Entry deterrence case study
Entry deterrence refers to a strategy that existing businesses implement in order to stop new businesses from entering markets in which they operate (Evans 64). Examples of such strategies include hostile takeovers, predatory pricing, edge-cutting innovation, and product differentiation. These actions are aimed at avoiding competition from new businesses that are a potential threat to existing businesses.
Microsoft Corporation is one of the firms that use entry deterrence to lock out new businesses from the operating systems market. Microsoft is an American technology company that deals with computer software, electronics, and personal computers. It is famous for the Microsoft Windows operating system that has evolved over time since its development. The company has dominated the operating systems market for many years.
In order to attain dominance, it has implemented several entry deterrence strategies that are aimed at discouraging new businesses from entering the market. These strategies include long term contracts, large minimum commitments, per-processor contract, restrictive nondisclosure agreements, indirect coercion of original equipment manufacturers (OEM) customers to use their products, and use of design to tie certain products together (Evans 65).
These actions have led to criminal cases against the company several times. In one instance, the judge ruled that the company was violating antitrust law by using the aforementioned strategies. The main strategy applied by Microsoft is the use of contracts to lock-in customers. For instance, OEM customers are indirectly coerced by Microsoft to use their operating system in order to ensure that new companies that develop operating systems lack a market for their products (Evans 67). These strategies ensure that Microsoft remains a monopoly because customers can not use its operating system on products manufactured or created by its competitors.
Collusion case study
Collusion refers to an agreement between rivals in a certain market to disrupt the market’s equilibrium by altering the price of a service or product, limiting opportunities, limiting production, defrauding people of their legal rights, or deceiving them with the aim of attaining unfair market advantage 9Utton 56). These practices are usually illegal because they give certain companies a competitive advantage over others. An example of collusion is the secret and illegal agreement between Virgin Atlantic and British Airways (BA).
In 2004, Virgin Atlantic and British Airways entered into an agreement that involved fixing the prices of fuel surcharges. After the secret talks, the two airlines decided to hike prices on passenger and cargo flights in order to cover the high cost of fuel (Flying in Formation par. 3). Virgin was not fined because it reported the incident to the United Kingdom’s Office of Fair Trading. The airline was fined £270 million by the U.S. Department of Justice and £121.5 by the U.K (Flying in Formation par. 5).
The collusion lasted for two years and the two airlines colluded on at least six occasions during that period. The collusion had a great impact on fare prices because surcharges rose by £55 per ticket (Flying in Formation par. 6). In his defense, the chief executive officer of BA argued that the surcharges were ethical because raising surcharges is the only legal way to cover high fuel costs. These actions compelled customers to pay more money to travel and ship goods. The collusion incident had severe consequences on customers and businesses because they both had to spend more money (Flying in Formation par. 8).
Moral hazard case study
Moral hazard refers to a situation in which one party engages in a risky action because of the knowledge that the other party will incur the cost of the action (Jennings 43). In such cases, one party is protected from the risk and the other party is not. An example of moral hazard is the behavior of financial institutions during the housing bubble of 2007. Investment banks, commercial banks, mortgage issues, and insurance companies offered loans to many creditors even those who had bad credit scores (Harrington par. 4). The companies were gambling with the hope that continued housing-price appreciation would make them large amounts of money.
These financial institutions placed large and risky bets because they were sure that they would not suffer as a result of their actions. They were aware that if housing prices plummeted and the bubble burst, the government would bail them out (Harrington par. 5). The actions taken by these firms had severe consequences because when the housing bubble burst, the losses were paid by taxpayers. Risky mortgage lending was fuelled by the government’s decision to lower financing costs. This move increased mortgage-credit expansion and housing prices. Increasing pressure from Congress for extra subprime lending also encouraged financial institutions to take large financial risks because they had backing from the government (Harrington par. 6). These initiatives encouraged many people to make risky investments because securing loans was easy.
Many subprime borrowers acquired houses with little or no money for a down payment. Moreover, many firms that were issuing mortgages were new in the market and had little capital at risk. Allowing people to easily access credit was a moral hazard because the financial institutions knew that in case losses were incurred, then taxpayers would be liable (Harrington par. 6). The collapse of the housing sector heralded a recession that had severe economic ramifications that lasted for several years.
Adverse selection case study
Adverse selection refers to a situation in which sellers/buyers possess information that buyers/sellers do not have regarding a certain product or service that puts them at an advantage (Mankiw 485). It occurs due to variations in the availability of information between buyers and sellers and the challenges involved in choosing customers. An example of the application of this economic concept is evident in the health insurance company.
Insurance companies issue health cover to applicants based on factors such as age, occupation, and health status. These companies grant policyholders coverage for a certain cost referred to as a premium. The amount of risk charged is commensurate with the risk associated with the specific factor that is covered by the policy. In many cases, people successfully trick insurance companies to grant them low premiums even though they are high-risk applicants (Mankiw 485). In such cases, applicants give erroneous or incomplete information that leads to their characterization as belonging to a lower risk group than they do in actuality.
Companies grant insurance cover to many applicants who give misleading information so that they can pay lower premiums than they are required to if they give accurate information (Mankiw 485). A company makes an adverse selection whenever it approves the application of an individual who gives wrong information in order to pay lower premiums (Mankiw 485). Adverse selection exposes insurance companies to great risks because the premiums that certain policyholders pay are not commensurate with the risk involved in covering them.
Works Cited
Evans, David. Microsoft, Antitrust, and the New Economy: Selected Essays. New York: Springer Science & Business Media, 2002. Print.
Flying in Formation: British Airways is Fined for Price Fixing. 2007. Web.
Harrington, Scott. Moral Hazard and the Meltdown: Everybody Felt Too Big to Fail. 2009. Web.
Jennings, Kate. Moral Hazard. New York: Pan Macmillan Australia Pty, Limited, 2003. Print.
Mankiw, Gregory. Principles of Economics. New York: Cengage Learning, 2003. Print.
Utton, Michael. Cartels and Economic Collusion: The Persistence of Corporate Conspiracies. New York: Edward Elgar Publishing, 2011. Print.