8/26/2008

Managerial Economics & Industry Analysis

Business Strategy
Market Structure
Chapter 7 I Number of firms, size, etc.
Conduct
The Nature of Industry I Pricing, advertising, R&D, etc.
Performance
I Profitability, consumer surplus, social welfare.

Michael R. Baye, Managerial Economics and Business Strategy. The McGraw-Hill Companies, Inc. Michael R. Baye, Managerial Economics and Business Strategy. The McGraw-Hill Companies, Inc.

Industry Concentration Rothschild Index

Four-Firm Concentration Ratio
I The sum of the market shares of the top four firms in the defined A measure of the elasticity of industry
industry: C4 = w1 + w2 + w3 + w4 demand for a product relative to that of an
Herfindahl-Hirschman Index (HHI) individual firm: R = ET / EF
I The sum of the squared market shares of firms in a given I ET = elasticity of demand for the total market
industry, multiplied by 10,000: HHI = 10,000 wi2 I EF = elasticity of demand for the product of an individual firm.
I R has a value between 0 (perfect competition) and 1 (monopoly).
Limitations
I Market Definition: National, regional, or local? When an industry is composed of many
I Global Market: Foreign producers excluded firms, each producing similar products, the
I Industry definition and product classes Rothschild index will be close to zero.

Michael R. Baye, Managerial Economics and Business Strategy. The McGraw-Hill Companies, Inc. Michael R. Baye, Managerial Economics and Business Strategy. The McGraw-Hill Companies, Inc.

Own-Price Elasticities of Demand Pricing Behavior

and Rothschild Indices
The Lerner Index
Elasticity Elasticity
Industry of Market of Firms Rothschild L = (P - MC) / P
Demand Demand Index I A measure of the difference between
price and marginal cost.
Food -1.0 -3.8 0.26
I An index from 0 to 1.
Tobacco -1.3 -1.3 1.00
Textiles -1.5 -4.7 0.32
Markup Factor
Apparel -1.1 -4.1 0.27 I Rearranging the above formula,
Paper -1.5 -1.7 0.88 P = (1/(1-L)) MC
Chemicals -1.5 -1.5 1.00 I 1/(1-L) is the markup factor.

Rubber -1.8 -2.3 0.78

Michael R. Baye, Managerial Economics and Business Strategy. The McGraw-Hill Companies, Inc. Michael R. Baye, Managerial Economics and Business Strategy. The McGraw-Hill Companies, Inc.

1
 8/26/2008

Lerner Indices & Markup Integration and Merger

Factors Activity
Vertical Integration
Industry Lerner Index Markup Factor I Where various stages in the production of a single
Food 0.26 1.35 product are carried out by one firm.
Tobacco 0.76 4.17 Horizontal Integration
Textiles 0.21 1.27 I The merging of the production of similar products into
Apparel 0.24 1.32 a single firm.
Paper 0.58 2.38
Conglomerate Mergers
Chemicals 0.67 3.03
I The integration of different product lines into a single
Petroleum 0.59 2.44 firm.

Michael R. Baye, Managerial Economics and Business Strategy. The McGraw-Hill Companies, Inc. Michael R. Baye, Managerial Economics and Business Strategy. The McGraw-Hill Companies, Inc.

DOJ/FTC Merger Guidelines

Preview of Coming Attractions
Based on HHI = 10,000 wi2
Merger may be challenged if Discussion of optimal managerial decisions
HHI exceeds 1800, or would be after merger, and under various market structures, including:
Merger increases the HHI by more than 100 I Perfect competition
But... I Monopoly
I Recognizes efficiencies: The primary benefit of mergers I Monopolistic competition
to the economy is their efficiency potential...which can I Oligopoly
result in lower prices to consumers...In the majority of
cases the Guidelines will allow firms to achieve
efficiencies through mergers without interference...

Michael R. Baye, Managerial Economics and Business Strategy. The McGraw-Hill Companies, Inc. Michael R. Baye, Managerial Economics and Business Strategy. The McGraw-Hill Companies, Inc.