ENTREPRENEURIAL ECONOMICS Market Processes and Competition Prof. Dr.

ENTREPRENEURIAL ECONOMICS Market Processes and Competition Prof. Dr.

ENTREPRENEURIAL ECONOMICS Market Processes and Competition Prof. Dr. Stefan Kooths UE, Campus Berlin Winter term 2018/2019 www.kooths.de/bits-mpc KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 1 Contact data Prof. Dr. Stefan Kooths Head of Forecasting Center Kiel Institute for the World Economy Office Berlin In den Ministergrten 8 10117 Berlin 030/2067-9664 [email protected]

www.kooths.de KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 2 Outline 1. Introduction and Overview 2. The Market System as an Economic Order 3. Equilibrium Analysis: Imperfect Competition 4. Process Analysis: Entrepreneurial Competition KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 3 Outline 1. Introduction and Overview 2. The Market System as an Economic Order 3. Equilibrium Analysis: Imperfect Competition 4. Process Analysis: Entrepreneurial Competition

KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 4 General perspective Austrian Economics? Methodenstreit with German Historical School Pronounced pro-theory approach in economics Cradle of modern economic thinking Marginal revolution, concept of opportunity costs Subjectivist theory of value Methodological individualism Next significant stage of economics after the classics Criticism of homo oeconomicus and Neoclassics Over-simplistic assumptions (economic core is assumed away) Pure-and-perfect competition as model without true competition (e.g. problem of representative firms)

Problematic macro-micro-dichotomy Economics as a social science, comprehensive view on entrepreneurs KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 5 Curricular context Catallactics Goods and Value Individual perspective Human action and economic thinking Categories of goods Preferences and choice Utility and value Exchange and Price Social equilibrium perspective Human inter-action

Division of labor and trade Perfect Markets Static efficiency (welfare theory) Market Processes and Competition Social process perspective Market institutions and social coordination Entrepreneurs and arbitrage Use of knowledge and dynamic efficiency Rivalry competition as discovery procedure KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 6 Curricular context: Sequence Goods and value

Building blocks (isolated and social economy) Exchange and Price Social interaction (basically in any economic system) Market Processes and Competition Social interaction in (real-world) market economies KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 7 Reading Coase, R. (1990): The Firm, The Market, and the Law; University of Chicago Press: Chicago. Hayek, F.A. (2014): The Market and Other Orders; The Collected Works of F. A. Hayek, Vol. XV (ed. by Bruce Caldwell), University of Chicago Press: Chicago.

Economics and Knowledge; Economica IV (new ser. 1937), 33-54. The Use of Knowledge in Society; American Economic Review, Vol. 35, September 1945, 519-530. Hayek, F. A. (1948): The Meaning of Competition; in: Hayek, F. A., Individualism and Economic Order, University of Chicago Press: Chicago 1948, 92-106. Competition as a Discovery Procedure; in: Hayek, F. A., New Studies in Philosophy, Economics and the History of Ideas, University of Chicago Press: Chicago 1978 (1968), 179-90. Liebowitz, St. J. and St. E. Margolis (2001): Winners, Losers & Microsoft Competition and Antitrust in High Technology; The Independent Institute: Oakland/California. Kirzner, I. M. (1973): Competition and Entrepreneurship; The University of Chicago Press: Chicago and London.

Machovec, F. M. (1995): Perfect Competition and the Transformation of Economics, Routledge: London and New York. Varian, H. R. (2014): Intermediate Microeconomics A Modern Approach; 9 th edition [7th edition (2005)], Norton & Company: New York and London. KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 8 Outline 1. Introduction and Overview 2. The Market System as an Economic Order 3. Equilibrium Analysis: Imperfect Competition 4. Process Analysis: Entrepreneurial Competition

KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 9 The Market ? Source: Varian (2005), p. 1 [left] and p. A35 [right] KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 10 The market ? (cont.) Missing entries International Encyclopedia of the Social Sciences (1968) The New Palgrave: A Dictionary of Economics (1987) Ronald Coase What is studied is a system which lives in the minds of economists but not on earth. I have called

the result "blackboard economics". The firm and the market appear by name but they lack any substance. The firm in mainstream economic theory has often been described as a "black box". () Even more surprising, given their interest in the pricing system, is the neglect of the market or more specifically the institutional arrangements which govern the process of exchange. As these institutional arrangements determine to a large extent what is produced, what we have is a very incomplete theory. Lecture to the memory of Alfred Nobel, December 9, 1991 KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 11 Coase on economic coordination and market institutions

