If a company commanding a large share severely affects pricing in a
new market do economists feel that those prices were historically
"wrong"? What if that company is later found to have engaged in
fraud? |
Request for Question Clarification by
pafalafa-ga
on
01 Apr 2005 05:22 PST
wynnwilliamson-ga,
The situation you're descirbing seems very much like the
"manufactured" prices for electricity during the 2001 energy crunch in
California. These prices were apparently manipulated by the largest
energy providers in the state in the newly-created energy market, and
are definitely deemed to have been "wrong" in a market sense, and are
now the subject of criminal prosecution:
http://www.fbi.gov/dojpressrel/pressrel04/energy040804.htm
Is this the sort of example you're asking about? If so, what
additional information do you need as an answer to your question?
pafalafa-ga
|
Clarification of Question by
wynnwilliamson-ga
on
01 Apr 2005 05:35 PST
I think that it is easy to say that higher prices are wrong - as in
the energy crisis. I am more interested in a scholarly argument that
inflated or deflated prices may be part of a developing market, even
if one of the companies that largely influenced this pricing was
engaging in fraud.
|
Request for Question Clarification by
pafalafa-ga
on
01 Apr 2005 05:49 PST
Thanks for the feedback.
I'm still not sure, though, what you're after. Economists routinely
invoke the notion of "market failure" or other market shortcomings,
where something is "wrong" with pricing due to constraints on the
operation of a perfectly free market -- monopolies, cartels, fraud,
government interference, imperfect information, etc.
Some of these factors are likely to be more pronounced in a "new"
market, since the operational dynamics haven't had time to settle into
place yet.
If you can provide a bit more detail about what you want -- what sort
of situation you are most interested in, and what sort of commentary
you hope to find -- we might be able to better assist you.
Thanks.
pafalafa-ga
|
Clarification of Question by
wynnwilliamson-ga
on
01 Apr 2005 06:49 PST
Ok, let me try to clarify. I am interested in a situation where
Company A affects a market - perhaps by paying too much money to
acquire the material resources for the industry. Because of this,
competitors have to pay more to acquire resources and compete. Or
perhaps Company A can sell a product for a very low price. The other
companies have to sell for a lower price as well to compete. It later
comes to the light that Company A was able to purchase raw materials
at such a high price and/or sell for so low because of some non-kosher
reason - (e.g. perhaps they were engaging in a ponzi scheme). Now, it
could be easy to say that all of these other companies got the shaft -
they were forced to pay too much and/or sell for too low, and that
this wasn't a "true" market because Company A distorted it through
fraud. I am interested in a counter argument. Perhaps since the
competitors could pay these prices and remain viable in the long run -
perhaps then the fraud is, in a sense, negligible in an assessment of
the historic market? And what if, as the market develops, pricing
goes to similar levels as when the fraudulent company was in business
- does this undermine an argument that Company A's pricing is wrong?
To sum up, I am looking for an argument: the fact that other companies
could compete and survive through the market suggests that the higher
prices were not wrong, even though they may have been influenced by
fraud. Does that make more sense?
|
Request for Question Clarification by
pafalafa-ga
on
02 Apr 2005 14:27 PST
When the mutual funds scandal broke a few years ago -- where brokers
were giving privileged access to some customers to make last-second
trades after the market actually closed -- one of the arguments was
"So what...no one got hurt". The special access (which was legaly
treated as fraud) didn't particularly affect the price of the funds
themselves.
Is that sort of thing relevant to your question?
|
Clarification of Question by
wynnwilliamson-ga
on
03 Apr 2005 07:42 PDT
I would need the pricing in the market to be affected by the fraud
(thank you, though, for continuing to investigate and to ask me
clarifying questions).
|
Request for Question Clarification by
pafalafa-ga
on
03 Apr 2005 08:45 PDT
Reading between the lines here, you seem to have a very specific
situation in mind that you're looking for feedback on. How about
spelling it out for us? It may be the only way we can realistically
attempt an answer to this question.
paf
|
Clarification of Question by
wynnwilliamson-ga
on
05 Apr 2005 04:55 PDT
I´m sorry, but I do not have a specific situation in mind. It is an
economic question.
|
Clarification of Question by
wynnwilliamson-ga
on
07 Apr 2005 08:38 PDT
I'm seeing that we're not getting very far with the fraud issue. Let
me ask two different questions (although any available information
regarding the first would still be helpful). I am going to up the
price to $100 as well since I am now really asking more than one
question (ignore fraud altogether when answering these questions):
(1) If a very powerful, well-funded company in a market affects prices
for other companies in the market, are those altered prices reliable
(i.e. isn't this how markets work)?
