The Structure of American Industry Walter Adams and James Brock

1
The Structure of American IndustryWalter Adams
and James Brock

• Chapters to be covered in class
• 1. Agriculture
• 2. Petroleum
• 3. Automobiles
• 4. Health Care
• 5. College Sports

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Chapters to be covered by teams

• Team One Cigarettes
• Team Two Beer
• Team Three Computers
• Team Four Motion Picture Entertainment
• Team Five Airlines
• Team Six Commercial Banking
• Team Eight Telecommunications

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Questions to be Addressed

• Briefly review the following
• 1. The history of the industry.
• 2. The structure of the industry.
• 3. The conduct of the industry.
• 4. The performance of the industry.
• 5. Public policy towards the industry.
• Be sure to write a coherent 1-2 page essay
  summarizing these elements of the industry. Be
  sure to explain any conceptual terms utilized.
  Demonstrate that you understand not only the
  industry investigated, but also the nature of the
  structure-conduct-performance paradigm.

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Chapter One AgricultureDaniel B. Suits

• Market Structure and Competition
• Supply
• Improvement in Technology
• Government Policy Towards Agriculture
• Conclusions

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Background

• Percentage of population engaged in agriculture
• Poorer nations of the world 50-80
• Western Europe less than 10
• United States a bit more than 1
• Conclusion Lower productivity in agriculture
  requires an increase in the number of workers
  required, and hence fewer workers available to
  produce other goods and services.

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Number and Size of Farms

• 2 million farms in the United States. At the
  start of the Great Depression there were
  approximately 6 million farms.
• 5 of all farms contains 1,000 acres or more, and
  these farms account for 40 of all farm acres.
• 50 of the nations wheat crop comes from 2.6 of
  the largest wheat farms.
• 35 of the nations tomato crop comes from 9 of
  the largest growers.
• 70 of all chicken broilers comes from 2 of the
  largest growers.

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Influence of Corporations

• Only 2 of farms are incorporated.
• The incorporated farms operate 12 of all farm
  land and produce 22 of the total value of farm
  crops.
• In California, corporate farmers manage 25 of
  all farm acreage and market 40 of the value of
  farm crops.

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The Level of Competition

• 50 of the nations grain comes from 2 of the
  largest farms.
• The 2, though, is comprised of 27,000 farms.
• Many farms are also able to produces a variety of
  crops, hence entry and exit into a market is
  relatively easy.
• Given this structure, the model that best fits
  the agriculture sector is perfect competition.

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Perfect Competition, reviewed

• Large number of producers
• Free entry and exit
• Homogenous product
• Perfect information
• These characteristics result in firms that are
  price takers.

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Demand Elasticity

• Review Table 1-1
• Implication of inelastic demand Increases in
  output will reduce price and total revenue.
• Hence, improvements in technology actually hurt
  farmers.

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Supply

• Harvest Supply-In very short run supply is
  inelastic (perfectly?).
• In the short-run, supply is relatively inelastic
  (0.2). Hint Do not confuse the very short-run
  with the short-run.
• In the long-run, farmers can exit and industry.
  This makes long-run supply relatively elastic.
• What determines prices in the agricultural
  market? The work of Alfred Marshall

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Technology

• As Schumpeter notes, a market comprised of a
  large number of small firms will not be able to
  invest in research and development.
• Consequently, technological change in agriculture
  is produced via the government.
• The impact of technology, again. Technological
  change increases output, lowers price, and due to
  the inelastic nature of demand, lowers total
  revenue.
• Review Table 1-7

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Government Policy

• As prices drop, farmers called upon the
  government to offer price supports.
• Paying farmers not to produce
• Subsidize farmers after the market is
  over-supplied.
• Encourage the development of monopoly marketing
  organizations.
• Who receives the benefits of these programs?
• 50 of the smallest farms receive only 8 of the
  aid.
• 5 of the largest farms receive 25 of the aid.
• Who is hurt, or not helped?
• Those who have left the farms are not helped.
• Consumers pay higher prices.
• The programs utilize tax dollars.
• The Agricultural Market Transition Act of 1996
  was an effort to end price supports.

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Chapter Two PetroleumStephen Martin

• Background Figure 2-1
• Outline
• Structure and Structural Change
• Conduct and Performance
• Public Policy

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Stages of Production

• Production Extraction of oil from environment.
• Refining Manufacture of finished products.
• Marketing Distribution of finished products.
• Transportation Transportation industry that
  connects the three vertical stages.
• There has historically been a tendency for these
  stages to integrate.

