Industrial Organization: contemporary theory and practice (3rd edition)

Lynne Pepall Dan Richards George Norman

Industrial Organization: Chapter 1

Introduction
How firms behave in markets Whole range of business issues
price of flowers; payment to be official sponsor of major events which new products to introduce merger decisions methods for attacking or defending markets

Strategic view of how firms interact

Industrial Organization: Chapter 1 2

 How should a firm price its product given the existence of rivals? How does a firm decide which markets to enter? Incredible richness of examples:
Microsoft/Netscape/Sun ADM (collusion) Toys R Us (exclusive dealing) American Airlines (predatory pricing) Merger wave

At the heart of all of this is strategic interaction

Industrial Organization: Chapter 1 3

 Rely on the tools of game theory

focuses on strategy and interaction

Construct models: abstractions

well established tradition in all science
physics engineering
are SUVs safe? Do seat-belts/Volvos save lives?

Industrial Organization: Chapter 1

The New Industrial Organization

The New Industrial Organization is something of a departure
theory in advance of policy recognition of connection between market structure and firms behavior

Contrast pricing behavior of:

grain farmers at first point of sale gas stations: Texaco, Mobil, Exxon computer manufacturers pharmaceuticals (proprietary vs. generics)
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 Do not say much about the internal organization of firms

vertical organization is discussed internal contracts are not

Industrial Organization: Chapter 1

Anti-trust Policy: an overview

Developments in modern IO are sensitive to the policy context
Microsoft and ADM
highlight aspects of developments in policy/law and economic theory

Need for anti-trust policy recognized by Adam Smith (1776)

The monopolists, by keeping the market constantly understocked, by never fully supplying the effectual demand, sell their commodities much above the natural price.
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 People of the same trade seldom meet together, even for merriment or diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

Sherman Act 1890

Section 1: prohibits contracts, combinations and conspiracies in restraint of trade Section 2: makes illegal any attempt to monopolize a market contrast per se rule
collusive agreements/price fixing

rule of reason
unreasonable conduct

Industrial Organization: Chapter 1

 Clayton Act (1914)

intended to prevent monopoly in its incipiency makes illegal practices that may substantially lessen competition or tend to create a monopoly

Federal Trade Commission established in the same year However, application affected by rule of reason
proof of intent the law does not make mere size an offence or the existence of unexerted power an offence - it does not compel competition nor require all that is possible.
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 Robinson-Patman (1936)
prohibits price discrimination that is intended to lessen competition intended to prevent aggressive price discounting

The Alcoa case (1945) was also important

90% market share expanded capacity in advance of market expansion inferred anti-trust violation from structure and conduct without overt evidence

More relaxed attitude in last two decades

emergence of large firms: merger waves importance of global competition
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The New Industrial Organization

Dissatisfaction with the structure-conductperformance approach
collect profit data on firms in an industry explain differences using information on size, organization, R&D, financial leverage etc. but what is the direction of causation?

The old IO has limited treatment of product differentiation

representative firm, little strategic interaction

New IO: strategic decision-making (Hotelling)

scheduling of blockbuster and Disney movies
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