**MASTER PROGRAMS**

**Fall Semester (PDF file: MA-IndOrg)**

**COURSE SYLLABUS**

**THEORY OF INDUSTRIAL ORGANIZATION**

**Program Master in International Business**

Year 1-st year

**Course status Elective**

Workload 3 ECTS, 30 hours of classes

Prerequisites Introductory Microeconomics

Teaching methods Lectures, group work, presentations, case study, home and class

assignments

**Course objectives**

To study the operation and performance of imperfectly competitive markets and the

behavior of firms in these markets

To determine factors and strategies that provide firms with a competitive advantage, with

a special focus on identifying strategies which create monopoly rents and allow firms to

maintain them

**Course content**

Topic 1. Introduction to Industrial Organization

Description of Industrial Organization. Different approaches to studying Industrial Organization.

Characteristics of perfect competition. Market equilibrium and the zero profit condition.

Monopoly (market) power and downward sloping demand. Equilibrium and positive economic

profit. Efficiency comparisons of competition and monopoly using surplus concepts.

Measures of Market Structure. Concentration Curves and Ratios. Herfindahl Index.

Measurement Problems.

Measures of Market Power. Lerner Index. Empirical Measures of Monopoly-Induced Market

Distortions. Economies of size and scale. Fixed, sunk, avoidable, and variable costs. Basic

structure of multiproduct firms

Topic 2. Price Discrimination

Uniform versus non-uniform pricing. Feasibility of Price Discrimination. Third degree price

discrimination. Third degree price discrimination for differentiated products. First degree price

discrimination. Two-part tariffs and block pricing. Idea and prevalence of volume discounts.

Second degree price discrimination. Incentive compatible pricing schemes.

Topic 3. Product Differentiation and Product Quality

Vertical versus horizontal price differentiation. Spatial model of product differentiation

(Hotelling). Vertical Product Differentiation. Offering more than one product in a Vertically

Differentiated Market. Product tie-ins and commodity bundling. Commodity bundling as a way

to price discriminate. Complementary goods and network externalities. Damaged goods.

Topic 4. Oligopoly and Strategic Interaction

Simultaneous (normal) and sequential (extensive) form games. Dominant and dominated

strategies. Nash equilibrium as a solution concept. Finding Nash equilibrium. Best response

functions. Oligopoly models. The simple Cournot model. The Bertrand Model. Strategic

substitutes / complements. Simultaneous vs. Sequential Games. Stackelberg model. Credibility,

credible commitments.

Topic 5. Oligopoly: Entry Deterrence

Predatory conduct and credible threats. Limit pricing in incumbent/entrant (Stackelberg) models.

Predation in incumbent/entrant (Stackelberg) models. Extensive form games. Subgames in

extensive form games and subgame perfection. Capacity expansion as a form of credible

commitment. Predatory pricing. Role of contracts in impeding entry into a market. Public policy

towards predatory behavior.

Topic 6. Horizontal and Vertical Relations between Firms. Mergers

Introduction to Stackelberg model of mergers. Gains from vertical integration. Oligopolistic

vertical mergers. Conglomerate mergers.

Topic 7. Strategic Investment and Nonprice Competition

Types of innovations, market structure, and competition in R&D. The Schumpeterian hypothesis.

Competition via innovation. Costs and benefits of advertising. Empirical facts on advertising

(pricing) and quality. Advertising and monopoly power.

**Plan of classes**

**Class 1.**Topic 1. Introduction to Industrial Organization

Key points:

Description of Industrial Organization. Different approaches to

studying Industrial Organization.

Characteristics of perfect competition. Market equilibrium and

the zero profit condition. Monopoly (market) power and

downward sloping demand. Equilibrium and positive economic

profit. Efficiency comparisons of competition and monopoly

using surplus concepts.

Measures of Market Structure. Concentration Curves and

Ratios. Herfindahl Index. Measurement Problems.

Measures of Market Power. Lerner Index. Empirical Measures

of Monopoly-Induced Market Distortions. Economies of size

and scale. Fixed, sunk, avoidable, and variable costs. Basic

structure of multiproduct firms

**Learning outcomes:**

The Nature of Industrial Organization.

The motivation for formal analysis of imperfect competition.

Explain the characteristics of perfect competition

Graphically show the profit of a monopoly firm using the

marginal revenue curve, the demand curve, the marginal cost

curve, and the average total cost curve.

