Unit 1 Economic Problems & Principles
PROBLEM 1 Can We Trust Each Other?
Consider the two dominant firms in the global smartphone market, Samsung and Apple. Now compare their respective premium smartphone series, Samsung Galaxy Note8 and the iPhone X. Each must decide on a fall 2018 pricing strategy. Your small group will represent one of these companies.
Assume you and your competitor have an equal share in the market and relatively high prices with healthy profit margins. Should you lower your price?
Pricing Strategy Choices / Outcomes
1. Cooperative Higher Price Strategy → profit of $1 billion USD per week IF your competitor follows the same strategy.
2. Cooperative Higher Price Strategy → profit of $0.2 billion USD per week IF your competitor does NOT follow the same strategy.
3. Competitive Lower Price Strategy → profit of $0.5 billion USD per week IF your competitor follows a low price strategy.
4. Competitive Lower Price Strategy → profit of $1.3 billion USD per week IF your competitor does NOT follow the same strategy.
1. Develop a Strategy (15 min.) -- As a group, take your time to discuss and decide on the pricing strategy you will make for your company. You MUST keep this decision confidential from ALL OTHER GROUPS be it a Samsung or Apple group.
Hint 1 -- Discuss what decision is most rational and what decision maximizes your company's interests. You may need to discuss what your company's interests actually are.
Hint 2 -- Discuss what decision is most likely from your competitor given your own company's strategy.
2. Test Your Strategy
(15 min.) -- your group will be paired with a group representing your
competitor. Join tables and each group will write out the name of the
pricing strategy (either higher or lower) they chose on a blank paper, fold it over and exchange
it with your competitor. Each company will open the other company's
paper at the same time and see how much each company will profit given
your two strategy choices. Discuss which company won / profited and why each
company chose the strategy they did. Did non-price information factor into your decision? Do you notice any patterns or
necessary assumptions in your strategy? How does cooperation and
competition play into this activity? Can you place the 4 profit scenarios in a decision matrix? Can you relate your outcome to any
economic principles you know? What is the bottom line statement that this case teaches us about price and competition in a market?
3. Large Group Debrief -- making links to competition, self-interest & free markets -- the prisoners' dilemma.
♦ The simulation can be described as a competitive approach to the condition of scarcity where self-interest went unchecked.
♦ A re-think of the simulation and the hypothetical "second chance" could be described as a collective approach to the condition
of scarcity where self-interest is restrained by cooperation, or "explicit collusion".
♦ Unrestrained self-interest coupled with distrust versus restrained, rational self-interest coupled with a trust in the agreed upon
♦ The schematics and all available resources represent a market.
♦ Distribution of wealth problematic.
♦ No formal system of exchange or currency.
♦ No formal price signals or demand and supply economics in operation.
♦ Subsistence economy.
♦ Illegal / black market in effect.
♦ Unrealistic moral hazard (when a party takes on more risks because someone else bears the cost of those risks ... it arises when
the parties have incomplete information about each other).
♦ Disproportionate # of participants idle (i.e., waste), even when specialization and economic interdependence operated.
♦ System of trade and specialization not "internationalized".
♦ No capacity to expand resource base by trade or exploration.
♦ Production / Consumption parity.
♦ No formal markers of status or wealth.
♦ Universal ability to participate / contribute.
♦ 3 economic questions predetermined (What, How, & For Whom to produce).
♦ 3 economic goals of Equity, Stability, & Efficiency not clear.
♦ Anti-competitive behaviour operated.
♦ False impression that market economy not viable as basic economic concepts distorted or did not operate.
♦ Opportunity cost skewed.
Listen to Jeff Rubin, former Chief Economist at CIBC, discuss the links between the economic growth imperative, oil and the 2008 global financial crisis (click on the audio on the left → minute 3:00 to 13:47).
Subprime Mortgage Market and Risk Backgrounder to Jeff Rubin's Audio Comments
Why did banks hold these toxic assets? Why were these subprime mortgages created in the first place?
In the early years of the new millennium, ever increasing housing prices were outstripping the increases in incomes. Fewer and fewer could afford new homes so banks needed a new way to entice buyers with ever more attractive mortgage conditions. These loans became known as NINJA loans (meaning, No Income, no Job, and no Assets).
The dangerous assumption these new subprime mortgages were predicated on was that housing prices always go up, thus, despite the low interest payments the banks (and others who bought the assets once they were turned into securities traded on a market) would collect on these mortgages, they assumed they could sell these houses financed by subprime mortgages for an attractive profit in the future.
Since banks must hold a reserve of funds available in cash relative to the size of their assets, banks used financial wizards to design ways to keep these subprime mortgages off their balance sheets. Anything that has a predictable steady stream of income can be packaged and sold as a security (called securitization), thus subprime mortgages were bundled into securities and sold to other banks and financial institutions as an investment. This kept these mortgages off the books, while the banks still enjoyed the monthly interest payments as a revenue stream.
Suddenly banks and other financial institutions that held billions in these toxic assets witnessed their value evaporate into huge losses. The financial crisis began to unfold as institutions "too big to fail" folded in bankruptcy, confidence in the markets faltered, and bailouts became reality.
FALLACY 2 → An Economic System Based on the Belief That We Are Rational, Self-Interested Beings
The fallacy of self-interest as rational, simplified human behaviour.
CENTRAL QUESTION IN THE TRAP DOCUMENTARY → Can stable economic order be created in a modern and complex world simply by unleashing individual freedom and self-interest?
The Free Market Claim → Individual freedom allows for self-directing individuals to maximize personal advantage by acting in their own self-interest according to market incentives and performance targets all the while balancing one's self-interest against all others.
STEPS TO STUDENT--LED DESCRIPTIVE FEEDBACK ON CAUSAL MODELS
FALLACY 3 → Economic Modelling is Values--Free