Important Changes

In case you haven't received my e-mail, there was a problem with the values of e that I sent out before. You should divide the initial value of e by 4; for example, if you previously had e=2, you should use e=0.5.

The due date for the exam has been pushed back by 1 hour, to 12:05am.

The BBQ tonight has been canceled; instead, I'll be at the CoHo from 10-11. You can drop off your exam then, and I'll buy you a drink (of the legal variety).

CRM

Final Exam Issues

Here are some answers to the questions I received about the final exam. The values for alpha and e are posted in the Course Materials section of the web site.

I'm going to be away from the computer for the next few hours; if you have a real emergency, please call me. Otherwise, good luck and I hope to see you tonight! (If you're done with the exam and plan on coming by, please do drop a note so I have a sense as to how many people will be here.) CRM

---

Note: for question 1.1, there are some different ways of calculating V(0), V(1), etc. Just document however you find these values. Your answers to the later questions will be graded on the basis of consistency with your answers with those questions. Therefore, even if your value of V(0) is wrong, if your answers to later questions are consistent with the values you found, they will be given full credit. Note in particular that in the hint, the value x/r for a stream of x received forever is true if you receive that x after one year. I should have specified that in the hint. We will accept answers that either specify the value as of the date of discovery, or the value as starting one year from the date of discovery. Please specify in your answer which it is.

Question 1: Prize vs. Patent

Question: You say that all firms who make the discovery have an equal probability of reaping the reward. Do you mean that they have a probability of getting lucky, and getting all the benefits from the patent, and the other firm (even though they got it at the same time) gets nothing? Or do you mean to say what it has been in the past where if 2 invent, they split the profits each getting 1/2, if 3 invent they split and each gets 1/3, and so on? I know you say that if 2 firms invent they each get z/2, but I wasn't sure if that was the expected value of their profits or not.

Answer: Your first analysis is correct. If two or more firms make the discovery at the same time, each has an equal chance of being selected the winner of the prize or being granted the patent. If it were the other way, then if two firms had a patent for it, Bertrand competition would reduce price to cost and the patent would be worthless!

Question: On the very first question, part 1 of question 1, I was wondering if we are to assume that for V(0) a firm will have earned the prize of Y since no patent is being offered.

Answer: For 1.1, disregard any welfare effects of a prize. These enter the question later.

Question: Is the demand function P=50,000-0.01Q a yearly demand function?

Answer: Yes.

Question: In calculating V(T), the net present value of discovery, do we
include the investment costs?

Answer: No; it's once the discovery has been made.

Question: For question 1 part 1, does the firm charge monopoly price while it has the patent and then unit cost?

Answer: Yes.

Question: The first period that the firm will get a cash flow from the production after its discovery today is 1 year from now, right? That is the first cash flow of the profits should be discounted by rho rather than have no discount. Is that correct?

Answer [AMENDED]: You can do this either way; please specify in your answer how you calculated it.

---

Qustion 2: The Principal-Agent Problem

Question: In question 2.2, when you say assume 0 costs, does that mean you're also not subtracting the chef's wage from their profits?

Answer: For question 2.2, yes; ignore the chef's wages. For question 2.3, you should factor those wages in.

Question: What happens if my square root of wage value is negative? Do I just keep going with the equation using its positive squared value or try to explain why that wage cannot exist?

Answer: For this question, it's a good idea to work in utilities first, not wages: that is, let v=sqrt(w) and solve the question using v's, then substitute in w = v^2 at the end. That ensures everything is positive. You can see the posted solution for the final problem set for an explanation of this technique.

Search Theory and Advertising

Sprint just launched a new service, the "Slifter," which allows consumers to use GPS technology to find goods in retail stores through their cell phones.

"The service allows shoppers to learn where they can buy, say, a certain iPod model or new Nike sneaker, based on a location signal, and at what price."

This will significantly reduce search costs - which, in the long, run, if widely used, will lower reservation costs and prices.

I've posted the full WSJ article as a link.

