Lecture #1

INDUSTRIAL ORGANIZATION ECONOMICS

A sample IO question: Why are some industries relatively concentrated and others not? Are entry barriers and economies of scale the entire story?

IO questions for managers:

- How much should we spend on marketing, R&D and product differentiation?

- When, and how fast, should we expand or contract capacity?

- What should our pricing policy be?

- How should we determine output levels?

The IO question for the regulator:

- When is it efficient to intervene in a market?

For the manager again:

- Are we in a market where the government will find it efficient to intervene? If, so will this be on our behalf or on the consumer’s? If the latter, what, if anything, can we do to prevent or to negate the effects of regulation?

1.2

`Old’ IO theory

- assumes competitive behaviour (this means: firms don’t choose their own prices or production costs!)

- answers the following questions:

- given consumer demand functions and aggregate industry production functions, at what price levels per firm can the industry maximize per unit profits?

- given proportions of fixed versus scaled costs, how many firms should we expect in a given industry, and at what mix of sizes?

- under what conditions will innovation occur in an industry?

- under what conditions will an industry under-produce, thus reducing consumer’s surplus below efficiency?

- under what conditions will an industry over-produce, thus reducing producer’s surplus below efficiency?

How useful to managers are answers to these questions?

Answer: Not very. This is industrial economics for governments.

1.8

An agent is competitive if she believes that either prices or production quantities are given and fixed.

Cournot competition: prices are given and firms choose quantities.

Bertrand competition: production quantities are given and firms choose prices.

An industry is at competitive equilibrium when, for a given price, aggregate quantity supplied equals aggregate quantity demanded.

In game theory, purely competitive behaviour is the limiting case of strategic behaviour. It typically, though it need not only, results from natural monopoly. (It may also result from very high demand elasticity.)

If we have increasing returns to scale, then there is no perfectly competitive equilibrium. This is one important (theoretical) motivation for turning to game theory. Another important (empirical) motivation is observation of concentration levels higher than would be predicted by parametric entry barriers alone.