Industrial Organization Taught by Dr. Prof. Fang Qiyun Textbook: Industrial Organization A Strategic pproach A Written by Jeffrey Church Roger Ware
Industrial Organization Taught by Dr. Prof. Fang Qiyun Textbook: Industrial Organization: A Strategic Approach Written by Jeffrey Church & Roger Ware
Part 1. Foundations · ntroduction The welfare economics of market power Theory of the firm
Part 1. Foundations • Introduction • The welfare economics of market power • Theory of the firm
Ch 1 Introduction 3 questions in IO 1. Why are markets organized or structured as they are? 4 aspects of market structure (1)Firm boundaries. What determines the extent of a firm's activities in production? In particular, what are the factors responsible for determining the extent to which a firm is vertically integrated? (2)Seller concentration seller concentration is a measure of the number and size distribution of firms. Industrial organization attempts to identify the factors that influence or determine seller concentration (3)Product differentiation. Product differentiation exists when product produced by different firms are not viewed as perfect substitutes by consumers. What are the factors responsible for the extent of product differentiation (4) Conditions of entry. The conditions of entry refer to the ease with which new firms can enter a market
Ch.1. Introduction • 3 questions in IO • 1. Why are markets organized or structured as they are? • 4 aspects of market structure • (1)Firm boundaries. What determines the extent of a firm’s activities in production? In particular, what are the factors responsible for determining the extent to which a firm is vertically integrated? • (2)Seller concentration. seller concentration is a measure of the number and size distribution of firms. Industrial organization attempts to identify the factors that influence or determine seller concentration. • (3)Product differentiation. Product differentiation exists when product produced by different firms are not viewed as perfect substitutes by consumers. What are the factors responsible for the extent of product differentiation. • (4)Conditions of entry. The conditions of entry refer to the ease with which new firms can enter a market
3 questions in IO 2. How does the manner in which markets are organized affect the way in which firms behave and market perform? If products produced by different firms are not viewed as perfect substitutes Qly consumers, then there will be a role foe non-price competition. In fact price competition might play a secondary role to other competition, such as product characteristics, advertising, and research and development expenditure A major area of research in industrial organization is concerned with the theory of oligopoly: pricing behavior in a market dominated by a few large firms a different kind of structural issue concerns the various institutions and practices adopted by oligopolistic firms to affect the nature of competition Adam Smith competitive markets were desirable because they led to outcomes that are socially optimal. Under certain circumstances, competition as if guided by an invisible hand results in the socially optimal level of output being produced at minimum resource cost, and distributed it to those who value it the most io is concerned with the efficiency or market performance of markets whose structure is not that are: What will the efficiency properties of imperfectly competition markets be, not just in terms of output but also in terms of product variety, quality, selection, and innovation? Is there a role for government intervention in terms of regulation or competition policy? Can We identify combinations of market structure and firm behavior where market outcomes are socially undesirable and susceptible to improvement? What are the economic foundations for regulation and antitrust policy? Why are intellectual property rights-patents, copyrights, and trademarks -created and enforced by the government?
3 questions in IO • 2. How does the manner in which markets are organized affect the way in which firms behave and market perform? • If products produced by different firms are not viewed as perfect substitutes by consumers, then there will be a role foe non-price competition. In fact price competition might play a secondary role to other competition, such as product characteristics, advertising, and research and development expenditure. • A major area of research in industrial organization is concerned with the theory of oligopoly: pricing behavior in a market dominated by a few large firms. • A different kind of structural issue concerns the various institutions and practices adopted by oligopolistic firms to affect the nature of competition. • Adam Smith: competitive markets were desirable because they led to outcomes that are socially optimal. Under certain circumstances, competition, as if guided by an invisible hand, results in the socially optimal level of output being produced at minimum resource cost, and distributed it to those who value it the most. IO is concerned with the efficiency or market performance of markets whose structure is not that are : What will the efficiency properties of imperfectly competition markets be, not just in terms of output but also in terms of product variety, quality, selection, and innovation? Is there a role for government intervention in terms of regulation or competition policy? Can we identify combinations of market structure and firm behavior where market outcomes are socially undesirable and susceptible to improvement? What are the economic foundations for regulation and antitrust policy? Why are intellectual property rights-patents, copyrights, and trademarks –created and enforced by the government?
