Industrial Organization: contemporary theory

and practice (3rd edition)

Lynne Pepall
Dan Richards
George Norman

Industrial

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

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 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

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 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?

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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)

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 Do not say much about the internal organization

of firms
vertical organization is discussed
internal contracts are not

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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.
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 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

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 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.
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 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
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The New Industrial Organization

Dissatisfaction with the structure-conductperformance 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
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