Supermarket Differentiation

Here's an article from the WSJ on how supermarkets have been differentiating themselves in order to compete against Walmart and gain market share. Some of it involves higher quality goods. But it also includes different atmospheres that appeal to consumers. Here's the link to the article: http://online.wsj.com/article/SB118109301239325910.html?mod=hpp_us_editors_picks

EMI signs deal with YouTube

EMI just signed a deal with YouTube to make their music videos available online for free. But unlike with iTunes, EMI is the last of the big four record companies to partner with YouTube.

What would make record companies willing to put their music on YouTube but not on iTunes?

Why would EMI hold out while all the other companies are signing on?



Here's the article:

EMI and YouTube Set Licensing Accord
By SHIRA OVIDE (Wall Street Journal)
June 1, 2007

NEW YORK -- EMI Group PLC became the latest major recording company to strike a licensing deal with Google Inc.'s YouTube.

EMI Music, the music division of EMI Group, will make music videos and recordings available on Google's popular online-video Web site. YouTube visitors will also be able to include EMI content in their own video postings on the site.

"With this deal, all four of the world's major music companies are now official YouTube partners," Chad Hurley, chief executive and co-founder of YouTube, said in a press release Thursday.

Citing copyright hurdles, EMI had been the lone holdout of the four major global music companies in striking a licensing agreement with YouTube.

EMI said it will work with YouTube and Google to develop business models for content that YouTube users create with EMI-owned and copyrighted audio and video. EMI is responsible for music groups such as Coldplay and David Bowie.

YouTube will help EMI track its content on the Web site and compensate the company and its music acts for relevant use. EMI also will have the ability to ask YouTube to remove its content from the Web site.

Matching and Price Competition: Would Personalized Prices Help?

Georgy Artemov, a Ph.D. candidate, published a paper analyzing the possible welfare from the NRMP switching to a differentiated salaries model. It specifically focused on the effect of imperfect information of preferences.


Here's the abstract:
We analyze the generalized deferred-acceptance algorithm when
preferences are known with an error. This algorithm incorporates personalized
salaries and is considered as a replacement for the current
algorithm for National Resident Matching Program (NRMP). Maintaining
Bulow and Levin’s (2006) assumption on preferences, we show
that an error in preferences of a worker propagates through the algorithm,
leading to a change in the salary of every more productive
worker. Thus, relatively small individual errors accumulate toward the
top and may lead to highly distorted salaries for top workers the same
way as mild compression translates into highly compressed salaries on
the top in the Bulow and Levin study of the current NRMP algorithm.

The article is slightly mathy, it reads a lot like the textbook, but it's interesting nonetheless. He uses a lot of the assumptions from Levin's model we saw in class, and it goes into more depth about the deferred acceptance algorithm than we went over in class. It's an interesting perspective! Check it out at: http://www.econ.brown.edu/students/Georgy_Artemov/artemov_personalized_mistakes_IJGT_f.pdf

The Marriage Market

Here are some readings for Thursday's class...

A piece for the Aplia Econ Blog that I wrote a while ago. The NYT article it references is pretty interesting...

A comment by Al Roth and Muriel Niederle on some of their findings about the NRMP and wages...

An article in the WSJ about the matching mechanism recently introduced in the market for Ph.D. economists...

Robert Frank on polygamy and marriage search.

More to come. Feel free to post links to other articles in comments...

GM Attempts to Capture Public Approval by Going Green

After a $2 billion loss in 2006, GM is trying something new. It wants to alter its reputation as a producer of gas-guzzlers, seeing that Green is in.

"The auto maker, as with companies in others industries, has concluded it can no longer wait and see how the public debate on global warming and the world economy's increasing thirst for oil plays out. A big consideration in this change: GM fears it will sell fewer cars if consumers associate it with gas guzzlers.'We have to have people think we are part of the solution, not part of the problem,' said Lawrence Burns, GM's vice president for research and development and global planning...