(2) Is it true that every company in a market wants to secure as large
a market share as possible? Are there situations were this is to the
advantage or disadvantage of a company?
|
I am responding to the revised questions you posted on April 7.
The answer to your first question is that yes, those prices would be
considered reliable. In fact, this is the normal state of most
industries in market economies. Economists refer to this state of
affairs as being imperfect competition. As opposed to perfect
competition, where every firm is insufficiently large to affect the
market price, imperfect competition means that one or more firms in an
industry can affect the market price by changing the amount of goods
they offer for sale.
While individual sellers have some degree of control over industry
pricing, imperfect competition does not mean that a firm has absolute
control. The degree of pricing power may only be a few percent if the
degree of monopoly power is small, whereas a full-fledged monopoly may
be able to drastically alter prices without having a significant
effect on short run demand.
Imperfect competition also does not mean that intense rivalry is not
occurring in the market. "Intense rivalry should be distinguished
from perfect competition. Rivalry encompasses a wide variety of
behavior, from advertising that attempts to shift out one is demand
curve to inventing better products. Imperfect competition says
nothing about rivalry but simply denotes that every firm in the
industry can sell all it wants at the prevailing market price." (Page
163)
Graphically, the demand curve for an imperfect competitor is downward
sloping, indicating that an increase in sales depresses the market
price for its products. In contrast, the demand curve for a perfect
competitors horizontal, indicating the firm can sell as much as it
likes without changing the market price. The demand elasticity is
also perfectly elastic for perfect competitors, where as demand has a
finite elasticity for imperfect competitors.
There are multiple types of imperfect competition, ranging from
monopolies to oligopolies to many differentiated sellers. Imperfect
competition among a few firms typically arises when there are large
economies of scale to be had or large barriers prevent competitors
from entering the marketplace.
The answer to your second question is that is not necessarily true
that every company wants to secure as large a market share as
possible. The objective for every company is to generate the largest
profits possible. In the case of a natural monopoly, where the firm
gains ever-increasing economies of scale with increasing size, it is
true that the company will want to secure the largest possible market
share because this will create the largest profits. However,
oligopolies are characterized by a few firms that have significant
economies of scale up to a particular output level, but whose
economies of scale reach a limit characterized by an increase in
average cost of production. Such firms want to achieve sufficient
market share to reach the limit of their economies of scale, but
additional production beyond that point is undesirable because it is
no longer profitable. Perfect competition allows for firms to achieve
efficiency with relatively small levels of production, and firms enjoy
minimal economies of scale. In this environment, additional
production may also be undesirable because of increased costs.
For a real-world example, consider the plight of General Motors.
Because of its high fixed costs, the company desires to produce large
volumes of vehicles and needs to acquire substantial market share.
However, for a variety of reasons, the company can only increase
market share by offering buyers substantial financial incentives. As
the company has discovered, the cost of the financial incentives to
drive its market share up significantly exceeds the benefit of the
increase sales by making the extra units sold unprofitable. Absent a
change in demand for its products, the company would be better served
by reducing its fixed costs so that it could generate profits with its
current market share.
Sincerely,
Wonko
Source: "Economics" 14th edition by Samuelson & Nordhaus, McGraw-Hill
Inc. (1992) pages 162-168 |
Clarification of Answer by
wonko-ga
on
11 Apr 2005 08:30 PDT
I inadvertently posted my answer before I completed proof writing. I
apologize for any confusion.
The answer to your first question is that yes, those prices would be
considered reliable. In fact, this is the normal state of most
industries in market economies. Economists refer to the state of
affairs as being imperfect competition. As opposed to perfect
competition, where every firm is insufficiently large to affect the
market price, imperfect competition means that one or more firms in an
industry can affect the market price by changing the amount of goods
they offer for sale.
While individual sellers have some degree of control over industry
pricing, imperfect competition does not mean that a firm has absolute
control. The degree of pricing power may only be a few percent if the
degree of monopoly power is small, whereas a full-fledged monopoly may
be able to drastically alter prices without having a significant
effect on short run demand.
