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Managerial Economics


The bargaining power of buyers; and. The rivalry among existing competitors' (35) ... But better guide to feasible policy than 'comparative advantage' ... – PowerPoint PPT presentation

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Title: Managerial Economics

Managerial Economics
  • Lecture Thirteen
  • Alternative perspectives on globalisation

  • Theory of comparative advantage
  • Appeals to economists because
  • Fits within age-old paradigm of specialisation
  • Consistent with usual static equilibrium method
  • But fails as empirical model (a flop)
  • Some better recent results really test absolute
    advantage because drop factor price
  • Dynamic model analysis rejects zero tariff
  • This week alternative (you guessed it!)
    Schumpeterian theory
  • Porters Competitive Advantage of Nations

Competitive Advantage
  • Direct attack on relevance of conventional
  • Why do some nations succeed and others fail in
    international competition? This question is
    perhaps the most frequently asked … of our times…
  • Yet … it is the wrong question… We must focus
    instead on another, much narrower one…
  • why does a nation become the home base for
    successful international competitors in an
  • why is one nation often the home for so many of
    an industrys world leaders?
  • How can we explain why Germany is the home base
    for so many of the worlds leading makers of
    printing presses, luxury cars, chemicals?
  • Why is tiny Switzerland the home base for
    international leaders in pharmaceuticals,
    chocolate…? (1)

Competitive Advantage
  • Focus not on natural endowment (comparative
    advantage) broadly defined industries
    (labour-intensive, capital intensive) but
  • Innovation very specific industries
  • Luxury cars (Germany)
  • Ski boots (Italy)
  • Mobile phones (Finland!)
  • Porters theory aware of recent economic trends
  • The long-dominant paradigm … is inadequate…
  • the rise of the multinational corporation … has
    weakened the traditional explanations of why and
    where a nation exports… (2)
  • Porter instead seeks to isolate … the national
    attributes that foster competitive advantage in
    an industry… (3)

Competitive Advantage
  • Dismisses other conventional explanations for
  • Good macroeconomic policies?
  • Nations have enjoyed rapidly rising living
    standards despite budget deficits (Japan, Italy
    Korea), appreciating currencies (Germany
    Switzerland), and high interest rates (Italy
    Korea)… (3)
  • Cheap labour?
  • The ability to compete despite paying high wages
    would seem to represent a far more desirable
    national target.
  • Natural resources?
  • Even within nations such as Korea, the United
    Kingdom, and Germany, it is the resource-poor
    regions that are prospering relative to the
    resource-rich ones (4)
  • Government intervention?
  • has occurred only in a subset of industries, and
    is far from universally successful even in Japan
    and Korea.

Competitive Advantage
  • Management style?
  • What is celebrated as good management practice
    in one industry would be disastrous in another.
  • Labour relations? (An Australian favourite…)
  • Unions are very powerful in Germany and Sweden,
    with representation by law in management
    (Germany) and on boards of directors (Sweden)…
    both nations … contain some of the most
    internationally preeminent firms and industries
    of any country. (5)
  • Rejects characterisation of nations as
  • We must abandon the whole notion of a
    competitive nation…
  • And focus instead on specific industries and
    industry segments… (9)

Competitive Advantage
  • Rejects comparative advantage
  • the assumptions underlying factor comparative
    advantage … are unrealistic in many industries.
  • The standard theory assumes that there are no
    economies of scale, that technologies everywhere
    are identical, that products are
    undifferentiated, and that the pool of national
    factors is fixed. (12)
  • (same reservations as early Samuelsonlast week)
  • The theory … is also frustrating for firms
    because … it assumes away a role for firm
    strategy, such as improving technology or
    differentiating products … most managers exposed
    to the theory find that it assumes away what they
    find to be most important and provides little
    guidance for appropriate company strategy.

Competitive Advantage
  • Old theory wrongly emphasises country factors
  • New theory emphasises companies BUT still has
    clear role for countries
  • the leaders in particular industries … tend to
    be concentrated in a few nations…
  • Competitive advantage is created and sustained
    through a highly localised process… While
    globalization of competition might appear to make
    the nation less important, instead it seems to
    make it more so. (19)
  • Basic elements of theory turn false comparative
    advantage theory on its head

