEE FOR SALES RIGHTS c RETAILER SETS P 56 SELLS Q 22 UNITS EARNS OPERATING PROFIT OF 968 2 FIXED FEE MUST BE LESS THAN 726 SO RETAILER EARNS AT LEAST 242 BUT MORE THAN 484 SO MANUFACTURER EARNS AT LEAST 484 BUT CAN DUPLICATE INTEGRATION OUTCOME WITH A CONTRACT F CHOICE BETWEEN INTEGRATION AND CONTRACT 1 NEGOTIATION COST 2 CAN CONTRACT BE COMPLETE UNCERTAINTY 3 ENFORCEMENT COST WHAT HAPPENS IF CONTRACT IS BROKEN G VERTICAL INTEGRATION AND PRICE DISCRIMINATION P 100 2Q IN MARKET 1 MONOPOLY PRICE C 12 56 Q 22 P 60 2Q IN MARKET 2 MONOPOLY PRICE C 12 36 Q 12 CANNOT ACHIEVE SUCH DISCRIMINATION UNLESS MARKETS SEPARATED SOLUTION INTEGRATE INTO LOW PRICE ELASTIC MARKET AND REFUSE TO SELL TO ANY OTHER RETAILERS Farmer X Farmer Z Farmer Y MODERNIZE ROAD SEGMENT X COST BENEFITS MODERNIZE ROAD SEGMENT Z 10 000 10 000 7 000 TO FARMER X 0 TO FARMER Y 0 TO FARMER Z 0 TO FARMER X 0 TO FARMER Y 7 000 TO FARMER Z POLITICAL SOLUTION VOTE BUILDING COMMISSION OR LEGISLATURE VOTES ON ROAD IMPROVEMENT BILLS PAID FOR OUT OF GENERAL REVENUES THEN VOTE TRADING REPRESENTATIVE FROM X VOTES FOR IMPROVEMENT IN ROAD TO Z IN RETURN FOR Z VOTING FOR IMPROVEMENT IN ROAD TO X BOTH ROAD IMPROVEMENT BILLS PASS BUT COST IS SPREAD EQUALLY OVER ALL THREE REGIONS REGION X REGION Y REGION Z COST 6 667 6 667 6 667 BENEFITS 7 000 0 000 7 000