Explain the importance of firm size (production or sales

potential) relative to market demand as it relates to monopoly

power and market inefficiency.

Explain the following measures of structure: concentration

ratios, Herfindahl-Hirschman index.

Explain the difference between a structure measure like CR4

and a performance measure like efficiency, profitability, or

Pareto optimality.

Explain the issues related to the definition of a market and how

this affects measures of concentration. The student will

understand that an appropriate definition for one type of

analysis may not be appropriate for another type of analysis and

how aggregation can both clarify and cloud issues of market

structure.

Understand the differences between the neoclassical

(technological) view of the firm and other views related to

agency theory, transactions costs, incomplete contracts, and

residual control rights. The student will be able to discuss some

of the limitations of the neoclassical approach in explaining the

boundaries of the firm.

Explain economies of size and natural monopoly and how

technology can affect industry structure.

Present a reasoned argument on various non-cost determinants

of market structure. The student will be able to give examples

of some of these determinants.

Assignments for class 1:

Reading: Pepall, ch. 1-4; Church, ch. 1, 2, 3.1, 12; Porter “The

Five Competitive Forces that Shape Strategy”

Topic 2. Price Discrimination

**Class 2.**

Key points:

Uniform versus non-uniform pricing

Feasibility of Price Discrimination

Third degree price discrimination

Third degree price discrimination for differentiated products

First degree price discrimination

Two-part tariffs and block pricing

Idea and prevalence of volume discounts

Second degree price discrimination

Incentive compatible pricing schemes

Learning outcomes:

Define and explain the differences between uniform pricing and

price discrimination.

Explain the conditions that must exist for a firm to practice

price discrimination.

Understand third degree price discrimination in the context of

differentiated products.

Differentiate the three types of price discrimination.

Show how second-degree price discrimination leads to volume

discounts and various ways to implement such discounts in a

way to maximize profits. The student will be able to analyze

block pricing schemes utilizing self-selection mechanisms.

Assignments for class 2:

Reading: Pepall, ch. 5, 6; Church, ch. 5

Exercises: problems 1, 2 (see problem set)

Topic 3. Product Differentiation and Product Quality

Topic 4. Oligopoly and Strategic Interaction

**Class 3.**

Key points:

Vertical versus horizontal price differentiation

Spatial model of product differentiation (Hotelling)

Vertical Product Differentiation

Offering more than one product in a Vertically Differentiated

Market

Product tie-ins and commodity bundling

Commodity bundling as a way to price discriminate

Complementary goods and network externalities

Learning outcomes:

Distinguish vertical from horizontal product differentiation.

Interpret physical space and distance as distance in product

space in defining a spatial model of product differentiation.

Explain the extension of the model with one shop

Extend the analogy of price discrimination in geographic space

to price discrimination in product characteristics space.

Distinguish commodity bundling (fixed proportions) from tie-in

sales (variable proportions).

Distinguish pure and mixed bundling strategies and determine

the optimal bundling strategy given data on reservation prices

for different groups.

Assignments for class 3:

Reading: Pepall, ch. 7-8; Church, ch. 6, 11

Exercises: problems 3, 4 (see problem set)

**Class 4.**

Key points:

Simultaneous (normal) and sequential (extensive) form games

Dominant and dominated strategies

Nash equilibrium as a solution concept

Topic 5. Oligopoly: Entry Deterrence

Finding Nash equilibrium

Best response functions

Oligopoly models

The simple Cournot model

The Bertrand Model

Strategic substitutes / complements

Simultaneous vs. Sequential Games

Stackelberg model

Credibility, Credible commitments

Learning outcomes:

The student will understand the ideas of strategic

interdependence and reasoning strategically and be able to

apply them to economic models of market behavior.

The student will understand and be able to apply simple ideas

from game theory to economic models.

The student will understand how to solve a simple Cournot

duopoly model.

Understand the logic behind the Bertrand model of price

competition, the idea of discontinuous reaction functions, how

to solve a simple Bertrand duopoly model, and the fundamental

differences between Bertrand and Cournot models.

Differentiate strategic substitutes and strategic complements.

Explain the difference between the Nash equilibrium of a

simultaneous form game (Cournot) and an extensive form game

(Stackelberg).