"A big part of GM's problem is that it is stuck with an image as a maker of primarily big trucks and sport-utility vehicles. By 2005, GM's top executives and members of its board were convinced it could get sales moving again in part by turning around its reputation on fuel economy and the environment. 'We saw how quickly the mantle of environmental leadership had been seized by Toyota because of the Prius.' GM Vice Chairman Bob Lutz said in an interview."

In other words, they're seeing how the public's tastes and preferences are changing horizontally, and trying to cater more towards the environmentally friendly sentiment that is increasingly conquering the United States.

They also are trying to gain a quality advantage, capturing some advantages in terms of vertical differentiation. GM plans to release two hybid SUVs later this year with "a system that GM believes has advantages over Toyota's hybrid technology."

In fact, their strategy includes trying to innovate in gas-economizing technologies and to push their image as an environmentally friendly company.

Full WSJ article posted as a comment "Shifting Gears, GM Now Sees Green."

Un-Bundling

An article in the New York Times talks about how airlines are now charging separately for things they used to bundle in with the price of a ticket. Why are they doing this? Is it welfare-improving?

What's so special about EMI?

We spoke on Thursday about why EMI might be more willing than other record labels to allow the sale of their material DRM-free. Well, it turns out that EMI may be bought out by a private equity firm (see story). Why would an impending sale potentially affect EMI's decision to go DRM-free?

Targeted Advertising: TV Networks and Bloggers

Like the Targeted Advertising campaign Google is undertaking, TV Networks are doing their own form of advertising: they give popular bloggers free stuff to entice them to write about specific shows on their network.

Big television stations, such as ABC, CBS and Warner Brothers have been using a new system to target their advertising. They identify popular blogs related to the subject of their shows, and invite the writers on an all-expenses paid trip to the studio, usually to meet the show's stars and witness the shooting of an episode.

"Warner Bros., the studio that produces the show for CBS, identified 12 blogs about motherhood, a key theme in "Old Christine," and invited the writers to spend the day on the set. The bloggers got free DVDs, watched a rehearsal and made videos with Ms. Louis-Dreyfus and other cast members to post on their sites. "

ABC even cast a popular blogger as a guest-star in "Scrubs". And it worked: "Since January, Mr. Ausiello has posted more than 20 items about "Scrubs" on Ask Ausiello, his popular blog. In comparison, he mentioned "Desperate Housewives," a show that reaches an audience four times that of "Scrubs," fewer than 10 times." The article cited several other advertising campaigns which induced the bloggers to write about their shows.

"Bribing" bloggers is the new wave in targeted advertising. Networks have had a long tradition of wining and dining news reporters. However, "mainstream news outlets now have strict rules governing to what extent their palms can be greased. Presents valued at more than $25 are typically banned, and that includes travel. But most blogs, many less than five years old, don't have such rules."

These advertising tactics seem exactly on target. It should be even more effective than newspaper or TV news advertising. Who is more interested in a sitcom about motherhood than women who are regular readers of a motherhood blog?

I posted the article in a comment, maybe it'll be useful in our discussion tomorrow.

Can Durability Trump Price in Laptop Wars?

This was the title of an article in the WSJ today, which examines the quality, durability and advertising decisions of a Chinese laptop manufacturer named Lenovo. (Full article posted as a comment to this post).

They specialize in laptop computers that are durable and high quality, but are much higher priced.

I have a few questions/comments about this article.
1. Given the nature of the computer industry, where technology is advancing so quickly that technology becomes obsolete in less than 5 years, is it wise to invest in durability? It remains to be seen how profitable their line of computers will be. They have a $5000 laptop they market to top corporate executives, which illustrates the income rule we saw in class.

2. Because the computer industry is so competitive and growing so rapidly, does the durability-innovation tradeoff even apply? It seems like this company focuses on innovating ways to make their product more durable and desirable. Also, the market is far from being saturated, especially as technology advances. This suggests that innovation will not be hindered (perhaps because the market is so highly competitive).

3. As Lenovo strives to be the industry leader in durability, they have actually cross-licensed many of their innovations. Is this in their best interest, even though it decreases their computers' attractiveness to consumers because they can get some of the same durability from cheaper brands?