The Firm, The Market, and the Law The Nature of the Firm Industrial Organization: A Proposal for Research The Marginal Cost Controversy The Problem of Social Cost Notes on the Problem of Social Cost The Lighthouse in Economics KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 12 Economics and the key allocation problem Human needs Subjectively felt uneasiness (reason for action) Generally unlimited Goods Means for (direct or indirect) satisfaction of a need

Generally limited Scarcity (allocation problem) Not all needs can be fully satisfied Selection inevitable - Ranking needs - Matching with disposable means (production possibilities) Economic growth: Reduction of uneasiness (more satisfaction by expanding the pool/efficiency of means) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 13 Alternative allocation mechanisms

Violence (military campaigns, robber barons) Discrimination (Sex, Nationality, Age, ) Greyhound racing (First come, first served) Communism (Each according to his/her need) Egalitarianism (Each the same) Market (competitive exchange mechanism) Property rights Voluntary exchange Each according to his/her preferences and performance (ability-to-pay resulting from market income = valuation by others) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 14 KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 15

Property rights and the primary role of government Property rights Usus Abusus Usus fructus (includes: accountability!) Role of government: Defining and guaranteeing property rights (legal framework) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 16 The market signal system: Profits, Losses, Bankruptcy Profits Revenues (value creation) > Costs (value destruction) Net creation of value Agent stays in the game, activity can be expanded Losses

Revenues < Costs Net destruction of value Yellow card (warning): activity should be reduced/modified Bankruptcy Revenues << Costs Net value destruction ongoing/at large scale Red card (sending-off): activity must stop KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 17 Origin of markets Source: Frank Fetter (1928|1915), Economic Principles, p. 57 f. KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 18

Instincts vs. extended order (Hayek, Popper) Atavistic instincts Solidarity, altruism Aggression against outsiders Stabilizing small groups (families, tribes, clubs) Extended order Contracts, exchange, money Trust, reputation Competition Non-aggression, openness, voluntary cooperation Enabling anonymous societies Market system Efficiency = Use of dispersed knowledge Justice (fairness) = Supremacy of abstract rules KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019)

19 Mercantilist atavism: Buy German KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 20 Market diagram KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 21 Demand and supply: Marshallian vs. Austrian value theory Marshallian scissors Austrian value theory Subjective demand side

(consumer preferences) Objective supply side (costs) Universal subjectivism Cost = opportunity cost ber den Ursprung und die Hauptgesetze des wirtschaftlichen Werthes (1884) Der natrliche Werth (1889) / Natural value (1893) Friedrich v. Wieser (18511926) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 22 Demand theory without psychology: Law of marginal utility Marginal utility

7th best use 6th best use 5th best use 4th best use 3rd best use 2nd best use 1st best use Demand Quantity KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 23

Supply theory without production cost: Cost as universal social opportunity cost Part II, Section II, Chapter 2 Marginal utility last-9th best use last-8th best use last-7th best use last-6th best use last-5th best use last-4th best use last-3rd best use

last-2nd best use last-1st best use last best use Supply Schumpeter, A.: Das Wesen und der Hauptinhalt der Theoretischen Nationalkonomie. Leipzig 1908: 213ff. KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) of available resources (relative to a given body of technological knowledge) Quantity 24 KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019)

last-9th best use last-8th best use last-7th best use 7th bestbest use use last-6th 6th bestbest use use last-5th 5th bestbest use use

last-4th 4th bestbest use use last-3rd 3rd best best use use last-2nd 2nd bestbest useuse last-1st 1st lastbest bestuse

use Market coordination for resource allocation Marginal utility D S Quantity 25 KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 26 Real world markets Short side of the market dominates Disequilibrium (arbitrage trends towards

coordination) Equilibrium (full coordination) Price D S Maximum trade volume Maximum social welfare x KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 27 Workable economic coordination What are markets expected to do?