3 questions in IO 3. How does the behavior of firms influence the structure or organization of markets and the performance of markets? The emphasis of the previous question was on the effect of market structure on the conduct of firms. The emphasis here is on adopting a more dynamic perspective and recognizing the possibility of feedback effects from firm conduct to market structure. We might expect that strategies which firms adopt today are intended to change market structure and thus firm behavior tomorrow. It would seem in fact that many aspects of non-price competition such as research and development, are specifically designed to alert market structure tomorrow. Clearly, the extent of product differentiation is not determined only by exogenous factors such as the preferences of consumers. Firms have some latitude to choose the characteristics, range variety, and quality of products they sell TWo issues that have received a great deal of attention are The potential strategies firms can adopt to drive competitors out of business in order to establish a monopoly position The strategies that monopolists and oligopolists can adopt to deter the entry of new competitors. These kinds of strategies obviously make seller concentration and barriers to entry endogenous
3 questions in IO • 3. How does the behavior of firms influence the structure or organization of markets and the performance of markets? • The emphasis of the previous question was on the effect of market structure on the conduct of firms. The emphasis here is on adopting a more dynamic perspective and recognizing the possibility of feedback effects from firm conduct to market structure. We might expect that strategies which firms adopt today are intended to change market structure and thus firm behavior tomorrow. It would seem in fact that many aspects of non-price competition, such as research and development, are specifically designed to alert market structure tomorrow. Clearly, the extent of product differentiation is not determined only by exogenous factors such as the preferences of consumers. Firms have some latitude to choose the characteristics, range, variety, and quality of products they sell. • Two issues that have received a great deal of attention are: • The potential strategies firms can adopt to drive competitors out of business in order to establish a monopoly position. • The strategies that monopolists and oligopolists can adopt to deter the entry of new competitors. These kinds of strategies obviously make seller concentration and barriers to entry endogenous
The demand for o 2 characteristics of markets in manufactured goods (1defferentiated products (2)a few relatively large suppliers Firms face downward sloping demand curves Small numbers of competitors or the preference of consumers for a specific products bestows some degree of market power on firms, and the competition will be imperfect Market power is the ability to profitably raise price above marginal cost lo is the study of the creation exercise maintenance and effects of market power
The demand for IO • 2 characteristics of markets in manufactured goods • (1)defferentiated products • (2)a few relatively large suppliers • Firms face downward sloping demand curves • Small numbers of competitors or the preference of consumers for a specific products bestows some degree of market power on firms, and the competition will be imperfect. • Market power is the ability to profitably raise price above marginal cost. • IO is the study of the creation, exercise, maintenance, and effects of market power
Methodologies ( The methodology of a discipline refers to the basic approach(es)commonly used in a discipline in the creation of knowledge. It is a guide for practitioners about how to go about answering a question or solving a problem The traditional approach in IO is the S-C-P(structure-conduct performance) paradigm. The orientation of SCP approach is primarily empirical: researchers in this tradition try to uncover empirical regularities across industries The"new lo has been more concerned with develo ping and testing explanations of firm conduct Key distinguishing features of the new lO (emphasis on specific industry (2)focus on developing models of firm behavior (empirical work is based on well-founded models of firm behavior
Methodologies (1) • The methodology of a discipline refers to the basic approach(es) commonly used in a discipline in the creation of knowledge. It is a guide for practitioners about how to go about answering a question or solving a problem. • The traditional approach in IO is the S-C-P (structure-conductperformance) paradigm. The orientation of SCP approach is primarily empirical: researchers in this tradition try to uncover empirical regularities across industries. • The “new IO” has been more concerned with developing and testing explanations of firm conduct. • Key distinguishing features of the new IO: • (1)emphasis on specific industry • (2)focus on developing models of firm behavior • (3)empirical work is based on well-founded models of firm behavior
Methodologies(2 The ability to develop good theoretical explanations of firm behavior is due to the developments in non cooperative game theory in the 1970s Non-cooperative game theory consists of tools that are used to model the behavior or choices of agents(individuals, firms, etc. when the payoff (profit) of a choice depends on the choices of others The focus of the new lo on the conduct of firms in imperfectly competitive markets involves determining the factors and strategies that provide firms with a competitive advantage. With its focus on the nature and form of rivalry in concentrated markets, much of lo is a theory of business strategy
Methodologies (2) • The ability to develop good theoretical explanations of firm behavior is due to the developments in noncooperative game theory in the 1970s. Non-cooperative game theory consists of tools that are used to model the behavior or choices of agents (individuals, firms, etc.) when the payoff (profit) of a choice depends on the choices of others. • The focus of the new IO on the conduct of firms in imperfectly competitive markets involves determining the factors and strategies that provide firms with a competitive advantage. With its focus on the nature and form of rivalry in concentrated markets, much of IO is a theory of business strategy
Methodologies(3 lo distinguishes between strategic and tactical decisions Strategic decisions have long-run implications for market structure-the competitive environment faced by firms Strategic decisions involve things like product characteristics and capacity. Tactical decisions determine the short-term actions firms take given the current environment. The tactical decisions of a firm are usually either its price or output. Strategic decisions matter because by determining the current environment of a firm, they affect its pricing or output decisions. The ability of strategic variables to affect tactical decisions arises because of commitment. Strategic decisions commit the firm to follow a pricing policy or production level-because they are in its best interests-and that commitment depends on the irreversibility of the strategic decisions
Methodologies (3) • IO distinguishes between strategic and tactical decisions. Strategic decisions have long-run implications for market structure-the competitive environment faced by firms. Strategic decisions involve things like product characteristics and capacity. Tactical decisions determine the short-term actions firms take given the current environment. The tactical decisions of a firm are usually either its price or output. Strategic decisions matter because by determining the current environment of a firm, they affect its pricing or output decisions. The ability of strategic variables to affect tactical decisions arises because of commitment. Strategic decisions commit the firm to follow a pricing policy or production level-because they are in its best interests-and that commitment depends on the irreversibility of the strategic decisions
Methodologies (4) Students of io and strategic management are concerned with identifying strategies which create monopoly rents and allow firms to maintain them of particular interest is the ability of firms to engage in profitable entry deterrence. An entry barrier is a structural characteristic of a market that protects the market power of incumbents by making entry unprofitable. Profitable entry deterrence-preservation of market power and monopoly profits-by incumbents typically depends on these structural characteristics and the behavior of incumbents post-entry. Appropriate strategic choices can commit an incumbent firm to act aggressively post-entry and insure profitable entry deterrence. In essence, firms can make investments that create barriers to entry or magnify raise the importance of existing barriers to entry
Methodologies (4) • Students of IO and strategic management are concerned with identifying strategies which create monopoly rents and allow firms to maintain them. Of particular interest is the ability of firms to engage in profitable entry deterrence. An entry barrier is a structural characteristic of a market that protects the market power of incumbents by making entry unprofitable. Profitable entry deterrence-preservation of market power and monopoly profits-by incumbents typically depends on these structural characteristics and the behavior of incumbents post-entry. Appropriate strategic choices can commit an incumbent firm to act aggressively post-entry and insure profitable entry deterrence. In essence, firms can make investments that create barriers to entry or magnify/raise the importance of existing barriers to entry