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The International Majors

• Exxon
• Texaco
• Gulf
• Chevron
• Mobil
• Royal Dutch/Shell
• British Petroleum
• Compagnie Francaise des Petroles (CFP) or Total
• In 1950 these eight companies controlled 100 of
  world crude oil production outside of North
  America and the Communist Bloc. By 1970 these
  firms still controlled 80 of crude oil
  production.
• Exxon, Texaco, and Chevron were the survivors of
  the 1911 antitrust decision that dismantled
  Standard Oil Trust.

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OPEC and Oil Crisis

• Organization of Petroleum Exporting Countries
  (OPEC) was established in 1960 by Saudi Arabia,
  Iran, Iraq, Kuwait, and Venezuela.
• From 1960 to 1973, the oil industry was dominated
  by OPEC and the seven majors.
• Over time, via the actions of Libya and Iraq, the
  production of oil was transferred from the majors
  to the nations who housed the oil.
• Two events
• Egypt-Israeli War of 1973
• Fall of the Shah of Iran in 1979
• Each event led to oil embargoes
• UNDERSTAND THE WORKINGS OF A CARTEL
• UNDERSTAND THE ROLE OF INELASTIC DEMAND

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U.S. Public Policy

• The 1911 Standard Oil case marks the only time a
  member of the U.S. oil industry was convicted for
  violating anti-trust laws.
• Low Price or Energy Independence?
• The wishful thinking of the U.S. and OPEC
• Review Figure 2-7

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AutomobilesJames W. Brock

• History
• Structure
• Conduct
• Performance
• Public Policy

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Automobile History

• The industry begins in the 1890s
• Sales in 1900 4,000 cars
• Sales in 1910 187,000 cars
• Early industry leader Ford Motor Company
• Key Demand for cars is price elastic
• Strategy Standardization, specialization, mass
  production will lower costs and allow constant
  price reductions. Hence market can continue to
  expand.
• In 1921 Fords Model T accounted for half the
  market it had also not changed for 19 years.

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History, cont.

• The rise of General Motors
• Merging of several independent firms (Chevrolet,
  Oldsmobile, Buick, Cadillac, etc.)
• Strategy
• A car for every purse and purpose
• Modify cars on a yearly basis to stimulate
  replacement demand.
• The rise of imports
• Beginning in the 1950s imports began to compete
  with the Big Three.
• By the 1970s imports had capture ¼ of the market.
• Government protection led foreign companies to
  transplant production to the United States.
• Today, the output of transplants equals General
  Motors U.S. production and exceeds the domestic
  output of Ford and Chrysler combined.

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Industry Structure

• Demand and the Nature of the Product
• Demand is dominated by replacement demand, which
  can be postponed. Hence demand can be quite
  volatile and tends to respond to macroeconomic
  conditions.
• Industry Concentration
• Review Tables 5-2 and 5-3
• Note the joint ownership of firms and the shared
  research efforts.
• Economies of Scale
• Note vertical disintegration of firms
• Has GM achieved diseconomies of scale? Review
  labor hours needed to produce a vehicle across
  the industry.
• Barriers to Entry Production, Marketing,
  Distribution
• The cost to construct a new plant equals 2-4
  billion.
• In 1998 the Big Three spend 5 billion on
  advertising.
• The Big Three utilize 17,000 dealership around
  the nation.

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Industry Conduct

• Pricing
• Review the Price Leadership model and Tacit
  Collusion
• The impact of foreign competition
• Product Rivalry
• The case of small cars The Big Three did not
  seriously offer small cars until the 1970s.
  Before these firms were reluctant to enter such a
  market, since one firm entrance would lead to all
  firms entering the market. Since no one believe
  the market could support all three entering, each
  refrained. The imports, though, were not
  constrained in this fashion.
• A similar story could be told with respect to
  minivans, where only the crisis faced by Chrysler
  in the early 1980s led to the production of this
  car.
• Today Product competition is much more the norm,
  with 260 different makes of cars, trucks, etc.
• Bureaucracy is increasingly a disadvantage
• Firms are vertically disintegrating

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Performance

• Production Efficiency
• Review Table 5-7
• Dynamic Efficiency or Product Innovation
• Prior to World War II, innovation was fairly
  rapid due to the number of firms in the industry.
• From World War II to the 1970s, innovation was
  virtually non-existent. The cars offered in the
  latter 1960s were quite similar technologically
  to what was offered in the latter 1940s.
• Foreign competition once again brought innovation
  back to the automobile industry.
• Review the pace of innovation on page 130.
• Social Efficiency
• With respect to smog, safety, and fuel efficiency
  the Big Three have adopted a strategy of
  indifference and denial, followed by resistance
  and pleas of technological impossibility.