Static functions Consumer sovereignty Efficient factor allocation Performance-based income distribution Dynamic functions Flexible adjustment to changing conditions Technological progress/innovations Coordination efficiency KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 28 Market process view: Product life cycle (market phases) Ernst Heu (1965): Allgemeine Markttheorie sales experimentation

expansion maturity stagnation/ decline time Static efficiency Dynamic efficiency KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 29 Market structure scheme (v. Stackelberg) Buyers Many

Few Single Many Pure (polypolistic) competition Limited monopsony Monopsony Few Oligopoly

Bilateral oligopoly Limited monopsony Single Monopoly Limited monopoly Bilateral monopoly Sellers KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019)

30 Free-market prejudice and market failures Voluntary exchange Implies gains from trade (for the parties involved) Market failures Technological externalities (impact on third parties) Natural monopolies (sub-additivity of cost functions) Information deficiencies (asymmetries) Instability (deficient adjustment processes) [Non-rationality] Relevant alternative allocation mechanism?

KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 31 Outline 1. Introduction and Overview 2. The Market System as an Economic Order 3. Equilibrium Analysis: Imperfect Competition 4. Process Analysis: Entrepreneurial Competition KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 32 Conditions for perfect competition Atomistic market structure

Large number of small buyers and sellers (no market power) Price taker/autonomous decisions Rationality Consumers/households: Utility maximization Producers/enterprises: Profit maximization Self-interest with fair means (no opportunistic behavior) Zero transaction costs (no costs for making an exchange of goods) Perfect factor mobility (unrestricted market entry/exit)

Given resources, constant technology No growth analysis, no process/product innovations KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) Perfect information/total transparency Full knowledge/free information about alternatives and prices No uncertainty Homogenous goods Stationary world Freedom of choice

No involuntary/compulsory transactions No technological external effects No personal/spatial/physical preferences No indivisibility World without frictions Infinite speed of response Focus on equilibrium analysis Transactions only at equilibrium prices (no false trading) 33 Imperfections

Market structure* Polypolistic (many) Oligopoly (few) Monopoly (one) Product characteristics Homogeneous (not differentiated) Heterogeneous (differentiated) As consumers see it! *Here: Supply-side (demand-side analysis works in a similar way) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 34 Categories of imperfection: Market structure and product differentiation

Product Homogeneous Heterogeneous Many Perfect competition Monopolistic competition Few Homogeneous oligopoly

Heterogeneous oligopoly Market structure Cartel (collective monopoly) Single KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) Monopoly 35 Categories of imperfection: Market structure and product differentiation Product Homogeneous

Heterogeneous Many Perfect competition Monopolistic competition Few Homogeneous oligopoly Heterogeneous oligopoly Market structure

Cartel (collective monopoly) Single KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) Monopoly 36 Monopoly Market demand = firm demand Price setting (consumers choose the quantity) Quantity setting (consumers determine the price) Static inefficiency Marginal revenue = marginal cost still holds BUT: price marginal cost (inframarginal units matter!) Deadweight loss

KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 37 Monopoly diagram KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 38 Monopoly behavior Price discrimination First-degree (perfect price discrimination) Second-degree (non-linear pricing) Third-degree (group-specific pricing) Separating customers according to willingness to pay Bundling Packaged offers Reducing dispersion of willingness to pay

Two-part tariffs Option pricing (fixed and variable component) Charging consumer surplus separately KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 39 Monopoly: Non-linear pricing Self-selection (in terms of quantity or quality) Airline industry: Business and economy class tickets KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 40 Monopoly: Bundling Offering all-or-nothing packages (bundles) Software industry: Office suites

KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 41 Monopoly: Two-part tariffs Fixed (admission) and variable (quantity) price component IT industry: Device (printers) and spare parts (toner) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 42 Special case: Natural monopoly Technology Market size Both matter simultaneously! KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019)

43 KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 44 Categories of imperfection: Market structure and product differentiation Product Homogeneous Heterogeneous Many Perfect competition

Monopolistic competition Few Homogeneous oligopoly Heterogeneous oligopoly Market structure Cartel (collective monopoly) Single KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) Monopoly

45 Monopolistic competition Small (atomistic) firms Product differentiation Tangent solution KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 46 Categories of imperfection: Market structure and product differentiation Product Homogeneous Heterogeneous

Many Perfect competition Monopolistic competition Few Homogeneous oligopoly Heterogeneous oligopoly Market structure Cartel (collective monopoly) Single

KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) Monopoly 47 Cartels (collective monopolies) Collusion Instability (prisoners dilemma) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 48 Categories of imperfection: Market structure and product differentiation Product

Homogeneous Heterogeneous Many Perfect competition Monopolistic competition Few Homogeneous oligopoly Heterogeneous oligopoly

