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Industrial Organization I

Industrial Organization I. A Brief History Price Discrimination. A Brief History. The Early Period (1800’s & early 1900’s) Cournot (1838) outlined theories of monopoly, competition and oligopoly Bertrand (1883) and Edgeworth (1897): no single theory, assumptions are crucial

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Industrial Organization I

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  1. Industrial Organization I A Brief History Price Discrimination

  2. A Brief History • The Early Period (1800’s & early 1900’s) • Cournot (1838) outlined theories of monopoly, competition and oligopoly • Bertrand (1883) and Edgeworth (1897): no single theory, assumptions are crucial • Marshall popularized supply curve and notion of partial equilibrium analysis. • Stagnant period in the early 1900’s

  3. Brief History • The Rebirth of Theoretical IO (1930-1950): • Chamberlin (1933): monopolistic competition and product differentiation; endogenous N • First Empirical IO Wave (1950-1960), little theory: • Regression analysis on Census (industry) data • STRUCTURE-CONDUCT-PERFORMANCE paradigm (Bain, 1956)

  4. Brief History • First Empirical IO Wave (continued): • Structure: # sellers & buyers, barriers to entry • Conduct: type of price/advertising competition • Performance: profits, social welfare, market share • Concentration=bad for consumers → anti-trust regulation • Weakness: Market Structure (concentration) is endogenous

  5. Brief History • The Chicago Critique (1960-1980): • Firms become big for particular reasons • More careful econometrics • Explains profitability with firm heterogeneity but does not treat oligopoly pricing • Mostly descriptive battle with S-C-P people

  6. Brief History • Theoretical IO Lives again (1980-1990): • Game theory dominates the field • Understanding of strategic behavior with few players. • Starts to become a key component in empirical work • Caveat: some theories predict “too many” outcomes, empirics struggle with finding testable hypotheses

  7. Brief History • Second Empirical IO Wave (1990-): • “New Empirical IO” (NEIO) • (Game) Theory and econometrics • Computationally intense, complex models • One industry at a time • IO economists differ in the methods used • Data sets more widely available (e.g. scanner data)

  8. The Modern Empirical Work • Main Objectives: • Estimate parameters of a model of equilibrium behavior (“structural work”) • Answer a (policy) question, test a model, create a counterfactual situation • Methods vary by industry, question and data available • Understand the industry • Collect data • Choose theory • Carry out empirical work

  9. Example • What is the effect of a merger? • Coordinated effects: is the new industry more able to collude? • Unilateral effects: less competitors means higher prices? • Efficiencies: bigger firm means reduced costs, better products • Other anticompetitive effects: more difficult entry, foreclosure

  10. Example : Nevo (2000) Kellogg: Corn Flakes, Fruit Loops, Krispix General Mills: Cheerios, Lucky Charms Quaker: Life, CapNCrunch Supply (Ω) Pre-Merger equilibrium Prices, Quantities, Advertising, etc. Demand (θ)

  11. Example : Nevo (2000)

  12. Example : Nevo (2000) Kellogg - General Mills: Corn Flakes, Fruit Loops, Krispix, Cheerios, Lucky Charms Quaker: Life, CapNCrunch Supply (Ω) Post-Merger equilibrium (?) Prices, Quantities, Advertising, etc. Demand (θ)

  13. Industrial Organization I Price discrimination

  14. Imperfect Competition and Market Power Price MC Producer surplus (PC) P* Demand QPC Q • Perfect competition: • Welfare is maximized, quantity is the largest and price is the lowest

  15. Imperfect Competition and Market Power Producer surplus Price MC P* Market power MC* Demand Marginal Revenue (MR) QIC QPC Q • With imperfect competition (monopoly, oligopoly): • Profit maximizing rule: MR=MC • At QPC: MC>MR, not optimal • QIC<QPC, price is higher and total welfare is lower

  16. Question • If there is market power: • Can firms do better than this? • Answer: yes, price discriminate

  17. Price Discrimination: Introduction • So far: • 1 price for all consumers • 1 price for all units purchased • Larger profits if: • Different consumers pay different prices (e.g. income, age, location, preferences) • Price per unit varies with quantity consumed

  18. Assumptions • Keys: • No arbitrage possibilities (for most PD cases) • Goods: high taxes or transportation costs, perishable products • Services (Restaurants, transportation, entertainment), e.g. student or senior citizen discounts (idcheck) • Market power (let’s assume monopoly for now)

  19. Assumptions • Price discrimination is legal • Firm has information on demand preferences • Ideally: all consumers’ exact willingness to pay • At least: “type” of consumer (e.g. age or income)

  20. Reasons for Price Discrimination • Firms with market power can do better • Consumers are different: willingness to pay varies (price sensitivity) • (Some) consumers receive a surplus with uniform pricing

  21. Classification

  22. Methods • Linear pricing: • Same price for all units purchased, but price differs by consumer type (“personalized” pricing) • Non-Linear pricing: • Take it or leave it package offer • x units of a good at package price “r” • Two-part tariff: • Fixed fee “A” • Per unit price “p” Can be “personalized” or not

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