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Economic Forces in American History
Entrepreneurship & Business
Economic Forces in American History
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Entrepreneurship & Business: Outline
Micro principles
Profit maximization & ethics
Trusts & Mergers
Advertising
Martha Olney (U.C. Berkeley)
Economic Forces in American History
How economists think. . .
. . . about firms & profit maximization
Perfectly competitive firms
Lots of sellers
No seller has a large share of total market
Homogeneous product
No barriers to entry or exit
In the long run (what’s that?), all firms will earn zero economic profit (what’s that?)
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Economic Forces in American History
Long-run vs short-run
Long-run
A period of time long enough so that anyone who wants to enter or exit an industry has enough time to do so
Short-run
A period of time shorter than the long-run
Not enough time to enter or exit industry
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Economic Forces in American History
Economic Profit
Accounting Profit
What is reported to the accountants (and the IRS)
Revenue minus costs
Economic Profit
What impacts decisions
Revenue minus costs
Costs include all opportunity costs
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Economic Forces in American History
Opportunity costs?
Implicit costs of running a business
Cost of time: what could I earn if instead of running my business, I worked for someone else?
Cost of (financial) capital: what could I earn on my wealth if it wasn’t tied up in my machinery & buildings?
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Economic Forces in American History
Zero economic profit
Zero is the best you can expect to do!
Zero economic profit means you are earning as much from your business as you would be earning from your labor and your (financial) capital if you were doing something else
Called “normal” profit
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Economic Forces in American History
Do you start off earning 0?
Not if you’re early and if demand is high
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New business Hmm, I
can do that too!
Lots of
profit!
Prices fall
Uh-oh. Less profit.
Start
something
newer
Economic Forces in American History
How avoid erosion of profit?
Barriers to entry!!
Monopoly
One firm
Unique product
Barriers to entry
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Economic Forces in American History
Barriers?
Government franchises (cable company)
Invention or production process (protected by patents)
High fixed costs (“natural” monopoly)
Ownership of scarce resource (diamond mine)
Violence to prevent competitors (drug cartels)
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Economic Forces in American History
Monopolists earn profit
Barriers to entry, so competition doesn’t erode firm’s profit
Can earn economic profit > 0 even in the long run
Called “abnormal” profit
Firms like this!!! (Consumers, not so much. Potential competitors, not so much either)
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Economic Forces in American History
Monopolistic Competition
In between the two extremes
Characterizes many small businesses
Lots of firms
No barriers to entry or exit
Selling a heterogenous product (close but not perfect substitutes)
In the long-run, economic profit = 0
Because no barriers to entry
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Economic Forces in American History
If product isn’t truly unique
Others will still compete away profit
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New business Hmm, I
can do that too!
Lots of
profit!
Prices fall
Uh-oh. Less profit.
Start
something
newer
Economic Forces in American History
Oligopoly
Most big businesses in the U.S.
Maybe lots, maybe a few firms
A few firms (3 or 4) sell 80-90 percent of total market
Product may be homogeneous or heterogeneous
May or may not be barriers to entry
Often wind up with abnormal profit
No one “model” to explain
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Economic Forces in American History
Profit Maximization
Math-y approach to show
All firms perfectly competitive
All firms maximizing profit
All information shared equally (no asymmetric information)
All consumers maximizing utility
All costs and benefits internalized
Then “Pareto optimal” allocation of resources
And enhances economic growth
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Economic Forces in American History
But but but
Profit maximization and ethical behavior are not one and the same
Slavery
What are the goals we as a society want to achieve?
Not on a standardized test
But probably an important conversation to have with the students!
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Economic Forces in American History
Businesses dislike competition
Competition erodes profit. Boo hiss.
Competition leads to lots of market failure
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Economic Forces in American History
Businesses prefer market power!!
Horizontal Merger
Consolidation of competing firms
Vertical Merger
Buying suppliers (backward) or distributors (forward)
Merger Waves
1879-1893 (horizontal)
1898-1904 (vertical)
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Economic Forces in American History
1890 Sherman Anti-Trust Act
Prohibits "formation of trusts" or other "conspiracy in restraint of trade or commerce"
Vague!
Doesn't apply to manufacturing
Doesn't prevent monopolies
Doesn’t prevent holding companies
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Economic Forces in American History
Lots of Mergers
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Economic Forces in American History
Stopping Monopolization
1914 Clayton Anti-Trust Act
price discrimination reducing competition banned
interlocking directorates banned
mergers reducing competition banned
labor & agriculture exempted
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Economic Forces in American History
Horizontal mergers, 1879-1893
Why merge horizontally?
decrease price competition
decrease business failures
reaction to price deflation of 1890s & high fixed costs following industrialization
Created firms such as National Biscuit (NaBisCo), Quaker Oats, U.S. Steel, U.S. Playing Card, DuPont, Otis Elevator
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Economic Forces in American History
Vertical mergers, 1898-1904
Reasons for vertical mergers
decrease price competition
guarantee access to supplies
stock market frenzy
difficulties financing small firms
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Economic Forces in American History
Creating a “heterogeneous” product
Marketing!
Advertising moves away from “reason-why” advertisements
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Economic Forces in American History
Advertising
Brand Names
Not just flour, but Gold Medal flour
Marketing
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Economic Forces in American History
Psychology & advertising
ambition
pleasure
bodily comfort
possession
approval by others
appetite
love of offspring
health
sex attraction
parental affection
Marketing
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