OTM 732 **** ECONOMICS FOR MANAGERS **** Fall 2010

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1 MBA Program Wisconsin School of Business University of Wisconsin Madison OTM 732 **** ECONOMICS FOR MANAGERS **** Fall Grainger Tuesday, Thursday 1:00-2:15 PM Your Two Professors Weeks 1-10 Weeks Donald (Don) Hausch Morris Davis 5249 Grainger 5261 Grainger Office Hours: TR 2:30-3:45 Office Hours: TBA Course Objectives: This course will demonstrate how economic logic offers powerful and elegant insights into issues relevant to business and to business decision making. The ultimate goal is to help you develop a framework for the firm and the economy that will allow you to analyze both opportunities and risks in a complex economic environment. The course is divided into 10 weeks of microeconomics and 5 weeks of macroeconomics. (This syllabus focuses on the first 10 weeks; later you will receive a second syllabus with details about the final 5 weeks of the semester.) The first part of the course addresses the economic behavior of individual decision makers - people, firms, and industries, with a focus on: Analysis of competitive markets Interventions in markets Role of costs (marginal, sunk, opportunity) in decision making Pricing strategies (price discrimination, two-part tariffs, bundling, vertical restraints on pricing) Strategic decision making through game theory Effects of asymmetry of information on markets The second part of the course will cover the nuts and bolts of macroeconomics: Why is free trade potentially beneficial to everyone? What is GDP? Why do economists study GDP? What does GDP tell us? What causes growth and why? What are the common features of business cycles? We will also address topics that seem to be on everyone s mind right now. Unless the economy changes course dramatically between now and the second part of the course, we will talk about the following: The financial crisis. Fiscal policy ( stimulus ) and monetary policy ( reserves ) and possible consequences. The usefulness of academic economists. Course Website: The course website contains the syllabus, various course materials, and links to online readings. It can be accessed at:

2 Required Textbooks & Materials Transactions and Strategies: Economics for Management (1st edition), Robert J. Michaels, South-Western Cengage Learning, This is the text for the first 10 weeks. Packet of PowerPoint slides, available at the Grainger Hall Copy Center ahead of 1 st day of class. Macroeconomics for MBAs, Morris A. Davis, Cambridge University Press. For the macroeconomics portion of the class, you are expected to be a daily reader of Jim Hamilton and Menzie Chinn s macroeconomic blog: You are strongly encouraged to start reading it regularly right away. Grading You will receive one final letter grade for OTM 732, and it will be weighted 2/3 on Part I (micro) and 1/3 on Part II (macro). Professor Davis will explain his grading for Part II later in the semester. The requirements and grading weights for the micro part are: PART I September 2 November 9 (2/3 of grade) Exam I 35% Exam II 40% 2 Homeworks 25% Homework and Exams There are two homework assignments over the first 10 weeks of the course. Solutions are due on TUESDAY, SEPTEMBER 28 and TUESDAY, NOVEMBER 2. Please submit a hard-copy of your solutions by 1:00 PM on the due date, either to me in class or to my mailbox on the 5 th floor. NO credit is given for late homework because I distribute solutions on the due date. For the first 10 weeks of the course, there are two in-class exams on TUESDAY, OCTOBER 5 and TUESDAY, NOVEMBER 9. For the macro portion of the course, the final exam will be on THURSDAY, DECEMBER 16, the last day of class. Laptop Policy Please do not use your laptop during class. If there is a reason to individually deviate from this policy, please talk with me. Honor Code We will abide by the MBA Honor Code, a copy of which follows. Three issues merit mention, though. 1) The Honor Code requires you write the following statement on each item that you submit for a grade: On my honor, I have neither given nor received unauthorized aid in completing this academic work. Write and sign this statement on your solutions to both homework assignments. 2) The Honor Code says, individual homework assignments that are to be handed in for a grade may not be discussed with students or others outside the class, such as other faculty members, alumni, etc., unless specified by the instructor. For this class, it is permissible (and, indeed, you are encouraged) to discuss the homework problems with the professor and other students in OTM 732 this semester (but not with anyone else). However, you are expected to independently write up your solutions, which means that no two answers should be too similar. This does allow an iterative process, however, where you work with others, then begin writing up your solutions, and then if you need more help, you can talk with others again, and so on. 3) Some of the homework problems assigned this year were assigned in previous semesters. You may NOT access any solutions from previous semesters.