As an interesting tidbit, some of the quality features of that Lenovo has pioneered include
spill-resistant keyboards (two drains on bottom of laptop designed to let liquid flow out), airbag technology that senses when the computer is being jerked around and instantly protects the hard drive, "battery stretch" setting (lets users extend battery life to more than eight hours by shutting down energy-sucking features like CD drives and USB ports), security function that allows users to log on to Web sites by swiping their thumbs instead of remembering a password, new fans in the shape of "owl's wings" to reduce the laptop's quiet whirring sound, and a roll cage in case the computer is dropped.

Paying More for a Printer, but Less for Ink

NY Times article

"Kodak decided to get into the inkjet printer business for the first time (not counting a joint venture with Lexmark a few years ago). And to drive the point home, Kodak decided to turn the razor-blades model of printers and cartridges on its head. Kodak’s printers cost a little more — but the ink, according to Kodak, costs half as much as Hewlett-Packard’s.

Kodak points to the H.P. news release that landed shortly after Kodak’s new strategy was announced. H.P. was announcing a new ink-pricing strategy.

“See? We forced your hand,” says Kodak (I’m paraphrasing here).

“Nonsense,” replies H.P. “This is a massive cartridge packaging, labeling and numbering reorganization that we’ve been working on since 2004.”

The thrust of H.P.’s new pricing scheme is that starting with its spring 2007 printer models, each ink will be available in two cartridge sizes: standard and XL. The smaller size will cost less than H.P.’s current cartridges, but also contain less ink.

H.P. says that by lowering the upfront cost, the new “standard” cartridge will benefit people who don’t print much. And yet, as Kodak points out, H.P. has actually managed to increase the ink’s cost per page.

H.P.’s new XL tanks, on the other hand, hold three times the ink of the standard ones — but cost twice as much.

So now, given all of these twists, here’s the 64,000-liter question: Do Kodak’s cartridges really save you money?

...

If you trust the study, then, it seems clear that the Kodak will indeed save you money on ink, sometimes a lot. You’ll have to weigh that advantage against some of its drawbacks.

For example, the Kodak is the new all-in-one on the block, so it doesn’t offer as many features as some of its rivals. For example, it can’t print directly onto blank CDs, scan slides or connect to a network.

So no, the new Kodak doesn’t run away with the crown in every department. But it easily holds its own against much bigger, more experienced manufacturers. And it has its priorities straight: great-looking photos that last a lifetime; easy-to-use controls; American-based toll-free tech support; and speeds and features that are no embarrassment.

More important, it makes a world-rocking point about the razor-blades model that’s lined the coffers of the inkjet industry for years. If you’re mad as hell, you don’t have to take it anymore.

Questions for Section: Passive-Agressive Modeling

There have been some great blog posts this week! Since we've been discussing advertising in class, I'd like you to read and discuss Shimon's post (and the article linked therein) about Google advertising in online games. In particular: can you write down a model which examines the welfare effects of developing technology that allows much more targeted advertising?

One place to start would be to assume that there are equal numbers of two kinds of consumers, aggressive and passive, and two kinds of goods, X and Y. Assume that aggressive consumers prefer X over Y, and the reverse is true of passive consumers. In the absence of Google's technology, ads would have to be delivered to both types of consumers, meaning that any given ad has only a 50% chance of reaching a customer. With Google's technology, ads can be delivered only to those who are likely to buy the product. Who benefits from this technology? What are the costs of it? How might privacy concerns be addressed within the parameters of the model?

(Hint: I might very well ask you to write down a "new" model like this on the final...it's a good idea to practice now, and present your model in section, or write it up as a comment or a new blog post.)

Amazon to Sell Music Free of Copy Restrictions

wsj article today:

Amazon.com Inc. plans to launch a digital music store later this year that will sell all songs without antipiracy technology, creating a rival to Apple Inc.'s iTunes store.