Imperfect competition also does not mean that intense rivalry is not
occurring in the market. "Intense rivalry should be distinguished
from perfect competition. Rivalry encompasses a wide variety of
behavior, from advertising that attempts to shift out one's demand
curve to inventing better products. Imperfect competition says
nothing about rivalry but simply denotes that every firm in the
industry can sell all it wants at the prevailing market price." (Page
163)
Graphically, the demand curve for an imperfect competitor is downward
sloping, indicating that an increase in sales depresses the market
price for its products. In contrast, the demand curve for a perfect
competitor is horizontal, indicating the firm can sell as much as it
likes without changing the market price. The demand elasticity is
also perfectly elastic for perfect competitors, whereas demand has a
finite elasticity for imperfect competitors.
There are multiple types of imperfect competition, ranging from
monopolies to oligopolies to many differentiated sellers. Imperfect
competition among a few firms typically arises when there are large
economies of scale to be had or large barriers prevent competitors
from entering the marketplace.
The answer to your second question is that is not necessarily true
that every company wants to secure as large a market share as
possible. The objective for every company is to generate the largest
profits possible. In the case of a natural monopoly, where the firm
gains ever-increasing economies of scale with increasing size, it is
true that the company will want to secure the largest possible market
share because this will create the largest profits. However,
oligopolies are characterized by a few firms that have significant
economies of scale up to a particular output level, but whose
economies of scale reach a limit characterized by an increase in
average cost of production. Such firms want to achieve sufficient
market share to reach the limit of their economies of scale, but
additional production beyond that point is undesirable because it is
no longer profitable. Perfect competition allows for firms to achieve
efficiency with relatively small levels of production, and firms
experience minimal economies of scale. In this environment,
additional production may also be undesirable because of increased
costs.
For a real-world example, consider the plight of General Motors.
Because of its high fixed costs, the company desires to produce large
volumes of vehicles and needs to acquire substantial market share.
However, for a variety of reasons, the company can only increase
market share by offering buyers substantial financial incentives. As
the company has discovered, the cost of the financial incentives to
drive its market share up significantly exceeds the benefit of the
increased sales by making the extra units sold unprofitable. Absent a
change in demand for its products, the company would be better served
by reducing its fixed costs so that it could generate profits with its
current market share.
Sincerely,
Wonko
Source: "Economics" 14th edition by Samuelson & Nordhaus, McGraw-Hill
Inc. (1992) pages 162-168
|
Request for Answer Clarification by
wynnwilliamson-ga
on
11 Apr 2005 08:49 PDT
Wonko, thank you very much for your response. I appreciate the
reference to an economics textbook, and I would appreciate more source
references, especially in regards to my second question.
|
Clarification of Answer by
wonko-ga
on
11 Apr 2005 09:40 PDT
Here is a reference describing General Motors problems and some
relevant quotations.
"Running Out Of Gas
With market share and sales falling fast, a bloated GM needs to shrink
to make money" by By David Welch, Business Week (March 28, 2005)
http://www.businessweek.com/@@PMJthWcQqC1hDg0A/premium/content/05_13/b3926042_mz011.htm
"The idea of the trip was to shore up morale -- and, more important,
to get some answers to the vexing question of why GM can't pump up
market share and wean buyers off profit-eating incentives."
"It's becoming painfully obvious that Wagoner's four-year-old strategy
of using rebates to grab market share and generate cash has failed.
Company insiders say the 52-year-old CEO is getting heat from the
board, and some mid-level managers are losing faith the top brass will
make the bold moves needed to execute a quick turnaround. Without a
dramatic rebound in sales -- an unlikely prospect anytime soon -- GM
may be forced to shrink the company to a size that more closely
matches its diminished market share. Wagoner may have to go back to
the United Auto Workers to get concessions to trim his workforce and
lower health-care costs. He will also have to squarely face a dilemma
that has haunted GM for years: Can it really continue to support eight
competing divisions? "GM is simply too big," says Sean McAlinden,
chief economist at the Center for Automotive Research. "They have to
shrink."
