Industrial Organization


Theory and practice                 3th edition

Don E. Waldman   Colage university                    Elizabuth J. Jensen  Hamilton collage

BRIEF CONTENTS

 

PART I        THE BASICS OF INDUSTRIAL ORGANIZATION

chapter 1 Introduction 1

 chapter 2 The Firm and Its Costs 17

chapter 3 Competition and Monopoly 51

chapter 4 Market Structure 88

chapter 5 Monopoly Practices 143

chapter 6 Market Power and Performance: The Empirical Evidence 161

 

PART II       MODERN INDUSTRIAL ORGANIZATION:

GAME THEORY AND STRATEGIC BEHAVIOR

chapter 7 Game Theory: A Framework for Understanding Oligopolistic Beha

chapter 8 The Development of Oligopoly Theory 230

chapter 9 Collusion: The Great Prisoner’s Dilemma 266

chapter 10 Cartels in Action 303

chapter 11 Oligopoly Behavior: Entry and Pricing to Deter Entry 335

chapter 12 Oligopoly Behavior: Entry and Nonpricing Strategies to Deter Entry

 

PART III      BUSINESS PRACTICES

chapter 13 Product Differentiation and Advertising 416

chapter 14 Technological Change and Research and Development 469

chapter 15 Price Discrimination 515

chapter 16 Vertical Integration and Vertical Relationships 562

chapter 17 Regulation and Deregulation 606

 

Glossary 639

Answere to Odd-Numbered Problems 652 Index 678 Credits 712

CONTENTS

PART 1  THE BASICS OF INDUSTRIAL ORGANIZATION

CHAPTER 1  Introduction

1.1 Two Approaches to the Study of Industrial Organization 3

1.1.1 The Structure-Conduct-Performance (SCP) approach 3

1.1.2 the Chicago School approach 6

1.2 Static versus Dynamic Models 7

1.3 Theory and Empiricism 7

1.4 Government and Industrial Organization 8

1.4.1 The Content of the Antitrust Laws 8

1.4.2 enforcement procedures 11

1.5 The Global Economy and Industrial Organization 12

1.6 General Approach of This Book 13

SUMMARY 14

 

CHAPTER 2 The Firm and Its Costs

2.1 The Neoclassical Firm 17

2.2 The Theory of the Firm 18 2.2.1 a Firm’s boundaries 18

2.3 The Structure of Modern Firms 21

2.3.1 separation of ownership and control 22

2.3.2 managerial objectives 23

APPLICATION 2:1 Executive Compensation: Pay for Performance? 23

APPLICATION 2.2 X-Inefficiency Goes Extreme: Putting Masseuses, Christmas Trees, Renoirs, and Monets on the Company Payroll 25

2.3.3 feasibility of profit maximization 26 application 2?3 How Do Firms Use Rule-of-Thumb Pricing? 26

2.3.4 constraints on managers 28

APPLICATION 2.4s Stockholder Revolt at the Happiest Place on Earth: The Disney Stockholders versus Michael Eisner 28

2.4 The Profit-Maximizing Output Level 31

2.5 Cost Concepts: Single-Product Firms 32

2.5.1 ACCOUNTING COSTS VERSUS ECONOMIC COSTS 32

2.5.2 SHORT-RUN COSTS OF PRODUCTION 33

APPLICATION 2.5 When Do Sunk Costs Matter to a Firm? 33

2.5.3 LONG-RUN COSTS OF PRODUCTION AND ECONOMIES OF SCALE 37

APPLICATION 2.6 A Measure of Economies of Scale 39

2.6 Cost Concepts. Multiproduct Finns 42

APPLICATION 2.7 A Measure of Economies of Scope 42

APPLICATION 2.8 Are There Economies of Scope in Institutions of Higher Education? 43

SUMMARY 45

CHAPTER 3 Competition and Monopoly

3.1 The Economics of Perfect Competition 51

3.1.1 the assumptions of perfect competition 52

3.1.2 The Firm’s Supply Curve 54

APPLICATION 3.1 Short-Run Losses in the Airline Industry 56

3.1.3 the Market Supply curve and equilibrium 57

3.1.4 properties of competitive equilibrium 58

3.2 Introduction to Welfare Economics 59

APPLICATION 3.2 Consumer and Producer Surplus and the Basic Theory of the Gains from Trade 59

