1. Course Wrap-up

2. What is IO? Study of how firms behave in markets Key role of strategic interaction Tools: – Neoclassical comparative static analysis e.g. Structure – Conduct – Performance Model – Game theory – Empirical testing Applications: – Regulation economics – Theory of business strategy

3. Market structure What is market structure? – MS is defined by the type of decision making Market structure and market concentration How to measure market concentration? – Define markets (substitution in consumption) – Define industry (substitution in production) – Use concentration ratios or HHI

4. Market power When a company exercises market power? – Prices are set above marginal costs (pure monopoly – at the level of willingness to pay) Why not to set price at this level if pure monopoly? – Barrier to entry – Threat of substitutes – Antitrust regulation – Basically, it’s not sustainable – we should think of something better than that Empirical estimations of market power Lessons for antitrust: fighting alligators is not a priority Develop competition instead

5. Technology: Economies of scale Definition: LAC Sources: Capacity is related to volume, costs to surface area Product specialization and division of labor Economy on inventory, maintenance, repair (“economy on mass reserves”) indivisibilities Indivisibilities and scale of entry If highly specialized – sunk costs. The greater sunk cost the more concentrated is the industry

6. Technology: Economies of scope Definition: LAC of individual vs combined production Sources: – Shared inputs – Cost complementarities (producing one good decreases the cost of producing another good)

7. Market concentration – Economies of scale – Economies of scope – BUT relative to the size of the market Market structure changes due to changes in demand and/or technology Network externalities

8. How to analyze markets? Simplest approach – 5 forces model Why not always produce good results?

9. Market behavior Clearly define short-term profit maximization actions and long-term strategic interaction Not everything that better off customers in the short-term will benefit them in the long- run (American Airline) What can firms do to improve their market position under given demand and technology?

10. Price discrimination 1 st degree – personalized pricing 2 nd – menu pricing 3 rd – group pricing When feasible? – Identification problem – Arbitrage Pricing rule – Reverse relationship between elasticity and price (Ramsey rule)

11. Third degree PD Identification – Observable characteristics Arbitrage – Impose restrictions on use – Damages goods – Discrimination by location

12. Non-linear pricing 1 st degree PD – Observable characteristics – Two-part tariff – Block tariff 2 nd degree PD – Unobservable characteristics – Self-selection mechanism – Quantity discounting – Technological and contractual tying – Pure and mixed bundling

13. Product differentiation Horizontal differentiation (product variety) – Address models (spatial, Hotelling models) What is location? Greater product variety when: – there are many consumers. – set-up costs of increasing product variety are low. – consumers have strong preferences over product characteristics and differ in these – Monopolistic competition models Consumers have taste for variety and ready to pay for this

14. Product quality Quality is a vertical attribute of a product Problem with profit maximization: asymmetric information Lemon problem and incomplete markets Moral hazard Adverse selection

15. Search goods Quality discrimination – Versioning – Widening the range of quality offered

16. Experience goods Reputation Commitment – Warranty – Investment

17. Strategic Investment Example: R&D – Static vs dynamic efficiency – Product, process and strategic (organizational) innovations – Drastic vs non-drastic innovations – Why investment in R&D is strategic?

18. Boundaries of firms Vertical integration Horizontal integration Mergers Nature of competition: competition inside an industry vs competition by supply chains