Industrial Organization, Defined

1
Industrial Organization, Defined

• Industrial Organization The study of the
  structure of firms and markets and of their
  interactions.
• Market Structure - the particular environment of
  a firm, the characteristics of which influence
  the firms pricing and output decisions.
• The continuum of market structures
• Perfect competition ------------------------------
  -Monopoly
• The study of perfect competition and monopoly
  provides the extremes, so we can see the limits
  of what is possible.

2
Outline of Discussion

• The Nature of Industry (Chapter 7)
• Perfect Competition and Monopoly (Chapter 8)
• Oligopoly
• Basic Model (Chapter 9)
• Game Theory (Chapter 10)

3
Structure-Conduct-Performance

• Structure Rules of the Game
• Concentration Measures
• Conduct How the Game is Played
• Pricing, Integration, RD, Advertising
• Performance Outcome of the Game
• Profits, Social Welfare

4
Seller Concentration Measures

• n-firm concentration ratio
• Herfindahl-Hirschman Index
• Rothschild Index
• Lerner Index

5
n-firm concentration ratio

• Sales of top n firms / Sales in the industry
• Examples
• C4 Sales of top 4 firms / Sales of industry
• C8 Sales of top 8 firms / Sales of industry

6
Herfindahl-Hirschman Index

• HHI 10,000 Swi2
• Where, w market share
• Note If one measures market share in whole
  numbers (i.e. 10 is 10), then one does not need
  to multiply by 10,000
• Purpose The HHI is designed to capture
  asymmetries in competition.

7
Interpretation of HHI

• Interpretation of HHI with respect to mergers
• If HHI lt 1,000 after merger no action taken
• If HHI gt 1,000 but less than 1,800, Justice
  Department will generally consider action if HHI
  rises by more than 100.
• If HHI gt 1,800 the merger is generally blocked if
  the HHI rises by more than 50.
• REVIEW TABLE 7-2

8
Rothschild Index

• Rothschild index - a measure of the sensitivity
  to price of a product group as a whole relative
  to the sensitivity of the quantity demanded of a
  single firm to a change in its price.
• R ET / EF (Ratio of elasticities in absolute
  terms)
• Why is this a concentration ratio? One must note
  that sales at the industry level will be less
  responsive to price than sales at the firm level.
  The closer the firm is to being the industry, the
  less the difference between the elasticity of the
  industry and elasticity of the firm.
• Rothschild index is bound between (0,1). Closer
  to 1 the more concentrated an industry probably
  is.
• REVIEW TABLE 7-3 and INSIDE BUSINESS 7-2

9
Limitations of Concentration Ratios

• Industry definitions and product classes
• National markets (proper geographic definition)
• Global markets (impact of imports and exports)
• Each of these can be overcome by the cross-price
  elasticity.

10
Lerner Index

• Lerner Index (Measure of Inequality)
• L (p - MC)/p
• Lerner Index is bound between (0,1)
• Closer to 1 the more pricing power the firm has.
• Why is this a concentration ratio?
• Mark-up power reflects monopoly power.
• REVIEW TABLE 7-5

11
Beyond Pricing

• Vertical, Horizontal, and Conglomerate Mergers
• Research and Development
• Advertising
• REVIEW TABLE 7-6

12
Measuring the Inefficiency of Monopoly Power

• Dansby-Willig Performance Index - Ranks
  industries according to how much social welfare
  would improve if the output in an industry were
  increased by a small amount.
• If DW 0 , Social welfare would not be improved
  if industry output was expanded.
• If DW gt 0 , Social welfare would be improved if
  industry output was expanded.
• REVIEW TABLE 7-7