Gain an intuitive understanding of credibility, credible

commitments, and credible threats.

Assignments for class 4:

Reading: Pepall, ch. 9-11; Church, ch. 7-9

Exercises: problems 5, 6 (see problem set)

**Class 5.**

Key points:

Predatory conduct and credible threats

Limit pricing in incumbent/entrant (Stackelberg) models

Predation in incumbent/entrant (Stackelberg) models

Extensive form games

Subgames in extensive form games and subgame perfection

Capacity expansion as a form of credible commitment

Predatory Pricing

Role of contracts in impeding entry into a market

Public Policy towards predatory behavior.

Learning outcomes:

Define and give examples of predatory conduct.

Compare the potential returns from predation and from merger

and analyze the incentives for particular types of strategies in

different markets.

Utilize backward induction to solve extensive form games. The

student will be able to prune extensive form game trees as a

means for backward induction.

Topic 6. Horizontal and Vertical Relations. Mergers

Topic 7. Strategic Investment and Nonprice Competition

Differentiate predatory conduct, predatory pricing, and limit

pricing.

Assignments for class 5:

Reading: Pepall, ch. 12-13; Church, ch. 13, 14, 21

Exercises: problems 7, 8 (see problem set)

**Class 6.**

Key points:

Introduction to Stackelberg model of mergers

Gains from vertical integration

Oligopolistic vertical mergers

Conglomerate mergers

Learning outcomes:

Explain the reasons behind mergers.

Differentiate horizontal, vertical, complementary, and

conglomerate mergers.

Differentiate the conclusions of the alternative horizontal

merger models (Cournot and multiple leader/follower

Stackelberg) and relate them to the model assumptions.

Apply the complementary goods model to the analysis of

vertical mergers.

Solve problems involving oligopolistic vertical mergers.

Relate scale and scope, transactions costs, proprietary

information, and agency problems to incentives for

conglomerate mergers.

Assignments for class 6:

Reading: Pepall, ch. 16-17; Church, ch. 22-23

Exercises: problems 9, 10 (see problem set)

**Class 7.**

Key points:

Types of innovations, market structure, and competition in

R&D

The Schumpeterian hypothesis

Competition via innovation

Costs and benefits of advertising

Learning outcomes:

Discuss which types of industries are more likely to see

research joint ventures.

Identify several ways in which advertising increases the demand

for a product.

Assignments for class 7:

Reading: Pepall, ch. 20, 22; Church, ch. 17-18

**Class 8.**

Key points:

Empirical facts on advertising (pricing) and quality

Advertising and monopoly power.

Office hours for individual consultations:

Calendar plan of current and final evaluation

Class assignment October 1, 2.45 pm, room 408

Announcement of coursework

results October 8, 2.30 pm, room 408

Pre-exam consultation: October 13, 4:30 pm, room 408

Exam: October 15, 1 pm, room 408

Announcement of exam results: October 17, 4:30 pm, room 408

Evaluation system

Form of current evaluation: class assignments

Form of final evaluation: written exam

Grading policy: final exam – 70%, class assignment – 30%.

Requited textbooks

The following two textbooks can be used interchangeably:

Pepall L., D. Richards, G. Norman. Industrial Organization: Contemporary Theory and

Empirical Applications. 4th ed. Blackwell Publishing. 2008. (available at GSOM library)

Church J., R. Ware. Industrial Organization: A Strategic Approach. McGraw-Hill. 2000.

(available online at http://homepages.ucalgary.ca/~jrchurch/ )

Other required reading

Besanko D., D. Dranove, M. Shanley, S. Schaefer. Economics of Strategy. 4th ed. John Wiley &

Sons. 2007. (The book is used mostly to demonstrate strategic management applications of IO)

Porter M. The Five Competitive Forces that Shape Strategy. Harvard Business Review, January

2008.

**Learning outcomes:**

Explain why the advertising to sales ratio for an industry is a

more useful gage of advertising intensity than the total dollars

spent on advertising.

Explain how price as well as advertising expenditures may be a

signal of quality. The student will be able to explain the

empirical literature that shows minimal positive correlation

between price and quality.

Assignments for class 8:

Reading: Pepall, ch. 20, 22; Church, ch. 17-18

Igor Baranov, on Tuesdays and Thursdays at 4.30 PM or by appointment,

office 227 (A. Schultz Building)

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