Lynne Pepall Dan Richards George Norman Industrial Organization: contemporary theory and practice (3rd edition) Lynne Pepall Dan Richards George Norman Industrial Organization: Chapter 1

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

Industrial Organization: Chapter 1 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

Industrial Organization: Chapter 1 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) Industrial Organization: Chapter 1

Industrial Organization: Chapter 1 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.” Industrial Organization: Chapter 1

Industrial Organization: Chapter 1 “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

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.” Industrial Organization: Chapter 1

Industrial Organization: Chapter 1 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 Industrial Organization: Chapter 1

The New Industrial Organization Dissatisfaction with the structure-conduct-performance 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 Industrial Organization: Chapter 1