3.3 The Economics of Monopoly 62

3.3.1 the Relationship Between Marginal Revenue and Price <

3.3.2 elasticities, the degree of market power, and the lerner Index 64

3.4 Welfare Comparison 65

3.4.1 measurement of the Costs of Market power 67

application 3.3 Monopoly Rent-Seeking in the Pharmaceutical Industry 68

3.4.2 cautions 70

3.5 Present Value and Discounting 71

3.6 Antitrust Policy Toward Monopolization 73

3.6.1 early Cases 74

APPLICATION 3.4 American Tobacco’s “Attempt to Monopolize* 74

3.6.2 the Alcoa Era 76

3.6.3 recent trends in section 2 cases 77

SUMMARY 81

CHAPTER 4 Market Structure 88

4.1 Concentration in Individual Markets 89

4.1.1 Structure-Based Measures 89

application 4.1 Aggregate Concentration 90

4.1.2 definition of the relevant market 94

4.2 Entry and Exit 96

4.2.1 patterns of entry and exit 96

4.2.2 ENTRY 97

4.2.3 Static or Structural Barriers to entry 98

application 4.2 How Do Economists Estimate Economies of Scale?   100

application 4.3 What Does the Evidence Say About Barriers to Entry? 109

4.2.4 Incentives to Enter 110

4.2.5 EXIT 111

4.2.6 the interaction of entry and exit 112

4.3 Mergers 113

4.3.1 Merger History 114

4.3.2 motives for merger 116

application 4.4 Can Pixar Save Disney?   119

4.3.3 the effects of mergers on competition and welfare 120

4.3.4 empirical evidence on the effects of mergers 123

4.3.5 public policy toward mergers 125

4.3.6 merger guidelines and the hart-scott-rodino act 132

SUMMARY 135

CHAPTER 5 Monopoly Practices 143

5.1 Dominant-Firm Price Leadership Model 143

5.1.1 Sources of dominance 144

5.1.2 pricing by a dominant firm 144

application 5.1 Banks and Credit Unions: Dominant Firms and Fringe Suppliers? 149

5.1.3 empirical evidence of the decline of domwant-firm Price Leaders 149

5.2 Contestable Markets: A Check on Market Power? 150

5.3 Network Economics 153

5.3.1 Complementarity, Compatibility, and Standards 153

5.3.2 Externalities 154

5.3.3 switching costs and lock-in 155

5.3.4 significant economies of scale 155

5.3.5 Summary of Network Effects 155

application 5.2 Microsoft and Network Effects 156

SUMMARY 157

CHAPTER 6  Market Power and Performance:

The Empirical Evidence 161

6.1 Stiuctuu:e-Condutf-Performance 162

6.2 Statistical Tools Used to Test the SCP Paradigm   163

6.2.1 Exogenous and Endogenous Variables 166

6.3 Measurement Issues 167

6.3.1 Measures of Performance 168

application 6.1 Does the Method of Calculating Profit Rates Matter? 171

6.3.2 correlations among measures of performance 174

6.3.3 summary of measures of profitability 175

6.4 Measures of Market Structure 176

6.4.1 measures of concentration 176

6.4.2 barriers to entry 176

6.4.3 other variables 177

6.5 Early Structure-Conduct-Performance Studies 177

6.6 Econometric Studies 178

6.6.1 concentration and profitability: evidence from industry-level studies    179

6.6.2 summary of industry-level results 180

6.7 Effects of Other Elements of Market Power on Profits 181

6.8 Conceptual Problems with SCP Studies 182

6.8.1 collusion versus efficiency 182

6.8.2 assumption of linearity 184

6.8.3 variations over time 185

6.8.4 endogeneity problem 187

6.9 Prices and Concentration 187

6.10 An Alternative Approach: Sunk Costs and Market Concentration 188

6.10.1 Markets with exogenous Sunk costs 189

6.10.2 Markets with endogenous Sunk Costs 189

6.10.3 Sutton’s empirical Tests 191

APPLICATION 6.2 Applying Sutton’s Theory in the Supermarket Industry 193

6.11 The New Empirical Industrial Organization 195

APPLICATION 6.3 Price-Cost Margins in the RTE Cereal Industry   197

SUMMARY 198

PART 2     MODERN INDUSTRIAL ORGANIZATION: GAME THEORY AND STRATEGIC BEHAVIOR

CHAPTER 7 Game Theory: A Framework for Understanding Oligopolistic Behavior 207

7.1 What Is Game Theory? 207

7.2 Simple Zero-Sum Games 208

APPLICATION 7.1 University Rankings and Merit-Based Financial Aid as a Zero-Sum Game 210

