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    Managerial Economics: First Entrants, Rational Consumers and the Lerner Index

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    1) Last summer the Wall Street Journal reported the declining market positions held by some of Japan's earliest innovators in the consumer electronics industry, including Sharp and Sony. Although these firms introduced the first low-cost electronic radios, stereos, and televisions, dominating the industry for several years, they are now experiencing declining market shares due to faster innovations and lower prices offered by electronics manufacturers in other countries. What are the advantages and disadvantages of being the first entrant into a new industry? What tools or strategies can these firms use to protect their early lead in the business?

    2) Panera Bread has many cafes located across the US and Canada. The chain was originally founded in St. Louis, MO. A few years ago the parent firm (St. Louis Bread Company) tried an experiment in one of their first stores in St. Louis - they removed the prices from the posted menus and allowed customers to pay whatever they felt was fair for food and beverages. Although we might expect some customers to take advantage of the policy and pay little or nothing, St. Louis Bread reported that the annual sales revenue for this store actually increased during the experiment. Some analysts explained this outcome by arguing that consumers were behaving in less than rational ways (e.g., they consistently over - estimated the prices or they over-paid due to altruism). In contrast, how could we use the concepts to explain the observed sales revenue as an outcome of rational economic behavior?

    3) Suppose your firm manufacturers vitamins and other specialty chemicals for the food processing industry. You have little competition and there are few close substitutes for your products, so you are able to set your price above the marginal cost of production. Last week, your corporate attorney learned that the US Department of Justice is investigating your market for potential antitrust violations, and they have requested your past pricing and cost information in order to estimate the Lerner index (markup on price) for some of your major products. While preparing the response to the federal authorities, your attorney asks you the following question - can external changes in the market situation that are beyond your control cause your Lerner index (markup) to increase? Please provide a detailed explanation.

    4) You take a new job as the assistant to the regional manager of a small office supply firm in the Northeast US. During your first day on the job, the regional manager explains that they use a quantity discount program to set prices for the firm's main product, paper for photocopiers and office printers. Under the current discount program, smaller firms pay lower prices because the regional manager wants to attract small business customers away from the big-box office supply firms, which use more conventional quantity discounts (they charge higher prices for small quantities and offer discounts for large volumes). Is the manager likely to succeed in capturing the small-business segment of the office paper market under the current discount program? Is this pricing policy likely to generate higher profits for your firm than a more conventional quantity discount program? Please explain your response.

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    Solution Preview

    1) Advantages of being the first entrant:
    - Technological leadership: The first entrant can patent its technology, keep it a secret, or continue to innovate quickly enough to prevent competitors from catching up.
    - Preemption of scarce assets: The first entrant can monopolize an important resource, such as the biggest diamond mine or the best software engineers in a country.
    - Brand loyalty: The first entrant can build up a large base of clients who will be reluctant to switch to later entrants.

    Disadvantages of being the first entrant:
    - Free rider effects: Later entrants can study and attempt to duplicate or improve on the first entrant's product.
    - Shifts in technology or consumer preference: Later entrants can respond more quickly to the emergence of new technologies or changes in consumer needs.
    - Incumbent ...

    Solution Summary

    This solution gives detailed answers to four common Managerial Economics review questions. The topics covered are:

    1. The advantages and disadvantages of being the first entrant in a market
    2. Why consumers pay a fair price even when they are not required to
    3. How changes in the market can affect a firm's Lerner Index
    4. Whether the pricing strategy of offering larger discounts to smaller customers will increase a firm's profits