That's something Wagoner has been loath to do. For three years he has
tried to stave off market-share losses by boosting sales incentives
and selling more cars to rental fleets. At first the gamble seemed to
make sense. Since union contracts force GM to pay workers at least 75%
of their take-home pay when they are laid off, Wagoner figured he
might as well have them working.
By selling more cars, even at lower margins, GM would preserve its
customer base. More important, that was the only way GM could generate
enough cash to pay its huge retiree obligations. The idea was to slog
along until 2008, when the company's retiree population is projected
to start declining. By then, Wagoner & Co. reasoned, the company's new
lineup of cars, sport-utility vehicles, and trucks also would be out,
allowing GM to pull back on profit-eating incentives.
Things haven't worked out as planned, though. Wagoner's strategy is
dependent on GM at least maintaining the market share of roughly 28%
it has held in recent years, plus some growth in the auto business.
But industry sales are off 5% from their 2000 peak of 17.4 million
vehicles. What's more, amid rising gasoline prices, sales of large
SUVs are slumping. As one of GM's strongest markets, that segment has
been crucial for both sales and profits. Full-size SUV sales are off
more than 20% this year, and GM's Chevrolet Tahoe sales are down 30%.
Meanwhile, sales of the company's new passenger cars -- the Pontiac
G6, Buick LaCrosse, and Chevrolet Cobalt -- are too sluggish to pick
up the slack."
Sincerely,
Wonko
|
Request for Answer Clarification by
wynnwilliamson-ga
on
11 Apr 2005 10:34 PDT
Wonko, I more than this. I am paying $100. I need more than 2 links.
I have found much more than this on my own.
|
Request for Answer Clarification by
wynnwilliamson-ga
on
11 Apr 2005 10:35 PDT
Sorry, I do not mean to be rude.
|
Clarification of Answer by
wonko-ga
on
11 Apr 2005 12:10 PDT
I appreciate you clarifying your needs. Here are several more
relevant links with particular emphasis on materials supporting my
answer to the second question contained in the last three. Please let
me know if these do not meet your needs.
Sincerely,
Wonko
"Imperfect Competition"
http://william-king.www.drexel.edu/top/prin/txt/Imch/Im1.html
"Imperfect Competition" LaborLawTalk.com
http://encyclopedia.laborlawtalk.com/Imperfect_competition
"Monopoly, Imperfect Competition, and Oligopoly"
http://www.chass.utoronto.ca/~reak/eco100/100_6.htm
"DaimlerChrysler. In spite of a good performance, the share price has
declined sharply. What do analysts cite as the main reason behind this
decline? The company?s pricing.
The leading German business magazine Wirtschaftswoche recently quoted
an analyst as saying that ?Chrysler has increased sales in the first
half of 2000, but their current prices are too low and their buying
incentives much too high. That will hurt profit.? This analyst
directly addresses the dilemma between profit and sales growth.
Nowadays, profit and growth are the essential drivers of shareholder
value, with somewhat similar weights. But it is difficult to achieve
both."
"Pricing Where is it heading? Five suggestions for CEO?s and managers"
By Hermann Simon, Simon, Kucher & Partners (2000)
http://www.marketingmix.de/Internetdatabase/publication.nsf/0/f8b741062c037084c125695b003b0ea5?OpenDocument
"Slower growth rates from the traditionally indirect vendors Compaq,
HP, and IBM point toward a renewed focus on profitability rather than
market share at any cost," said Dataquest's Charles Smulders in a
statement."
"Dell topples Compaq in U.S. market share"By Stephen Shankland, CNET
News.com (October 25, 1999)
http://news.com.com/Dell+topples+Compaq+in+U.S.+market+share/2100-1001_3-231851.html
"Building market share to the detriment of the business: Market share
is not God, although CEOs of the many failing dotcoms who pursued a
strategy of building market share at any cost may have you believe
otherwise. Look through the financial filings of many of the
best-known dotcoms, and what's stunning is that a common practice is
selling merchandise for less than they paid for it. Pay $300 to a
wholesaler for handheld computers, and no matter how many you sell for
$250, you won?t do anything but go broke. "
"Avoid Common Dotcom Mistakes" Entrepreneur.com Inc. (February 22,
2001) http://www.entrepreneur.com/article/0,4621,287072-2,00.html
|
"Cornering a market", controlling prices either as a monopolist or
with a cartel, the situation you originally describe, is different
from a Ponzi scheme (see Wikopedia), in which the operator offers a
get-rich-quick financial instrument, promising an extremely high
return, which is indeed fraud. But this only has an indirect influence
on the market, for a while attracting reckless buyers from serious
investments maybe, but the operator does not command a large share of
the market, such as the Hunt brothers tried to do in the silver market
in the early 1980s.