Market structure Cartel (collective monopoly) Single KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) Monopoly 49 Oligopolistic interdependence Noticeable impact of one competitors action on other competitor(s) Conduct Autonomous/passive Conjectural/strategic Strategy

Simultaneous (Cournot/Betrand) Leader/follower (Stackelberg) Competition (Bowley) Collusion Homogeneous: Quantity Heterogeneous: Quantity or price KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 50 Homogenous duopoly KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 51

Outline 1. Introduction and Overview 2. The Market System as an Economic Order 3. Equilibrium Analysis: Imperfect Competition 4. Process Analysis: Entrepreneurial Competition Profits and entrepreneurship in the market system Competition and Monopoly revisited Static efficiency vs. dynamic coordination KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 52 References Kirzner, I. M. (1973): Competition and Entrepreneurship

Hayek, F. A. Economics and Knowledge (1937) The Use of Knowledge in Society (1945) The Meaning of Competition (1948) Competition as a Discovery Procedure (1968) Mises, L. v. (1949): Human Action A Treatise on Economics Chapter XV (The Market) Chapter XVI (Prices) Critical assessment of orthodox competition theory and welfare economics KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019)

53 Outline 1. Introduction and Overview 2. The Market System as an Economic Order 3. Equilibrium Analysis: Imperfect Competition 4. Process Analysis: Entrepreneurial Competition Profits and entrepreneurship in the market system Competition and Monopoly revisited Static efficiency vs. dynamic coordination KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 54 Static and dynamic view on the market system

Static: Equilibrium conditions Walras: Auctioneer model (tatnnement analysis) Edgeworth: Recontracting Marshall: False trading, but neglectable income spill-overs Invisible hand (implicit market forces) Dynamic: Equilibrating process Disequilibrium as normal state of affairs Entrepreneurial alertness Incentives for arbitrage (broadly defined, including innovations) Entrepreneurship (explicit economic activity) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 55 Price theory (broadly defined) Static Law of one price Level

Dynamic Price differentials, multiple prices Change KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) Prices, quantities, qualities, methods of production 56 Dynamic market theory [Understanding] how the decisions of individual participants in the market interact to generate the market forces which compel changes in prices, in outputs, and in methods of production and the allocation of resources. (Kirzner)

KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 57 Market process Complex interdependency of decisions expectations Ignorance about decisions of other market participants Some individual plans fail Opportunities remain unexploited Sequence of plan revisions Sequence of plan revisions Overambitious plans replaced by more realistic ones Opportunities overlooked in t exploited in t+1

Market process = series of systematic changes in the interconnected network of market decisions KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 58 Profits Non-profits Interest Managerial wages Income of resource owners Quasi-rents Pure profits

Gains from so far unexploited opportunities (price gaps) Discovery of something obtainable for nothing at all (no investment at all is required) Absent in total equilibrium (eroded by omniscience) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 59 Entrepreneurs vs. capitalists Capitalists Bond holders: Interest (+ risk premium) Share holders: Interest Entrepreneurs Vision and alertness to hitherto unnoticed opportunities Responsible for the effective decisions of the corporate firm Share holders: entrepreneurial (= residual) income Managers Mere control not sufficient for entrepreneurship

KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 60 Decision making and knowledge Robbinsian economizer (homo oeconomicus) Known alternatives (means and ends) Means-end-framework optimization Entrepreneurial explorer (homo agens) Data modifiers, shaping new means-end-frameworks Alertness/search for new alternatives: knowing where to look for knowledge, smelling profits Highest order of knowledge: Harnessing available information - already possessed

- or capable of being discovered Ultimate hiring decision - Final responsibility for all factors directly or indirectly hired - Includes hiring of superior knowledge KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 61 The Entrepreneur: Nature Elusive role Extraecononmic element in human action Crucial to economizing activity, but cannot itself be analyzed in terms of economizing (efficiency) Learning from experience

Less-than-optimal courses of action Systematic changes in expectations Alterations in plans Process of discovery of changing ends-means-frameworks KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 62 The Entrepreneur in the literature Schumpeter The Theory of Economic Development (1911/1934) Disruptive innovator (as opposed to imitators) disequilibrating force Knight Risk, Uncertainty and Profit (1921) Control and responsibility profits as residual income Gordon