The Seattle online retailer said its music store will have "millions of songs" in the MP3 format without so-called digital rights management, or DRM, software, which prevents consumers from freely copying and transfering their music among a variety of devices.

Amazon said the store will launch with music from EMI Group PLC, which said last month it would allow Apple and others to sell its music without copy protection. But Amazon didn't identify any other major music labels that have agreed to let it sell music without DRM restrictions, and it's unclear whether the e-commerce giant will be able to convince other big labels to open up their catalogs.

In its announcement Wednesday, Amazon said it has made deals with "more than 12,000 record labels," though much of the digital music now being sold online without DRM is from lesser known artists. Many of the biggest acts have resisted efforts to sell their music online without restrictions, for fear that it would lead to increased illicit file sharing.

FURTHER READING

• EMI to Sell Music Without Antipiracy Software¹
04/01/07

• Steve Jobs Raises Pressure on Music Firms²
02/07/07

• Statement: Jobs Speaks Against DRM³
02/07/07

• Reply All: Protecting Downloads, and Rights⁴
06/20/06

Amazon didn't provide other details about its much-discussed music store, including a specific launch date or pricing. The company, however, is starting from a position of strength, already being one of the largest distributors of music online, albeit on compact discs.

"Our MP3-only strategy means all the music that customers buy on Amazon is always DRM-free and plays on any device," said Amazon Chief Executive Jeff Bezos. "We're excited to have EMI joining us in this effort and look forward to offering our customers MP3s from amazing artists like Coldplay, Norah Jones and Joss Stone."

DRM has been a contentious issue in online music sales. Record companies have insisted that digital-download services like iTunes employ the software to prevent rampant copying. But because the DRM used by Apple is proprietary and doesn't work with services or devices made by competitors, music purchased on the iTunes store can only be played on the iPod, and not rival devices. Microsoft Corp. rolled out its own music store to sell copy-protected songs for its new Zune player.

Jonathan Hoopes, an analyst at ThinkEquity Partners, said Amazon's move validates the importance of the digital-music market and making files DRM-free. He said he doesn't expect Amazon's entry to pressure Apple, given that company's early arrival to the digital music market, its strong brand name and its wildly popular iPod.

"Apple's platform is so strong," said the analyst, who rates Apple a "buy."

Meanwhile, Shaw Wu, an analyst at American Technology Research, said Amazon's push could, ironically, yield more sales of Apple's iPods. "It might help Apple because they are selling unprotected music, which is something Steve Jobs has been pushing for," said Mr. Wu.

Apple Chief Executive Steve Jobs has spoken out against DRM restrictions⁵, and has said Apple is eager to sell music without them. But so far the majority of music sold on iTunes incorporates the anticopying technology.

Also fueling the DRM debate has been a drop in CD sales, which has forced the music industry to look at different ways to sell music online.

London's EMI announced with Mr. Jobs last month⁶ that it would offer a significant portion of its catalog on iTunes DRM-free, albeit at a higher price point than the 99 cents charged for other iTunes songs.

EMI's competitors have been divided on the DRM debate. Warner Music Group Corp. has argued that the technology will be increasingly important once digital sales eclipse CD sales. Vivendi SA's Universal Music Group and Sony BMG Music Entertainment, a joint venture of Sony Corp. and Bertelsmann AG, on the other hand, have conducted experiments with dropping the technology.

First the Internet, then the World?

Everyone jokes that it's only a matter of time before Google takes over the world, and while this is probably a bit of an exaggeration, it may not be long before they own your home PC. Although it's in all likelihood a long ways off, this would perhaps be the ultimate example of a network externality, Google gives you the computer, then reaps the benefit of you surfing the Internet (while viewing their ads) and even doing day to day work using their free but ad-supported software.

Google Patents Targeted Advertising in Games

This article describes how Google has patented plans for software designed to track the actions of players in games such as Second Life and World of Warcraft. This tracking will be used to develop detailed psychological profiles for targeted advertising within the games.

