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The Structure of American Industry Walter Adams and James Brock

The Structure of American Industry Walter Adams and James Brock Chapters to be covered in class 1. Agriculture 2. Petroleum 3. Automobiles 4. Health Care 5. College Sports Chapters to be covered by teams Team One: Cigarettes Team Two: Beer Team Three: Computers

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The Structure of American Industry Walter Adams and James Brock

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  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

  2. 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

  3. 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.

  4. Chapter One: AgricultureDaniel B. Suits • Market Structure and Competition • Supply • Improvement in Technology • Government Policy Towards Agriculture • Conclusions

  5. 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.

  6. 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 nation’s wheat crop comes from 2.6% of the largest wheat farms. • 35% of the nation’s tomato crop comes from 9% of the largest growers. • 70% of all chicken broilers comes from 2% of the largest growers.

  7. 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.

  8. The Level of Competition • 50% of the nation’s 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.

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

  10. 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.

  11. 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

  12. 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

  13. 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.

  14. Chapter Two: PetroleumStephen Martin • Background: Figure 2-1 • Outline • Structure and Structural Change • Conduct and Performance • Public Policy

  15. 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.

  16. 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.

  17. 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

  18. 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

  19. AutomobilesJames W. Brock • History • Structure • Conduct • Performance • Public Policy

  20. 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 Ford’s Model T accounted for half the market; it had also not changed for 19 years.

  21. 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.

  22. 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.

  23. 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

  24. 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.”

  25. 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 wouldn’t have had the kinds of safety built into automobiles that we have had unless there had been a Federal law. We wouldn’t have had the fuel economy unless there had been a Federal law, and there wouldn’t 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.

  26. College SportsJohn Fizel and Randall Bennett • History • Structure • Conduct • Performance • Public Policy

  27. 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

  28. 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

  29. 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?”inEconomics 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)

  30. 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?

  31. 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).

  32. 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.

  33. 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.

  34. 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

  35. 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.

  37. 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.

  38. 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.

  39. 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)

  40. 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

  41. 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?

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