Competitive Advantage
  • firms can and do choose strategies that differ…
  • successful international competitors often
    compete with global strategies in which trade and
    foreign investment are integrated… (19)
  • a nations firms gain competitive advantage in
    all its forms, not only the limited types of
    factor-based advantage contemplated in the theory
    of comparative advantage… (20)
  • Acknowledges inspiration by Schumpeter but he
    stopped short of answering the question … Why do
    some firms, based in some nations, innovate more
    than others? (20)
  • Theory developed by empirical research
  • 10 countries examined at deep industry level
    Denmark (5.1 million people in 1987) Germany
    (61m) Italy 57 Japan 122 Korea 42 Singapore
    2.6 Sweden 8.4 Switzerland 6.5 UK 57 USA 244 m

Competitive Advantage
  • Statistical technique used to select
    industries/firms in which each country was
    outstanding competitor in 1985
  • gt 100 industries selected
  • From obvious (Japan semiconductors)
  • To obscure (British biscuits)
  • Industry classifications show how specific
    capital is
  • Machines essential for one industry useless in
  • Key point in critique of neoclassical concept of
    factor of production ease of movement from
    one industry to another
  • The complete list by country

Competitive Advantage
  • Historical study of industry undertaken
  • Global history as well as specific to successful
  • In printing presses … we sought to understand
    why Germany and Switzerland had sustained
    advantage but also why the United States had lost
    ground and Japan was gaining. (28)
  • Found country far from relevant scale of

Competitive Advantage
  • Successful firms are frequently concentrated in
    particular cities or states within a nation. In
    the United States …
  • many of the nations leading real estate
    developers are based in Houston, Texas
  • oil gas equipment suppliers in Houston
  • hospital management chains in … Nashville…
  • carpet producers in Dalton, Georgia…
  • Something about these locations provides a
    fertile environment for firms in these particular
    industries. (29)

Competitive Advantage
  • Narrow and meaningful definition of industry
  • Many discussions of competition … employ overly
    broad definitions such as banking, chemicals, or
  • These are not strategically meaningful industries
    because both the nature of competition and the
    sources of competitive advantage vary a great
    deal within them.
  • Machinery, for example, is not one industry but
    dozens of strategically distinct industries such
    as weaving machinery, rubber processing
    equipment, and printing machinery … each with its
    own unique requirements for competitive success.

Competitive Advantage
  • Delineates 5 forces shaping an industry
  • The threat of new entrants
  • The threat of substitute products or services
  • The bargaining power of suppliers
  • The bargaining power of buyers and
  • The rivalry among existing competitors (35)
  • Two basic determinants of competitive advantage
  • lower cost and differentiation (37)
  • It is difficult, though not impossible, to be
    both lower-cost and differentiated relative to
    competitors. (38)
  • Any successful strategy, however, must pay close
    attention to both types of advantage while
    maintaining a clear commitment to superiority on
    one. (38)
  • 3rd important factor is competitive scopehow
    broad industry is how much of it firm covers

Competitive Advantage
  • Combination of cost differentiation give
    different forms of competitive advantage

Competitive Advantage
  • Innovation crucial
  • First mover advantage can last well past short
  • German and Swiss dye companies (Bayer, Hoecsht,
    BASF, Sandoz,… Ciba-Geigy) have sustained their
    positions as international leaders since before
    World War I… (47)
  • Early movers gain advantages such as being first
    to reap economies of scale, reducing costs
    through cumulative learning… (47)
  • Schumpeters assumption confirmed Often,
    innovators are outsiders … to existing
    industry. (48) Also…
  • larger companies were often supplanted by
    smaller ones… (49)

Competitive Advantage
  • 4 key determinants of Competitive Advantage
  • Factor conditions
  • Only one considered by comparative advantage
  • Concerns innovation as well as endowment
  • Demand conditions…
  • Related supporting industries…
  • Firm strategy, structure, and rivalry. (71)

Competitive Advantage
  • Porters National Diamond
  • Advantages throughout the diamond are
    necessary for achieving and sustaining
    competitive success … but
  • Advantage in every determinant is not a
    prerequisite… (73)

Competitive Advantage
  • Factors matter but may enhance CA through their
  • an abundance of factors may undermine instead of
    enhance competitive advantage. Selective
    disadvantages in factors, through influencing
    strategy and innovation, often contribute to
    sustained competitive success. (74)
  • Opposite of economic theory belief
  • Gives example of Hollands advantage in flowers
    despite its cold, grey climate…
  • Second factor also important for Dutch flowers
  • Home demand
  • Quality more important than quantity
  • Discerning consumers drive product innovation

