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Prof. Amine Ouazad LLM in International Business Law, March 28 2014 Microeconomics/Industry Analysis Session Prof. Amine Ouazad LLM in International Business Law, March 28 2014 Microeconomics/Industry Analysis Session #1: Competitive Markets

About Me • Has been teaching core economics in the INSEAD MBA program since About Me • Has been teaching core economics in the INSEAD MBA program since 2008, 170+ students; and has about 30 Ph. D students in Management. • Research in microeconomics & finance. • Recent work featured in the press: Washington Post, France 24, Guardian, Daily Telegraph. • Works/teaches in US, UK, France, Singapore.

This Workshop Central unifying theme How does market competition affect prices? Why should you This Workshop Central unifying theme How does market competition affect prices? Why should you care? • As a consumer/investor, understand price dynamics. • As a lawyer, understand the economics impacts of limited competition. • Analysis of one of the largest antitrust cases in US history. ➥Forecast prices on a commodity market. (Session #1) ➥Detect & Deter collusion on that market. (Session #2)

Outline for this Session 1. Commodity Markets: Demand Supply Analysis 2. Minimum wage 3. Outline for this Session 1. Commodity Markets: Demand Supply Analysis 2. Minimum wage 3. Selling less to earn more

1. Commodity Markets: Demand Supply 1. Commodity Markets: Demand Supply

April 8, 2012 Aluminium buckles under weight of supply pressure By Jack Farchy in April 8, 2012 Aluminium buckles under weight of supply pressure By Jack Farchy in London Daniel Brebner, metals analyst at Deutsche Bank, estimates that the operating profit margin for a marginal aluminium producer has been 14 per cent over the past “I don’t like aluminium. ” decade, compared with 43 per That may seem an unlikely cent for copper. statement from the world’s sixthlargest producer of the metal. But “While copper has been Marius Kloppers, chief executive exceptionally profitable, aluminium has had an of BHP Billiton, is putting his money where his mouth is. BHP unremarkable performance during will from now on run its aluminium one of the greatest commodity division for cash, he announced boom periods in history in terms of demand, ” he says. “This is a in February. condemnation of the state of the After a decade of sub-par industry that it can’t generate profitability, is it still worth super-normal returns in an investing in aluminium? environment of super-normal demand. ”

If Mr Kloppers is correct, the future is bleaker still for producers of the If Mr Kloppers is correct, the future is bleaker still for producers of the metal used in the manufacture of everything from drinks cans to cars and aircraft. The argument underpinning his pessimism is simple: years of overcapacity have kept prices subdued and led to a huge buildup of inventories – now estimated at more than 12 m tonnes, or enough to build 180, 000 Boeing 747 s. And with the price of energy, which accounts for as much as half of aluminium production costs, rising rapidly, industry-wide profitability is flat at best. The most popular response among rival aluminium executives is to point to China which, as well as being the world’s largest aluminium consumer, is also the top producer. “If you are the average Chinese producer you should probably quit this business right now or a few months ago, ” says Oleg Mukhamedshin, head of corporate development at Rusal, predicting that many Chinese aluminium smelters will be forced to shut down in the next few months, pushing up global prices.

Built by 2013 students, Used by commodity analysts (ktpy) Built by 2013 students, Used by commodity analysts (ktpy)

Aluminum prices 2011 -2013 Source: London Metal Exchange Homogeneous good? Aluminum prices 2011 -2013 Source: London Metal Exchange Homogeneous good?

Commodity Market Analysis Price ($/ton) Consumer surplus “We are positioned in the lower part Commodity Market Analysis Price ($/ton) Consumer surplus “We are positioned in the lower part of the supply curve” Cynthia Caroll Supply curve P* Firms’ profit $2000 Demand curve Q* 40 Mt 2013 Quantity (tons)

Demand Shock Price ($/lb) “But the company added that it expected a slight pick-up Demand Shock Price ($/lb) “But the company added that it expected a slight pick-up in consumption in the fourth quarter thanks to a recovery in China’s economic growth and improvement in key sectors such as the US car industry. ” FT article on Rusal Supply curve - Aluminum producers P’ P* Demand curve Quantity (lb) Q* Q’

Demand Shocks In Business… • “Demand for aluminum has started falling as construction growth Demand Shocks In Business… • “Demand for aluminum has started falling as construction growth slows. ” FT Oct 26, 2011. • Mc. Donald’s same-store sales increased by 2. 6% year-to-year in 2009. … and in other aspects of life • Demand for marijuana increased 8% in US states that decriminalized most posession offenses. • Demand for prostitution services increases around 4 th July.

Supply Shock Price ($/lb) Supply curve - Lysine producers P* P’ Demand curve - Supply Shock Price ($/lb) Supply curve - Lysine producers P* P’ Demand curve - Food producers Quantity (lb) Q* Q’

Supply Shocks are Everywhere In business… • Discovery of substantial new oil production capacity. Supply Shocks are Everywhere In business… • Discovery of substantial new oil production capacity. • Geopolitical events in the Middle East limiting supply of oil. And in other aspects of life… • Increases in drug punishment for dealers since 1985 rose the price of cocaïne by 5 to 15% in the US. • The supply of prostitution increases in response to the demand for prostitution services (4 th July).