Enterprise, Profits, and the Modern Corporation (1936) Control over production managers Mises Human Action (1940/1949), Profit and Loss (1951) Competitive, speculative decision making arbitrage theory of profits Bronfenbrenner Reformulation of Nave Profit theory (1960) Ultimate uncertainty-bearing profits as reward for risk taking KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 63 Kirzner on Schumpeter Entrepreneurship for me is not so much the introduction of new products or of new techniques of production as the ability to see where new products have become unsuspectedly valuable to consumers and where new methods of production have,

unknown to others, become feasible. For me the function of the entrepreneur consists not of shifting the curves of cost or of revenues which face him, but of noticing that they have in fact shifted. () For Schumpeter, entrepreneurship is important primarily in sparking economic development; for me it is important primarily in enabling the market process to work itself out in all contexts with the possibility of economic development seen as a special case. KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 64 Means, ends, arbitrage, speculation, and entrepreneurship Speculation Selection Expected effect Means

Factor markets: Prices of resource services Valuation Arbitrage End End Subjective judgment Speculation Means (Future) product markets:

Prices of consumer goods Imperfect communication between two markets (price of bundle of inputs price of consumption good) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 65 Mises on profits and entrepreneurship What makes profit emerge is the fact that the entrepreneur who judges the future prices of the products more correctly than other people do buys some or all of the factor of production at prices which, seen from the point of view of the future state of the market, are too low. Intertemporal speculative arbitrage KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 66

Outline 1. Introduction and Overview 2. The Market System as an Economic Order 3. Equilibrium Analysis: Imperfect Competition 4. Process Analysis: Entrepreneurial Competition Profits and entrepreneurship in the market system Competition and Monopoly revisited Static efficiency vs. dynamic coordination KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 67 Competition and competitiveness Process or

Entrepreneurial activity is per se competitive (rivalry) Lack of competitiveness = arbitrary barriers to entry Setting up the Robbinsian framework for allocative decision making state resulting from the process Perfect competition (price takers) Imperfection = absence of perfect elasticity (price setters) Decision making within a given Robbinsian framework KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 68 Entrepreneurial activity, market entry, and monopoly Entrepreneurial activity Requires alertness Does not require resource ownership Freedom of market entry Potential competition

Contestable markets Price elasticity only temporary (pioneers demand = market demand) Barriers to entry Regulatory (governmental intervention) Restricted ownership of resources (blocked access to inputs) Monopoly ( control over the product) Diversion of entrepreneurial process into other activities KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 69 Critique of Monopolistic/Imperfect Competition Chamberlin (1933), Robinson (1933) More realistic than the perfect competition paradigm but replacing one equilibrium approach by another Key assumption: Known demand and supply curves facing each firm Diverting attention from deeper theoretical flaws Market testing: Competition as a discovery process

Decisions by competing (!) market participants (quality, quantity, price, packaging etc.) constitute a disequilibrium set Product differentiation as part of equilibrating process Very essence of competition is not monopolistic KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 70 Industry concept Industry view Market demarcation (price-elasticity) Static concept Competition within industry (not among industries) Holistic (economy-wide) view General competitiveness among goods (Triffin) Competition as a rivalrous process - Offering opportunities to other market participants - that are more attractive than those currently available

Competition for each unit of purchasing power KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 71 Monopoly revisited Immunity from the entry of competing entrepreneurs Unique ownership of resources Source of monopoly positions? Alert entrepreneurial action: Buying up the entire supply of a specific resource Entrepreneurial foresight: short-run vs. (backward-looking) long-run Position won in open competition with other entrepreneurs Pioneers: First mover advantage (temporary monopoly) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 72

Market phenomena as a sequence of decisions arbitrage selling output buying inputs short-run monopoly D1 D2 D3 Dn Target

long-run competition time KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 73 Notion of monopoly Category Neoclassics Entrepreneurial Control over product input

Industry matters yes no Substitutes monopolistic competition conceptually inherent Theory of the firm (cost/revenue curves) relevant

irrelevant Surplus monopoly profit monopoly rent Welfare resource allocation (equilibrium) process efficiency (speed, equilibrating) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 74

Product variability and selling costs Product characteristics as an economic variable Patterns of prices, quantities, product types, qualities Entrepreneurs seeking to offer better opportunities (price-product-bundles) to the market Holistic cost approach No distinction between so-called selling costs and production costs All cost are incurred to offer attractive opportunities to consumers Entrepreneurial supply as production and selling effort Going beyond mere fabrication of products Making consumers aware of opportunities (alerting them to the availability and desirability of a product) Relieving the consumer of the necessity to be his own entrepreneur Competition as a rivalrous multi-dimensional process KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 75

