Managerial Economics &e Business strategy Chapter 7 The Nature of Industry Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Managerial Economics & Business Strategy Chapter 7 The Nature of Industry
Overview Ⅰ. Market structure a Measures of Industry concentration IL Conduct Pricing behavior a Integration and Merger Activity II. Performance ■ Dansby- Willig Index a Structure-Conduct-Performance Paradigm IV Preview of Coming Attractions Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Overview I. Market Structure n Measures of Industry Concentration II. Conduct n Pricing Behavior n Integration and Merger Activity III. Performance n Dansby-Willig Index n Structure-Conduct-Performance Paradigm IV. Preview of Coming Attractions
Industry analysis Market structure Number of firms size. etc Conduct Pricing, advertising, r&D, etc Performance Profitability, consumer surplus, social welfare Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Industry Analysis • Market Structure n Number of firms, size, etc. • Conduct n Pricing, advertising, R&D, etc. • Performance n Profitability, consumer surplus, social welfare
The Structure-Conduct Performance paradigm The CausalⅤiew Market Conduct Performance Structure The Feedback Critique No one-way causal link Conduct can affect market structure Market performance can affect conduct as well as market structure Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 The Structure-ConductPerformance Paradigm • The Causal View Market Structure Conduct Performance • The Feedback Critique n No one-way causal link. n Conduct can affect market structure. n Market performance can affect conduct as well as market structure
Industry Concentration Four-Firm Concentration ratio The sum of the market shares of the top four firms in the defined industry: CA=W1+ W2+W3+ W4 Herfindahl-Hirshmann Index(hhD a The sum of the squared market shares of firms in a given industry, multiplied by10.000:HH=1000×Σw2 Limitations a Market Definition: National, regional, or local? Global Market: Foreign producers excluded Industry definition and product classes Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Industry Concentration • Four-Firm Concentration Ratio n The sum of the market shares of the top four firms in the defined industry: C4 = w1 + w2 + w3 + w4 • Herfindahl-Hirshmann Index (HHI) n The sum of the squared market shares of firms in a given industry, multiplied by 10,000: HHI = 10,000 S wi2 • Limitations n Market Definition: National, regional, or local? n Global Market: Foreign producers excluded n Industry definition and product classes
Rothschild index A measure of the elasticity of industr demand for a product relative to that of an individual firm:R=ET/EF Er= elasticity of demand for the total market EF= elasticity of demand for the product of an individual firm R has a value between 0(perfect competition)and 1(monopoly) When an industry is composed of many firms, each producing similar products, the Rothschild index will be close to zero Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Rothschild Index • A measure of the elasticity of industry demand for a product relative to that of an individual firm: R = ET / EF n ET = elasticity of demand for the total market n EF = elasticity of demand for the product of an individual firm. n R has a value between 0 (perfect competition) and 1 (monopoly). • When an industry is composed of many firms, each producing similar products, the Rothschild index will be close to zero
Own-Price elasticities of demand and rothschild indices Elasticity Elasticity Industry of market of Firm's Rothschild Demand Demand ndex Food 1.0 -3.8 0.26 Tobacco 1.3 1.00 Textiles 4.7 0.32 apparel 4 0.27 aper 1.5 0.88 Chemicals 1.5 1.00 Rubber 18 2.3 0.78 Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Own-Price Elasticities of Demand and Rothschild Indices Industry Elasticity of Market Demand Elasticity of Firm ’ s Demand Rothschild Index Food -1.0 -3.8 0.26 Tobacco -1.3 -1.3 1.00 Textiles -1.5 -4.7 0.32 Apparel -1.1 -4.1 0.27 Paper -1.5 -1.7 0.88 Chemicals -1.5 -1.5 1.00 Rubber -1.8 -2.3 0.78
Pricing behavior The lerner index -(P-MC)/P A measure of the difference between price and marginal cost An index from o to 1 Markup Factor Rearranging the above formula P=(1/(1-L)MC 1/(1-L)is the markup factor Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Pricing Behavior • The Lerner Index L = (P - MC) / P n A measure of the difference between price and marginal cost. n An index from 0 to 1. • Markup Factor n Rearranging the above formula, P = (1/(1-L)) MC n 1/(1-L) is the markup factor
Lerner Indices markup factors Industry Lerner Index Markup factor Food 0.26 1.35 Tobacco 0.76 4.17 Textiles 0.21 127 apparel 0.24 1.32 Paper 0.58 2.38 Chemicals 0.67 3.03 Petroleum 0.59 2.44 Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Lerner Indices & Markup Factors Industry Lerner Index Markup Factor Food 0.26 1.35 Tobacco 0.76 4.17 Textiles 0.21 1.27 Apparel 0.24 1.32 Paper 0.58 2.38 Chemicals 0.67 3.03 Petroleum 0.59 2.44
Integration and merger Activity Vertical Integration a Where various stages in the production of a single product are carried out by one firm Horizontal Integration a The merging of the production of similar products into a single firm Conglomerate mergers The integration of different product lines into a single fir Michael R Baye, Managerial Economics and Business Strategy, 3e. CThe McGraw-Hill Companies, Inc, 1999
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Integration and Merger Activity • Vertical Integration n Where various stages in the production of a single product are carried out by one firm. • Horizontal Integration n The merging of the production of similar products into a single firm. • Conglomerate Mergers n The integration of different product lines into a single firm