Competitive Advantage
  • Nations gain competitive advantage … where the
    home demand gives local firms a clearer or
    earlier picture of buyer needs…
  • if home buyers pressure local firms to innovate
    faster… (86)
  • A products fundamental or core design nearly
    always reflects home market needs. (87)
  • small nations can be competitive in segments
    which represent an important share of local
    demand but a smaller share of demand elsewhere,
    even if the absolute size of the segment is
    greater in other nations. (88)

Competitive Advantage
  • Related supporting industries
  • Suppliers assist process of innovation and
  • Suppliers help firms perceive new methods and
    opportunities to apply new technology. (103)
  • The full pattern of interlinking industries is
    very complex…

Competitive Advantage
  • A more disaggregated view…

Competitive Advantage
  • Competitive advantage in suppliers means spinoffs
    from one industry can be means to develop new
  • Italian world leadership in gold and silver
    jewelry has been sustained … because other
    Italian firms produce two-thirds of the worlds
    jewelry-making machinery. (101)
  • Related industries give strength to each other…

Competitive Advantage
  • Competitive advantage in related industries

Competitive Advantage
  • Japan's strength in long-filament synthetic
    textile fibers reflects a long tradition of
    success in silk, as does a leading export
    position in silk-like continuous synthetic
    weaves, woven from long-filament synthetic
    fibers. Carbon fibers employ technology closely
    related to synthetic filament fibers and many of
    the same competitors participate in both.
  • Also, while not overall leaders in textile
    machines, Japanese firms are leaders in water jet
    weaving machines, used to weave long-filament
    synthetic fibers into synthetic weaves. Such
    groups of linked competitive industries in a
    nation are common. (105)

Competitive Advantage
  • Firm strategy structure rivalry
  • No one management system is universally
  • But character of national management structure
    needs to suit needs of industry.
  • Nations will tend to succeed … where the
    management practices and modes of organization
    favored by the national environment are well
    suited to the industries sources of competitive
  • Italian firms … are world leaders in a range of
    fragmented industries … operating in small
  • In Germany … the engineering and technical
    background of many senior executives produces a
    strong inclination towards methodical product and
    process improvement… (108)

Competitive Advantage
  • National goals
  • Short term focus of US firmsadvantage in
  • Long term focus of German/Japaneseadvantage in
  • Domestic rivalry
  • Desire to beat own national competitors often
    drives innovation
  • Italian supercars Japanese electronics US
    software, computers…
  • With little domestic rivalry, firms are more
    content to rely on the home market. (119)

Competitive Advantage
  • Japan in particular has large number of
    internationally competitive firms in different

Competitive Advantage
  • National competitive advantage therefore tends to
    occur in clusters
  • Geographic clusters Many of the Italian jewelry
    firms, for example, are located around two towns,
    Arezzo and Valenca Po… (120)
  • Industry clusters
  • Related industries and supplier-buyer chains

Competitive Advantage
  • The individual determinants that define the
    national environment are mutually dependent
    because the effect of one often depends on the
    state of the others… (129)
  • Example of clustering Denmark

Competitive Advantage
Competitive Advantage
  • Geographic clustering also strikingly obvious
  • Clustering of internationally competitive
    industries in Italy

Competitive Advantage
  • Interactions in the Diamond for Italian Ski
    Boot industry

Competitive Advantage
  • Not so much a model in economic sense
  • More description of process
  • But better guide to feasible policy than
    comparative advantage
  • Industry policy promoted over free trade
  • Identify present clusters
  • Expect innovation in areas where domestic demand
    is an important share of local demand but a
    smaller share of demand elsewhere
  • Obvious examples for Australia
  • solar energy
  • water conservation…
  • (if only government policy helped!)

Integrating Managerial Economics
  • Weve covered a fair bit of territory…
  • Theory empirics of…
  • Firm
  • Market
  • Economy
  • Finance
  • Trade
  • In all areas
  • Data doesnt support conventional economic
  • Dominant theories have obvious flaws
  • But alternative theories exist…

The Firm
  • Conventional Theory
  • Production subject to diminishing marginal
  • Firms internal structure black box
  • Firms objective profit maximisation
  • Equates marginal cost to marginal revenue
  • Empirical Evidence
  • 89 (Blinder) to 95 (Eiteman) of firms have
    constant or falling marginal costs
  • Prices via markup on average costs
  • Marginal cost well below average
  • Marginal considerations irrelevant
  • Alternative Theory
  • Conventional profit maximisation rule wrong for
    multi-firm industries
  • Profit maximisation where marginal revenue
    exceeds marginal cost even with rising marginal