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Public Policy

• Anti-Trust
• Anti-trust action has never directly attacked the
  industry.
• Part of the motivation behind saving Chrysler in
  the later 1970s was the desire to maintain
  competition in the industry.
• Protection from Foreign Competition
• Regulations
• We wouldnt have had the kinds of safety built
  into automobiles that we have had unless there
  had been a Federal law. We wouldnt have had the
  fuel economy unless there had been a Federal law,
  and there wouldnt have been the emission control
  unless there had been a Federal law. Henry Ford
  II
• Note Federal oversight is a second-best
  solution. Competition can cause many of these
  innovations to occur. Without competition,
  though, innovation stagnates.

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College SportsJohn Fizel and Randall Bennett

• History
• Structure
• Conduct
• Performance
• Public Policy

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NCAA History

• NCAA National Collegiate Athletic Association
  (named in 1910) was formed in response to the
  rise in injury and death in college football.
• The promotion of safety expanded in the years
  that followed to include
• The elimination of professional athletes in
  college sports.
• Review the Sanity Code of 1948 and the Committee
  of Infractions (1954)
• Control over broadcast of NCAA games
• Broadcast revenue from college football rose from
  1.15 million in 1962 to 59 million in 1992.
• The larger schools, though, protested the
  distribution of revenues.
• Hence the move to multiple divisions in 1973.
• What model fits the NCAA? The Cartel

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Structure

• Review Table 12-1 for a review of NCAA football
  attendance.
• Cartel stability is undermined by the following
• Heterogeneity in revenue generation
• Monitory and enforcing rules
• Barriers to Entry
• To be a Division I-A football program you must
  have
• a minimum number of male and female varsity
  sports
• a stadium with 30,000 seats
• average more than 17,000 paid attendance
• Both the College Football Association and
  Collegiate Professional Basketball League are
  efforts to undermine the NCAA cartel

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Conduct Television

• The NCAA Television Plan for 1983 allowed two
  networks (ABC and CBS) to air 14 telecasts
  annually. Each network could show national and
  regional games, but over a two year period 82
  different teams must be shown. Each team could
  not appear nationally more than four times, with
  six total appearances allowed.
• Why these restrictions? Competitive balance
• In 1984 the Supreme Court ruled that the NCAA
  Television Plan, which restricted appearances on
  television, was a violation of the Sherman
  Anti-Trust Act.
• Impact of removing NCAA control over television
• Number of televised games increased.
• Improvement in competitive balance?
• Review Berri, David J. Is There a Short Supply
  of Tall People in the College Game?in Economics
  of Collegiate Sports eds. John Fizel and Rodney
  Fort Praeger Publishing forthcoming in 2003.
• The rise and fall of the College Football
  Association (1977-1997)

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Conduct Playoffs?

• Review the Bowl System 1902-1994
• The Bowl Championship Series 1995-present
• A Division I-A Playoff System
• A playoff system would clearly enhance NCAA
  revenues
• Problems
• Playoffs lengthen the football season
• Playoffs may eliminate the bowl system, or at
  least, limit post-season participation for many
  teams. Currently 40 teams play in bowl games. A
  16 team playoff would eliminate post-season
  participation for 24 teams.
• How will the revenue be distributed? 93 of NCAA
  revenue comes from the post-season basketball
  tournament. Will a football playoff be a cash
  cow for the NCAA, but not as lucrative for the
  major programs?

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Conduct Monoposony

• College athletes are not paid. Why?
• The NCAA argues competitive balance.
• Economists argue for the increased profits from
  lowering the price paid for inputs.
• How does the NCAA lower the price of labor?
• Recruiting controls
• Limiting athletic scholarships
• Freshman eligibility increases the potential
  number of years available
• The National Letter of Intent ends the
  expenditure on recruitment by imposing a two year
  penalty on athletes who change their minds.
• Most importantly, compensation to athletes are
  limited to the cost of attending the school.
  Review the work of R. Brown.
• Review the restricted earnings case for
  assistant coaches (pp. 339-40).

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Performance

• Most college sports lose money. Review Table
  12-2
• How much do athletes cost?
• Review the stated cost per athlete
• Review the NCAA rule that payments should not
  exceed the cost of attending the school.
• What is the marginal cost of admitting an
  athlete?
• Sports also serve to promote the school. Such
  promotions enhance both admissions and the
  ability of the school to gain financial
  contributions. This impact tends to be ignored
  by schools in assessing the profitability of
  athletic programs.