Persons with a Ponzi scheme don't/can't waste any effort trying to run
another business. They know it is a fly-by-night scheme and that they
are going to have run when the bubble bursts. Or if they don't
recognize this, they are too stupid to manage a half-way legitimate
business on the side.
In your first clarification, you are describing more the situation in
the "New Market" in Germany in the late 1980s, a newly established
secondary stock exchange for young companies. A couple of these were
fraudulent, showing inflated sales and profits and attracting
investors that boosted the companies' share prices, maybe thereby
raising the index for the New Market and fueling general expectations
and prices for that New Market. The New Market certainly did boom for
a couple of years till March 2000, and banks set up investment funds,
lending their names and reputations, and by providing funds, that
supposedly give safer market distribution, attracted more investors,
helping to raise prices generally. When the New Market collapsed,
there were no clains that this was caused by the couple of fraudulent
companies, just that general expectations had been inflated.
But this is a different market and pricing situation than you seem to
mean, since you return to mention material resources. The Hunt
brothers had lots of money and did drive the price of silver up to $
50/ounce for a short while, but that was/is only possible in a narrow
market, and it turned out that the silver market was not so narrow
that they could control it. I have forgotten if they were accused of
any wrongdoing, but as you suggest, the market survived, and now it is
only an historical incident.
Maybe we are trying to talk about different situations. |
Greetings Wynn,
Thanks for your interest. I was writing off the top of my head, but
have now checked for sites about the German New Market. As someone
described it, it was trying to be a German NASDAQ, a new stock
exchange for companies in technological fields, established under the
management of the Frankfurt (main German) Stock Exchange. Germany has
always (well, since the war) had a relatively thin stock market
considering the high industrialization, lots of non-listed companies
and low private stockholdings. In the 90s, with the increasing links
within the European Union after the Maastricht Agreement that led to
the establishment of the Euro, there was a move to try to broaden
stock investment and issuance - the ?neue Markt?. Naturally, there
were some older, established companies that took the opportunity, but
also a lot of start ups: cell phone networks, IT, etc.,
and a the market did take off.
From my humble point of view (living in Germany), the New Market with
its own index was a significant part of the problem: having a index
separating these companies from the broader existing index made it
volatile and self-reinforcing. It went up, and looked even better
because the older index did not move as much; banks set up New Market
Funds (an activity of major banks in Germany, which lent their ?good
names? to the funds), and sold these to their customers with the usual
implication that a fund was safer than individual stocks. Their
success at this, of course required them to expand the funds or create
new ones, fueling the prices in the market.
It all looked rosy. I play tennis with a man who was in a major bank
dealing with high net worth individuals, and he was entirely convinced
that the funds were a great investment - and they looked like it
until March 2000.
But now I will send you to search for sites yourself - and hope they
don?t disagree too strongly with my explanation. Search with ?neue
markt? fraud -betrug Betrug is the German word for fraud,
eliminating it in the search will cut down on the number of German
language hits, but you?ll still get some.
AND - there are enough hits to maybe undermine my claim in the
previous comment that this was not influential on the New Market?s
demise. Yes, it was completely disbanded subsequently. But that will
be more supportive of what you are looking for, I imagine :)
?hunt brothers? silver will find you lots of sites on that
episode. It drove the price of silver to $50/oz (when gold was also
up near $800). At the time, a friend of mine weighed all the silver
in his house ?
Hmm? A lot of that is repetition of before, and you have probably
already found sites on these two subjects.
Other scenarios? One thought, no, a question first:
When fraud occurs, how often do the perpetrators start out with that
in mind, relative to those who thought they had a good, honest project
(and may indeed have had one), and then slipped into fraud in the
expectation that they would be able to repair the damage when the
market really took off? Or they were being successful, but then just
became too greedy?
The thought: that fraud is easier in a buoyant market. Everyone is
optimistic, including banks that should be doing their credit analyses
and inventory control of their security, also accountants.
Good luck! |