7.3 The Information Structure of Games 210

7.4 Prisoner’s Dilemma Games 211

application 7.2 A Prisoner’s Dilemma—Doctors and HMOs 212

7.5 Repeated Games 214

7.6 Games of Mixed Strategies 215

7.7 Sequential Games 218

7.7.1 credible versus noncredible threats and subgame perfect nash equilibria 219

APPLICATION 7.3 Dr. Strangelove and Credible Threats Gone Wrong 221

SUMMARY 223

CHAPTER 8 The Development of Oligopoly Theory 230

8.1 Models Based on Quantity Determination 230

8.1.1 The Cournot Model 230

8.1.2 The Cournot-Nash Equilibrium 236

8.1.3 cournot-nash model with more than two firms 238

application 8.1 Empirical Evidence of Cournot-Nash Behavior-Experimental Games with Varying Numbers of Players 240

APPLICATION 8.2 The Paradox of Mergers in a Cournot-Nash Market 242

APPLICATION 8.3 Examples of Cournot-Nash Pricing in Real Markets 242

8.1.4 USING THE COURNOT-NASH MODEL IN THE CONTEXT OF INTERNATIONAL TRADE 243

APPLICATION 8.4 The Effectiveness of Industrial Policy: UK Subsidies and Tariffs 248

application 8.S The Effectiveness of Industrial Policy: The Commercial Aircraft Industry 250

8.2 The Stackelberg Model 251

8.2.1 FIRMS WITH IDENTICAL COSTS AND DEMAND 251

8.2.2 THE STACKELBERG MODEL: FIRMS WITH DIFFERENT COSTS 253

APPLICATION 8.6 Empirical Examples of Stackelberg Equilibrium 255

8.3 The Bertrand Model 256

application 8.7 Bertrand Pricing in the Airline Industry 260

APPLICATION 8.8 Bounded Rationality, Sluggish Consumers, Internet Pricing, and the Failure to Achieve a Bertrand Equilibrium 260

SUMMARY 262

CHAPTER 9 Collusion: The Great Prisoner’s Dilemma 266

9.1 The Prisoner’s Dilemma Revisited 266

application 9.1 Tit-for-Tat in Baseball 268

application 9.2 A Real-World Example of “Nice” Behaviorin Response to Random or “Accidental” Defections Automobiles 273

9.2 Another Strategy for Maintaining Effective Collusion: Trigger Price Strategies 274

9.3 Collusive Agreements as Viewed by One Firm in a Cartel 275

9.4 Factors Affecting the Ease or Difficulty of Effective Collusion 282

9.4.1 the existence of market power 283

9.4.2 The Costs of reaching and Maintaining an Agreement 284

application 9.3 Factors Facilitating Global Cartels: Evidence from Lysine, Citric Acid, and Vitamins A and E 287

9.5 Antitrust Policy Toward Collusion 289

9.5.1 public Policy toward direct price-Fixing agreements 291

9.5.2 price-Exchange Agreements 292

9.5.3 oligopolistic behavior—conscious parallelism 293

9.5.4 trade associations 295

9.5.5 nonprofit organizations: cases involving colleges and universities 296

SUMMARY 298

CHAPTER 10 Cartels in Action

10.1 Attempted Methods of Achieving Effective Collusion 303

10.1.1 Dominant-Firm Price Leader and benefactor 303

10.1.2 price leadership 306

APPLICATION 10.1 A Sweet Case of Price Leadership: . Dole and Del Monte in the Canned Pineapple Industry 310

10.1.3 most favored customer clauses and ” low-price” guarantees 311

APPLICATION 10.2 Most Favored Customer Clauses for Medicaid, But What About Everyone Else? 313

10.1.4 basing point pricing systems 315

10.1.5 trade and professional associations 317

APPLICATION 10.3 “Something Is Rotten in the State of Denmark The Danish Government Promotes Tacit Price Fixing 319

10.1.6 schemes to divide markets 321

10.1.7 Patent Cartels 323

10.2 How Successful Are the Solutions? 325

10.2.1 Excess Capacity problems 325

10.2.2 encroachment of Substitute products 326

10.2.3 more effective antitrust strategies: The Department of justice Corporate Leniency program 326

SUMMARY 329

CHAPTER 11 Oligopoly Behavior: Entry and Pricing to Deter Entry

11.1 limit Pricing 335

11.1.1 Limit Pricing with a Cost Advantage for the monopolist firm 335

11.1.2 limit pricing in the absence of a cost advantage for the monopolist firm 338