The Firm
  • Alternative Theory (cont.)
  • Sraffa well-designed factories mean factor
    proportions constant out to capacity
  • Constant marginal cost
  • Kornai firms in dynamic industries
  • Growth uncertainty make excess capacity
  • Schumpeter creative destruction
  • Entrepreneurs profit by revolutionising
  • Technical change drives costs down, diversity up
  • Combination means
  • Costs constant/falling
  • Firms compete on product diversity/production
    innovation rather than just price…

The Market
  • Conventional Theory
  • Taxonomy of industry types
  • Competitive markets
  • Many sellers, buyers
  • Homogenous product
  • Price equals marginal cost (with erroneous
  • Monopoly
  • Single seller
  • Single product
  • Price exceeds marginal cost
  • Oligopoly
  • Several sellers
  • Compete with each other game theoretic style
  • Welfare position between monopoly PC

The Market
  • Empirical Evidence
  • Most industries characterised by power law
    distribution of firm sizes
  • Some very large many very small no average
  • Competitive outcomes (falling price, rising
    quality diversity) independent of number of
    firms in industry
  • Alternative Theory
  • Evolutionary process of dynamic selection.
  • Varying products increases survival chances of
  • Varying consumer interaction alters environment
  • Multi-agent modeling can capture essential
    features of process
  • Diversity of firm behavior rather than
  • Power-law distribution of firm sizes rather than
    non-existent neoclassical taxonomy of PC,
    monopoly, oligopoly

The Economy
  • Conventional Theory
  • Equilibrium processes
  • Keynesian/Neoclassical dispute over tendency to
    full employment
  • Both agree real wages have to fall in boom
    (diminishing marginal productivity)
  • Exogenous money, causation from base money supply
    to credit money to economic activity
  • Empirical Evidence
  • Disequilibrium the rule all variables cyclical
  • Real wages rise, prices (relatively) fall during
    boom (no DMP)
  • Credit money drives economy, base money reacts
  • Rising debt levels since WWII

The Economy
  • Alternative Theory
  • Schumpeters vision
  • Underlying disequilibrium dynamics reflect
    entrepreneurial search for profit
  • Credit essential to entrepreneurial process and
    endogenous to economy
  • Debt entrepreneurial activity co-extensive
  • Minskys vision
  • Cyclical trend for debt over trade cycle
  • Secular trend for debt/output levels to rise as
    memory of crisis recedes
  • Potential for debt-deflation
  • Big Government reduces likelihood of crisis by
    anti-cyclical spending

The Finance Sector
  • Conventional Theory
  • Equilibrium process
  • Investors balance risk vs return
  • Empirical Evidence
  • Far from equilibrium dynamics
  • Fractal rather than efficient markets
  • Beta is dead (and always was!)
  • Market inefficient but still hard to predict
  • Alternative Theory
  • Sophisticated models from physicists
  • Power law / Hurst exponent / Tsalliss
    qnon-extensive statistical mechanics /
    minority game

The Finance Sector
  • Alternative Theory (cont.)
  • Inefficient Markets Hypothesis
  • Non-institutional investors can construct low
    volatility high return portfolios
  • Tendency of finance boom/bust cycle to drive
  • Argument for reform of asset markets

Trade Global Economics
  • Conventional Theory
  • Comparative advantage
  • Countries specialise where they have comparative
    advantage over rest of world, not absolute
  • Trade governed by relative factor abundance
  • Free trade equalises wages profits worldwide
  • Empirical Evidence
  • Comparative Advantage a flop
  • Absolute advantage more relevant than comparative
  • Factor abundance largely irrelevant to trade
  • Innovation rules
  • Compounded by transnational corporations,
  • Take advantage of absolute cost differences

Trade Global Economics
  • Alternative Theory
  • Role for industry promotion in development
  • Success comes via competitive advantage
  • Not countries but firms, products, industry
  • Where to from here?
  • Other courses at UWS
  • Behavioural Finance (myself Craig Ellis)
  • History of Economic Thought (James Farrell
    sometimes also me)
  • Political Economy
  • Undergraduate (Neil Hart others)
  • Honours (myself others)
  • Further reading…

Building on Managerial Economics
  • Further reading
  • All full readings from this course but
  • Schumpeter Theory of Economic Development
  • Minsky John Maynard Keynes
  • Ormerod Butterfly Economics
  • Haugen The New Finance
  • Peters The Fractal Markets Hypothesis
  • Debunking Economics
  • Book via Zed Books, Pluto Press
  • Website
  • Other critical resources
  • PAECON movement