3 MBA Academic Integrity Policy Honor Code Discrimination I understand that it is the policy of the University of Wisconsin-Madison to not discriminate on any grounds, and especially not on the basis of gender, race, color, religion, national or ethnic origin, disability, or sexual orientation. I support this policy and will not tolerate any deviations from it in the classroom. If I feel that some form of discrimination has been directed toward me or another during class time, it is my right to contact the Honor Board (or Dean) immediately. Plagiarism I understand that plagiarism is a major offense at this University and that it is my duty to understand what plagiarism is and actively seek out advice when I have a question about my work. Plagiarism is defined by this University as: Plagiarism means presenting the words or ideas of others without giving credit. You should know the principles of plagiarism and the correct rules for citing sources. In general, if your [work] implies that you are the originator of words or ideas, they must in fact be your own. If you use someone else s exact words, they should be enclosed in quotation marks with the exact source listed. You may put someone else s idea in your own words as long as you indicate whose idea it was.. If you are unsure about the proper ways to give credit to sources, ask your instructor or consult the Writing Center at 6171 Helen C. White Hall (phone: 608/ , writing@wisc.edu) for a copy of their handout "Acknowledging, Paraphrasing, and Quoting Sources." (Excerpt taken from Exams I understand that all exams whether in-class or take-home are strictly individual efforts. I will not communicate with any student regarding any aspect of the exam such as, content, coverage, etc., until all students have taken the exam. Moreover, I will be certain that anyone with whom I discuss the examination has previously handed in their examination.

4 Individual Homework I understand that homework that is not handed in for a grade may be discussed with the professor and other students; indeed, I am encouraged to do so. However, individual homework assignments that are to be handed in for a grade may not be discussed with students or others outside the class, such as other faculty members, alumni, etc., unless specified by the instructor. Note that similar or identical homework may have been assigned in previous semesters; I may NOT access solutions from any source for those previous semesters. Difficulties with, or questions regarding, graded and ungraded work may always be directed to the instructor of the class. Group Work Basic Rules: I understand that group work must be done solely within the group and when required I must hand in a single set of answers for my group. I must contribute equitably in the assignment s/case preparation if I am to take full credit for it. This does not mean that my ideas must be included. It means that I should make a significant contribution to the overall process. If that did not happen for some individual, I can include in my report an estimate of that person s contribution relative to others in my group. On Consulting with Others: I may not discuss the group work with anyone outside my group, with the exception of my professor or TA. That necessarily means that I will have no discussions with other groups, with those in other cohorts, or with anyone who may have previously studied the case. The only exception may be if my professor allows cross-group discussion as part of an assignment. Even in this case, however, I am obligated to be sure my work is not too similar to another group s work in its completed version. Using Sources: The set of materials to be used in completing the group work will be clearly defined by the professor; under no circumstances am I to use sources outside the allowed set. This may include company or knowledgeable sources interviews or library/online searches. All sources, whether written, oral, or online, must be cited properly. Note on the Internet: I understand that unless explicitly instructed, the use of any internet materials to complete an exam, homework or group work, not explicitly assigned to the class are strictly prohibited. Cases and Case Discussions: I understand that case write-ups are to be done individually, or within your assigned group, as your professor/instructor designates. In addition, case discussions conducted in class are to be done within my section or cohort unaided by alumni, 2 nd year students or students in other sections/cohorts who have already reviewed the case. Discussing the analyses, arguments, logic, etc. that go into the case compromises the equitable distribution of class participation and more importantly, undermines the learning process. Thus, since the path taken to arrive at an answer is as important as the answer itself, it is critical that case discussions are a product of my own thinking. If you are unsure about a rule or policy: Finally and very importantly, I recognize that the principle ingredient in the successful operations of the honor code is good faith among all parties. From time to time, situations will arise in which the application of the honor code is unclear. In such cases, it is important that I contact my Professor/instructor immediately for clarification.