11.1.3 the critique of game theorists 339

11.1.4 Limit pricing with Asymmetric information 344

11.1.5 empirical Evidence of Limit Pricing 347

APPLICATION ii.i Limit Pricing in the Antihistamine Market 350

11.2 Predatory Pricing 351

11.2.1 predatory pricing with perfect, certain, complete,and Symmetric Information 352

11.2.2 Predatory Pricing with imperfect, certain, incomplete, and asymmetric information 353

11.2.3 The kreps and Wilson Predatory Pricing game 354

11.2.4 Empirical evidence: predatory pricing and building a Tough reputation 355

APPLICATION 11.2 Does Wal-Mart Use Predatory Pricing? 358

APPLICATION 11.3 Don’t Mess with Bill: Netscape versus Microsoft in the Internet Browser Market 359

summary 361

Appendix: Details of the Kreps and Wilson Predatory Pricing Modef 367

CHAPTER 12 Oligopoly Behavior: Entry and Nonpricing

Strategies to Deter Entry 372

12.1 Excess Capacity 372

12.1.1 investing in research and development to Lower costs 376

12.1.2 Empirical evidence 376

12.2 Raising Rivals’Costs 380

12.2.1 Lobbying to increase Barriers to Entry 381

12.2.2 increasing advertising 381

12.2.3 Providing Complementary Goods and services 382

12.2.4 Sabotaging Corporate Competitors 382

12.2.5 Empirical evidence on Raising Rivals’ Costs 382

APPLICATION 12.1 Detergent Wars and the Battle of Good versus Evil: Amway v. Proctor & Gamble 385

12.3 Learning by Doing 386

12.3.1 Empirical evidence on Learning by doing 388

application 12.2 Qualitative Learning by Doing

in the Motion Picture Industry: The Case of the “Talkies” 392

12.4 Product Proliferation 394

12.4.1 Empirical evidence on the Use of product Proliferation 394

12.5 Empirical Evidence on the Use of Price and Nonprice Strategies to Deter Entry 399

SUMMARY 402

Appendix: Product Proliferation Revisited 408

PART 3      BUSINESS PRACTICES

CHAPTER 13 Product Differentiation and Advertising 416

13.1 Forms of Product Differentiation 416

13.2 Theoretical Analysis of Product Differentiation 417

13.2.1 the potential impact of product Differentiation on price: The bertrand model Revisited 418

13.2.2 the economics of monopolistic competition and the optimal amount of variety 420

13.2.3 product differentiation with asymmetric Information 428

APPLICATION 13.1 What Do the Markets for Thoroughbred Racehorses and Baseball Players Have in Common? Product Differentiation, Asymmetric Information, and Adverse Selection 433

13.3 The Social Benefits and Costs of Advertising 435

13.3.1 the social benefits of advertising 435

13.3.2 the social costs of advertising 436

13.4 Advertising and Market Structure 439

13.4.1 Welfare effects of Advertising 439

13.4.2 the dorfman-steiner model 441

13.4.3 Advertising and oligopoly Behavior 443

APPLICATION 13.2 The Variability of Advertising-to-Sales Ratios Across Industries 447

13.4.4 The product Differentiation advantages of First Movers 451

13.5 Advertising as a Barrier to Entry 455

13.6 Strategic Advantages of Heavily Advertised Brands 456

13.7 Product Differentiation and Increased Competition 457

13.8 Empirical Evidence 457

13.8.1 traditional studies of the relationship between advertising and performance across industries 458

13.8.2 new empirical industrial organization studies 461

summary 462

 

CHAPTER 14 Technological Change and Research and Development 469

14.1 Schumpeter and the Process of “Creative Destruction” 469

APPLICATION 14.1 Examples of Creative Destruction 471

14.2 The Process of Technological Change 472

14.3 The Relationship Between Market Structure, Firm Size, and Technological Advance 473

14.3.1 the impact of oligopoly 475

14.3.2 dominant firms as fast-second innovators 480

14.3.3 a contribution of game theory 481

14.3.4 the theoretical impact of a patent system 483

14.4 The Impact of Firm Size 486

14.5 Empirical Evidence 489

14.5.1 measurement issues 489

14.5.2 Testing Schumpeter’s hypotheses 489

14.6 The Economics of the Patent System 493

14.6.1 empirical evidence on the Impact of Patents 496

14.6.2 intellectual property rights and Copyrights 499

application 14.2 Why Bother with Intellectual Property Rights? The Case of China 500