Homogeneity of all cost Entrepreneurial production decision: Converting expenditure into a hitherto unperceived revenue possibility No feature of the product was introduced without regard to its contribution to a salable finished product No single penny of the outlay (including PC in the strictest sense) can be perceived as anything but costs incurred in order to sell View of selling cost (shifting D-curve) and production cost (shifting S-curve) assumes product as given Selling cost/production cost-classification is arbitrary All cost are selling cost or All cost are production cost KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 76

Entrepreneurial role and advertising (selling efforts) Making opportunities available to consumers Getting potential consumers know about these opportunities Technical information and emotional appeal Social function: Information indistinguishable form persuasion Affluent society (greater varieties, alertness more difficult to evoke): Smaller relative informational content Integrated task The most effective way to convince consumers is to take steps that in fact alter the nature of the opportunity being made available Information and product are inseparable (strength of demand for an unknown product is meaningless) Similar: Sourcing efforts Example: Working conditions KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 77

Outline 1. Introduction and Overview 2. The Market System as an Economic Order 3. Equilibrium Analysis: Imperfect Competition 4. Process Analysis: Entrepreneurial Competition Profits and entrepreneurship in the market system Competition and Monopoly revisited Static efficiency vs. dynamic coordination KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 78 Critique of orthodox welfare economics: Efficiency revisited Orthodox welfare theory: Market as computer Given data: Resources, technology, products, preferences

Finding optimal allocation of known means to known ends (in principal by omniscient social planner) Hayek: Market as communication device Relevant data are not given The economic problem of society is thus not merely a problem of how to allocate given resources. () It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Utilization of knowledge, not given to anyone in its totality KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 79 Inefficiency as absence of coordination Conditions for exchange transactions Mutually beneficial opportunity (intersecting indifference curves) Awareness of this opportunity (knowledge) Incomplete knowledge = scope for profitable entrepreneurship (exploiting conditions for exchange)

Example Person A (apple owner): offering up to 5 apples for 1 orange Person B (orange owner): offering up to 2 oranges for 1 apple 0.5 < p [apple/orange] < 5 Success of a system of social organization Coordination of the decisions of its individual members No need for the concept of social welfare KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 80 Knowledge, foresight, and equilibrium Disequilibrium Imperfect knowledge Uncomplete coordination

Equilibrium Perfect knowledge Complete coordination Entrepreneurial-competitive process (communicating information) - Information (prices) - Action (exchange) Market clearing Price movements and changing patterns of product quality Perfect foresight as result of, not condition for equilibrium Profit directing

KOOTHS | UE Berlin | Entrepreneurial Economics: Marketopportunities Processes and Competition (winter term 2018/2019) coordination process 81 Double task of allocation mechanisms Generating information about all benefits of employing resources in alternative uses Market system: Price signals Motivating people to take account of this information (perception, alertness) Market system: Profit incentives Mobilization of information (Hayek) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019)

82 Beyond neoclassical price-quantity-analytics: Coordination between resource owners and consumers p S universal opportunity costs conjectural market demand and price as one of many factors only D not given KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) x 83 Nirwana critique Orthodox welfare and competition framework

All relevant information is already possessed Problematic notion of social welfare Efficiency judgements based on irrelevant yardstick of omniscience (nirwana critique of the irrelevant alternative) Entrepreneurial competitive process Decisions reflect the most up-to-date intelligence gathered by alert, profit-motivated entrepreneurs Actions based on these decisions effectively communicate information to others Improvement (gradual elimination of imperfect knowledge) rather than optimality (omniscience) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 84 Potential room for improving societal coordination: The two-stage burden of proof Intervention analysis: Market vs. hierarchy (central planning) (1) Significant market failure? (2) Market failure > government failure?

(comparing relevant alternatives) - Information problem (getting/distributing data, value problem) - Incentive/bureaucracy problem (individual utility vs. realization of the plan) - Financing/spillovers to other fields (distortions on other markets) Intervene only, if (1) and (2) Default: Market-based coordination (free-market prejudice) Minimally invasive operations (market-compatible solutions) KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 85 Perfect vs. rivalrous competition Frank M. Machovec (1995): Perfect Competition and the Transformation of Economics. London: Routledge.

KOOTHS | UE Berlin | Entrepreneurial Economics: Market Processes and Competition (winter term 2018/2019) 86

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