5 PART I: ECONOMICS FOR MANAGERS The schedule for Part I of Economics for Managers is below. The schedule for Part II will be provided later. The readings that are listed below refer to our textbook, Transactions and Strategies: Economics for Management, by Robert J. Michaels. Please check out the online version of the syllabus at to read optional articles (most are online) that provide examples and perspectives on the topics that we cover in class. Part I of the course begins with a thorough treatment of classical supply & demand analysis. We then investigate the firm's responses to external forces, such as tariffs, regulations, changes in competition, new input prices, and so on, followed by a more careful investigation of demand, with a focus on the effect of price on revenue. We also identify the relevant costs for decision making, which is important for understanding how firms should respond to changes in their environment. Bringing together the firm s demand for its product and its costs, we next address optimal pricing strategies for firms with market power. Shifting from a position of studying our firm in isolation, we use a game theoretic approach to investigate interdependent multi-firm decision making, providing further insights into the performance of firms and industries. We end by introducing asymmetry of information among the participants to the market. This feature provides several insights on the functioning of markets, including the prevalence of lemons in markets and the why there is a curse associated with winning an auction. September 2, 7, 9 How Do Markets Work? SCHEDULE These sessions develop the basic model of supply and demand analysis for studying competitive markets. The model is then used to consider the consequences of a variety of interventions and shocks to the market. Efficiency properties and externality issues are also studied Demand, supply and equilibrium Producer and consumer surplus Efficiency Externalities Examples with excise taxes, price controls, tariffs, quotas Readings: Ch 1 (review quickly), Ch 3 (p , , 106) September 14, 16 How Do Our Customers Value Our Products? These sessions focus on the demand function. The goals are to show how the demand function accounts for both price and non-price factors of demand, develop revenue concepts, and develop elasticity concepts. Demand curve and demand function Total, average and marginal revenue Price elasticity, short-run and long-run Other elasticity notions, e.g., income, advertising, cross-price, etc. Readings: Ch 3 (p )

6 September 21, 23 What are the Relevant Cost Measures for Decision Making? There are many ways to measure costs. These sessions will present several of them and consider how and when each is useful. In particular, for the purposes of decision making, we both show the central role of marginal cost and highlight the need to properly account for sunk costs and opportunity costs. We also discuss the differences that can exist between accounting (historical) costs and economic (opportunity) costs. Total, average and marginal costs Fixed and variable costs Sunk costs Opportunity cost Readings: Ch 4 (p , ) September 28, 30 How Does Competition Affect Our Decisions? We begin our look at market structure with a more thorough analysis of competitive markets, now that we have a better understanding of cost functions. The goal is to build the competitive outcome by aggregating the behavior of many firms that are price-takers and profit-maximizers. This allows us to address short-run and long-run effects in competitive markets, understand the challenges of price competition in commodity markets, and consider the interest in and approaches to protecting profits. Price-taking behavior Competitive Equilibrium Entry and Exit Creating and Protecting Rents Readings: Ch. 5 HOMEWORK #1 due on September 28 October 5 ********** EXAM 1 *********** How Do Markets Work? How Do Our Customers Value Our Products? What are the Relevant Cost Measures for Decision Making? How Does Competition Affect Our Decisions?

7 October 7, 12, 14, 19 Market Power and Pricing With some degree of market power, a firm has the opportunity to be a price maker, rather than a price taker as occurs in competitive markets. These sessions study the sources of market power and the means available to exploiting that market power. Approaches to expanding market power are also discussed. Optimal pricing Efficiency aspects of pricing Cost-plus pricing Two-part tariffs Market segmentation and price discrimination Versioning Bundling Vertical Price Restraints Readings: Ch 6 (including p ) October 21, 26, 28 Game Theory & Oligopoly Objectives: These sessions start with an introduction to game theory, a mathematical approach to studying interdependent decision problems. We will study static and dynamic games and consider several solution concepts for games. We will then use game theory to study oligopoly situations, where decisions by each firm are influenced by the actions and reactions of the other firms in the industry. Static games Dominant strategies Nash equilibrium Sequential games Subgame perfect equilibrium Commitment Oligopoly models Cartels and collusion Price and quantity competition Readings: Ch. 7

8 November 2, 4 Markets with Private Information: Adverse Selection, Lemons, Screening, and Auctions Objectives: So far, our analysis has assumed that everyone knows the relevant information that they need to make their decisions (e.g., a firm know its demand curve, a firm knows the costs of its competitor, a customer knows the quality of the good when they buy it). In this section, we will consider markets with information that is private or asymmetric. This means that information held by one party is not known or observed by the others in the market. For example, the seller of a car likely knows its quality better than a prospective buyer, a job applicant know his ability better than a prospective employer, a manager knows the financial circumstances of her firm better than the public, and each bidder in auction likely holds some private information. As we will see, private information can greatly influence the functioning of markets. Quality Uncertainty Adverse Selection Market for Lemons Screening Auctions & Competitive Bidding Readings: Ch. 11 HOMEWORK #2 due on November 2 November 9 ***** EXAM 2 ***** Market Power and Pricing Game Theory Oligopoly Markets with Private Information: Adverse Selection, Lemons, Screening, and Auctions