14.7 Patents, Intellectual Property Rights, and the Law 503

SUMMARY 505

Appendix: Game Theory and Patent Races 511

CHAPTER 15 Price Discrimination

15.1 Types of Price Discrimination 515

15.1.1 first-Degree Price Discrimination 516

application 15.1 Microsoft’s Attempt to Use First-Degree Price Discrimination 517

15.1.2 Second-Degree Price Discrimination 518

APPLICATION 15.2 The Use of Coupons and Second-Degree Price Discrimination 520

15.1.3 the welfare effects of second-degree price Discrimination 522

15.1.4 third-Degree price Discrimination 523

15.1.5 Welfare implications of Third-Degree price Discrimination 523

application 15.3 Third-Degree Price Discrimination at Disney World 527

15.2 Two-Part Tariffs, Tying, and Bundling 528

15.2.1 Two-part Tariffs 528

15.2.2 The welfare Effects of a Two-part Tariff 530

application 15.4 Changing Pricing Strategies at Disneyland and Disney World 532

15.2.3 bundling 532

15.2.4 Mixed Bundling 533

15.2.5 Requirements Tie-in Sales 538

Distribution Effects of Price Discrimination 539

Effect on Competition 540

Antitrust: Price Discrimination and the Robinson-Patman Act 542

15.5.1 Secondary-Line Cases 543

15.5.2 Primary-Line Cases 548

15.5.3 Illegally induced Price discrimination 551

summary 552

Appendix: The Welfare Implications of Price Discrimination with Nonlinear Demand 560

CHAPTER 16 Vertical Integration and Vertical Relationships 562

16.1 Vertical Relationships as a Solution to Economic Problems 562

16.1.1 the Problem of Double Marginalization 564

16.2 Alternative Methods of Achieving Joint Profit Maximization 566

16.2.1 THE PROBLEM OF INSUFFICIENT PROMOTIONAL SERVICES 567

APPLICATION 16.1 Vertical Integration, Exclusive Dealing, and the Value of an Upscale Pub’s Amenities in Australia 569 APPLICATION 16.2 The Welfare Effects of Exclusive Dealing in the U.S. Beer Industry 573

16.2.2 SOLVING THE PROBLEM of INPUT SUBSTITUTION 574

16.3 The Competitive Effects of Vertical Relationships 575

16.3.1 RESALE PRICE MAINTENANCE AGREEMENTS 575

 APPLICATION 16.3 Toys “R” Us as the Facilitaor of Toy Manufacturer Collusion 577

16.3.2 STRATEGIC USES OF VERTICAL RESTRAINTS AND INTEGRATION 579

16.3.3 RAISING THE CAPITAL BARRIER TO ENTRY 581

16.3.4 COLLUSION AND VERTICAL INTEGRATION 581

APPLICATION 16.4 The Possible Negative Welfare Impacts of Increasing Vertical Integration: The Case of the Southern California Gasoline Retailing Market 582

16.3.5 FORECLOSURE 584

16.4 Antitrust: Public Policy Toward Vertical Restraints of Trade and Group Boycotts 585

16.4.1 TYING AGREEMENTS 585

16.4.2 CASES DEALING WITH FRANCHISING AGREEMENTS 588

16.4.3 Exclusive dealing agreements 588

16.4.4 Territorial and Customer Restrictions 591

16.4.5 Resale Price Maintenance Agreements 593

SUMMARY 596

Appendix: The Problem of Input Substitution 601

CHAPTER 17      Regulation and Deregulation

17.1 The Rationale for Regulation: Traditional Public Utility Regulation 606

17.2 The Workings of American Regulation 608

17.2.1 setting the Permitted Rate of Return 609

17.3 Efficiency Problems Associated with Rate of Return Regulation 611

17.3.1 x-inefficiency 611

17.3.2 the averch-Johnson Effect 611

17.3.3 Setting the price structure 614

17.4 The Spread of Regulation into Other Markets 616

17.4.1 The Capture theory of Regulation 616

application 17.1 It’s More Than Peanuts  618

17.5 The Movement from Regulation to Deregulation 619

17.5.1 Surface Transportation 619

17.5.2 airline regulation and deregulation 620

application 17.2 Airline Regulation: Where Did All the Profits Go? 622

17.5.3 regulation of telecommunications and Broadcasting 625

17.5.4 electricity 629

application 17.3 Electricity Restructuring: Lights Out in California 630

17.5.5 natural gas industry 631

 summary 632

glossary 639

Answers to Odd-Numbered problems 652 index 678

CREDITS 712

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