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Public Policy Title IX

• Title IX no person in the United States, on the
  basis of sex, be excluded from participation in,
  be denied the benefits of, or be subjected to the
  discrimination under any education program or
  activity receiving federal funds.
• In 1984 the Supreme Court ruled that Title IX
  only meant that federal funds would not flow into
  violating college athletic programs.
• The 1988 Civil Rights Restoration Act barred the
  flow of funds to any college or university that
  violated Title IX.
• Review the requirements that must be met for a
  school to be in compliance with Title IX.
• How do colleges meet the proportionality
  requirement?
• Review court cases filed by women and men.

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Public Policy Monoposony

• The Competitive Balance Argument
• The Amateur Athlete Argument
• Are college athletes viewed as amateurs?
• The Temporary Underpayment Argument
• Are athletes only temporarily underpaid?
• Less than 1 of college athletes ever become
  professionals.
• The majority of college athletes come from the
  lower levels of the income distribution. Hence,
  the nature of the labor market results in a
  transfer of income from the poor (the athlete) to
  the wealthy (the University).
• How could athletes gain adequate compensation?
• Unionization
• Compensation funds
• Impact of paying players?
• Fewer non-revenue generating sports
• Declines in the salaries paid to coaches.
• Fewer players leaving college early or avoiding
  college entirely

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Health CareJohn Goddeeris

• History
• Industry Structure
• Conduct
• Performance
• Public Policy Issues

36
Overview

• National health expenditures account for 13.5 of
  GDP. In other words, 1 in 7 dollars are spent on
  health care.
• What does this money buy?
• Review Figure 10-1
• 44 million American (16.3 of the population) are
  uninsured.

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Brief Historical Review

• In 1929 health spending was only 3.5 of GDP.
  Why? Health practitioners could identify illness,
  but do little to stop the illness.
• In 1929, the Blue Cross plan was introduced at
  Baylor University. Why? To create revenue
  certainty.
• In 1940 only 9 of the American public had health
  insurance.
• By 1950, over half the population had private
  coverage. Why did this change?
• Health plans were not counted towards an
  employees taxable income, hence this was an
  attractive enticement during the tight labor
  market of World War II (where wages were
  controlled).
• Health care improved and increased in cost.
• By 1975, 82 of the population had private
  coverage. This number has declined over time, as
  public coverage has expanded.

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Industrial Structure

• Health Insurance and Managed Care Note the
  following
• The purpose of health insurance (transferring
  risk from the individual or group to the insurer)
• The rise of the HMO
• The rise of for-profit health insurance
  organizations
• The role of public health insurance plans
• Physicians Note the following
• The role of the AMA in restricting entry
• impact on income
• maintenance of standards
• The trend towards group practice Review Table
  10-4
• Economies of scale in the industry
• Hospitals (Students read)
• What do I mean by students read? Your
  discussion of health care should show that you
  read this section, and other sections that I do
  not touch upon in lecture.

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Conduct

• Pre-managed Care
• Physicians
• Note the absence of price competition
• Even when consumers paid for services
  out-of-pocket, it is difficult for consumers to
  acquire the necessary information to correctly
  evaluate prices.
• Note the prohibition on advertising prior to 1982
• Note the declining share in revenue directly from
  consumers. As insurers and public programs play a
  larger role, prices are no longer set entirely by
  doctors.
• Should an increase in supply lead to a decline in
  prices and incomes? Not if demand increases over
  time.
• Hospitals As non-profit organizations, what is
  their motivation?
• Maximizing the mix of quantity and quality.
• Maximizing the utility of physicians
• Managed Care and Conduct (Students Read)

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Performance

• Review of American Health Care
• Review Table 10-6
• Why does the United States finish first in
  expense but not in results?
• Greater income inequality in one possible
  explanation
• Again, 16.3 of the U.S. population does not have
  health care
• Except for Mexico and Turkey, all other OECD
  countries insure at least 99 of their
  populations.
• Impact of managed care HMOs appear to lower
  costs with an unclear impact on the quality of
  health care. What impact has managed care had on
  provider compensation?
• The impact of consolidation
• of hospitals
• of HMOs
• Note the general motivations for mergers
• Note the level of output where economies of scale
  are exploited

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Public Policy

• Can the Market Work in Health Care
• The United States utilizes the market much more
  extensively than any other industrialized
  country.
• Problems with the market
• Insurance, which arises due to uncertainty,
  reduces price sensitivity.
• Asymmetry of information between doctor and
  patient reduces the level of consumer
  sovereignty.
• Can managed care solve these problems?