2. Minimum wage 2. Minimum wage

Scrap the Minimum Wage Forbes Magazine Art Carden Raising hourly wages seemed like a Scrap the Minimum Wage Forbes Magazine Art Carden Raising hourly wages seemed like a good idea, but it has only destroyed jobs. • “Do you want to get serious about expanding employment? Then it's time to realize that spending on jobs programs is the wrong approach. It would be much better to eliminate hurdles for people who want to find work. One of those hurdles is the minimum wage. ” His predictions: 1. “Minimum wages create unemployment. At above market prices people want to supply more labor than employers wish to hire. ” 2. “Repealing the minimum wage would create job opportunities. ” Really? ? September 2010 edition

The Forbes’ columnist says this Hourly wage ($) Supply curve - Unskilled workers Minimum The Forbes’ columnist says this Hourly wage ($) Supply curve - Unskilled workers Minimum wage w* This is the wage that would prevail without a minimum wage law. Demand curve - Employers Number of q* hours worked Supply of work Hours worked Forbes’ Carden says: 1. “Minimum wages create unemployment. At above market prices people want to supply more labor than employers wish to hire. ” In other words : supply of work > demand.

Should we believe the Forbes’ columnist ? ? Alan Krueger Chairman of the Council Should we believe the Forbes’ columnist ? ? Alan Krueger Chairman of the Council of Economic Advisers Since September 2011 & Prof. of Economics at Princeton Myth and Measurement: The New Economics of the Minimum Wage. His statements: 1. “the minimum wage at levels observed in the United States had little or no effect on employment. ” 2. “increases in the minimum wage lead to increases in pay, but no loss in jobs. ” How can this make sense? ? “ 1992: New Jersey implements a state-level minimum wage above the Pennsylvania minimum wage. ” ➥ “Employment did not change. ”

What about a very steep demand curve? Hourly wage Supply curve - Unskilled workers What about a very steep demand curve? Hourly wage Supply curve - Unskilled workers Alan Krueger says: 2. “increases in the minimum wage lead to increases in pay, but no loss in jobs. ” Minimum wage w* Demand curve - Employers Why a very steep demand curve? Employers willing to hire workers at hourly wages far above $5. q* Hours worked with minimum wage. Little change! Hours This is the level of employment without a minimum wage law.

Main Lessons from Minimum Wage Example Commodity markets are everywhere A minimum wage above Main Lessons from Minimum Wage Example Commodity markets are everywhere A minimum wage above the market wage may lead to lower employment and higher unemployment. But if the demand curve for unskilled work is very steep, the impact on employment is small, and it raises the wages of employed workers For thought: Does this mean we should have very high minimum wages? ?

3. Selling less to Earn More 3. Selling less to Earn More

Earning more by selling less? Price ($/ton) Consumer surplus Supply curve In a commodity Earning more by selling less? Price ($/ton) Consumer surplus Supply curve In a commodity market, suppliers do not control the price… but they could gain by selling less at a higher price. Pc P* Firms’ profit Demand curve Quantity (ton) Qc Q*

Earning more by selling less? Inelastic Demand Price ($/ton) Consumer surplus Supply curve In Earning more by selling less? Inelastic Demand Price ($/ton) Consumer surplus Supply curve In a commodity market, suppliers do not control the price… but they could gain by selling less at a higher price… especially if demand is very steep. Pc P* Firms’ profit Demand curve Quantity (ton) Q*

Elastic and Inelastic Products In commodity or commoditized markets… “Heroin demand is inelastic” Steve Elastic and Inelastic Products In commodity or commoditized markets… “Heroin demand is inelastic” Steve Levitt “We think gold and platinum are an outright buy at present levels as both metals have very low supply elasticity and are key beneficiaries of loose monetary policy” UBS Gold Outlook 2013 …and in other markets. “We’ve done price elasticity studies” Jeff Bezos -- HBR Interview, September 2012 "We feel quite confident with the response we've seen to our pricing actions, " Rosenfeld said. Price "elasticity has been essentially where we expected it to be. ” -- Irene Rosenfeld, Kraft CEO (now Chairman), 2011

Take Aways • On a commodity market, use demand supply analysis to forecast prices. Take Aways • On a commodity market, use demand supply analysis to forecast prices. • Upward demand shocks lead to higher prices and to higher production. • Upward supply shocks lead to lower prices and to higher production. • Commodity markets are everywhere: unskilled work, drugs, food. • Firms may have an incentive to agree on a higher price, selling less to earn more… ➥ This is particularly true when demand is inelastic. An inelastic demand is a demand that does not change much when the price increases. Example: drugs. • Setting a higher price is hard on a commodity market.

Pork food additive: Lysine In a commodity market, suppliers do not control the price… Pork food additive: Lysine In a commodity market, suppliers do not control the price… but they could gain by selling less at a higher price.