"The patent says: 'User dialogue (eg from role playing games, simulation games, etc) may be used to characterise the user (eg literate, profane, blunt or polite, quiet etc). Also, user play may be used to characterise the user (eg cautious, risk-taker, aggressive, non-confrontational, stealthy, honest, cooperative, uncooperative, etc).'"

The patent goes on to give some particularly ridiculous examples of how this might be used:

"Players who spend a lot of time exploring 'may be interested in vacations, so the system may show ads for vacations.' And those who spend more time talking to other characters will see adverts for mobile phones."

Interesting research paper

Next Wednesday, May 16^th, Professor Matt Shum of Johns Hopkins University will be the guest speaker for the GSB Marketing seminar. The title of his presentation is “How Much Competition is a Secondary Market?” (link to the accompanying paper below). I think it might be interesting to many people taking this class. The seminar is from 12:00 to 1:15 pm in Littlefiled 103.

http://www.stanford.edu/~asela/2007_05-16_Shum.pdf

More generally, the GSB marketing group consists of two tracks: one track is behavioral, where people (like me) do psychological research on consumer behavior, and the other track is quantitative, where researchers employ economic (including game-theoretical) models to understand market phenomena.

I hope you’ll find the paper interesting and worthwhile!

Points for Discussion

Today in discussion sections you'll be talking about Steve Jobs's essay in the context of Chapter 10. Here are some questions you may want to think about:

(1) When is it efficient for there to be incompatibility between music players and music?

(2) When do companies have an incentive to make their products compatible with one another? When do they have an incentive to make their products incompatible with one another? If the music companies didn't require it to use DRM, would Apple really make music downloaded from iTunes DRM-free? Why or why not?

(3) Music companies talk about DRM in much the same way as pharma companies talk about patents: without distribution rights, they will have no incentive to invest in producing music. Is that true? What are the similarities and differences between the music and pharma industries?

(4) We looked at the components approach in lecture (10.3). That seemed to indicate that companies do better when their components are compatible with one another. However, the model was very stylized. Which of the results in that model are generalizable? Which are specific to the formulation of the model? Can we really apply the model to music and mp3 players, or not? Why?

(5) Compare the three different approaches described in chapter 10 (the network externalities approach, the supporting services approach, and the components approach). Is one "better" or "more realistic" than the others? How would you go about deciding which approach to use in analyzing different goods?

(6) What role does price play in the market for goods with network externalities? A lot of these goods are given away for free - for example, you can set up a blog or a myspace page for free. Yet we almost always say that setting price to zero isn't profit maximizing. What's up? Will these always be free? Why or why not?

Guerrilla Video Sites

For those blissfully aware of the magic known as www.alluc.org (I mean...I've just heard about it...uhhh...) you know how easy it is to watch entire seasons of TV shows online. And, you don't even have to download them. Or pay for them. Everyone wins, right?

Well, apparently Big Media is crying pretty loudly, because this new development is one hell of a legal pretzel to chew on.

Horribly annoying ad: 5 million users!

Here is the horribly annoying ad that I mentioned today in class. Note the large bubble letters with "5 million users" in candy-yellow.



Here's a question for you: suppose, as in the case we looked at in class today, the inverse demand for a networking product is given by p = n(1 - x). If expectations are accurate, then n = x, so the inverse demand curve is given by p = x(1 - x). This has two solutions at each price: for example, if p = 3/16, then it could be that x = 1/4 or x = 3/4. How much would the monopoly be willing to pay in advertising in order to convince consumers that x = 3/4? Is that what this ad is meant to do?

Goal of this blog

I've created this blog so members of the class have a common space to post articles of interest, and to comment on the articles posted by other members of the class. I'll also post links to articles I find. If you'd like to post, please drop me an e-mail. In the "labels for this post" field, please use the chapter number from the Oz Shy book.

To get the ball rolling, here is the article by Steve Jobs on DRM in iTunes. Joshua Gans has a nice blog post about it on on the Aplia EconBlog. Since this relates to chapter 9, I'm tagging it with the label "Chapter 9."