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Industrial Economics An-najah National Univ. Lecturer: Baker Shtayeh First Semester - 2013

Industrial Economics An-najah National Univ. Lecturer: Baker Shtayeh First Semester - 2013. Definitions of Industrial Economics “It is concerned with the workings of markets and industries, in particular the way firms compete with each other.” Luis Cabral (2000)

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Industrial Economics An-najah National Univ. Lecturer: Baker Shtayeh First Semester - 2013

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  1. Industrial EconomicsAn-najah National Univ.Lecturer: Baker ShtayehFirst Semester - 2013 Industrial Economics - Baker Shtayeh - 2012-2013

  2. Definitions of Industrial Economics “It is concerned with the workings of markets and industries, in particular the way firms compete with each other.” Luis Cabral (2000) “It is the study of the operation and performance of imperfectly competitive markets and the behavior of firms in these markets.” Church & Ware (2000) Industrial Economics - Baker Shtayeh - 2012-2013

  3. Definitions of Industrial Economics “…Moreover, whereas microeconomics typically focuses on the extreme cases of monopoly and perfect competition, industrial organization is concerned primarily with the intermediate case of oligopoly, that is, competition between a few firms.” (Cabral) Industrial Economics - Baker Shtayeh - 2012-2013

  4. Definitions of Industrial Economics “The main reason for considering industrial organization as a separate subject is its emphasis on the study of the firm strategies that are characteristic of market interaction: price competition, product differentiation , advertising, research and development, and so forth …” Industrial Economics - Baker Shtayeh - 2012-2013

  5. The importance of the industrial sector in the national economy: Industrial sector is increasingly important in the national economy and development, especially in developing countries, for several reasons: 1. The growth in the industrial sector can provide opportunities for employment. Most developing countries suffer from the problem of unemployment. Industrial Economics - Baker Shtayeh - 2012-2013

  6. The importance of the industrial sector in the national economy: 2. The industrial sector helps to increase the sources of production, income and exports in the developing countries. So, the importance of the industrial sector will rise as a percent of (GDP). This helps reducing the dependence on exporting row materials. Industrial Economics - Baker Shtayeh - 2012-2013

  7. The importance of the industrial sector in the national economy: 3. The industrial sector is a high productivity sector, because it is most able to apply the use of modern technology, and it can make use of specialization. The industrial sector is not affected by the law of diminishing returns as speed as the agricultural sector does. Industrial Economics - Baker Shtayeh - 2012-2013

  8. The importance of the industrial sector in the national economy: 4. The growth of the industrial sector contributes in raising the rate of economic growth in the national economy, because the growth of industrial activities helps to drive growth in other sectors, such as agriculture and services sector, because there is interdependent relationships between industry and other sectors. Industrial Economics - Baker Shtayeh - 2012-2013

  9. The importance of the industrial sector in the national economy: 5. Industrial sector provides the foreign exchange currency, and solves the payment balance deficit, through the manufacturing of goods to replace imports or manufacturing of goods for export to the outside. Industrial Economics - Baker Shtayeh - 2012-2013

  10. Industrial Strategies: Industrial strategies can be divided to several groups, according to: 1. Project ownership (Private or Public) The size of each of the private sector and public sector and the role of each sector in the growth of the industrial sector differs from one country to another for several reasons, including: Industrial Economics - Baker Shtayeh - 2012-2013

  11. Industrial Strategies:1. Project ownership (Private or Public) a. The economic system: Is it a capitalist, socialist or mixed economy. b. The stage of economic growth: With economic growth, the importance of the private sector increases, and raises its relative importance. Industrial Economics - Baker Shtayeh - 2012-2013

  12. Industrial Strategies:1. Project ownership (Private or Public) c. The type of industry (heavy or light): The private sector usually seeking for light industry, a consumer industries that do not require large amounts of capital, where the rate of profit is high, and the degree of risk is low. The heavy industries are usually government industries through public sector projects, as they require a huge volume of capital with high degree of risk, and they don not make quick profits. Industrial Economics - Baker Shtayeh - 2012-2013

  13. Industrial Strategies:1. Project ownership (Private or Public) d. The external economies and diseconomies of scale: The projects with high external economies of scale are highly social benefit projects than private benefit. The government usually gets involved to establish such projects or to regulate them, especially at the beginning of the development process. Industrial Economics - Baker Shtayeh - 2012-2013

  14. Industrial Strategies:2. The type of industry (heavy or light) a. Light manufacturing strategy: It is based on the consumer and light industries, such as: clothes, food. Then after that moving to intermediate-goods industries that produce inputs for other industries. Such as: spinning and weaving industry - Manufacture of building materials, fertilizers, and other. And finally transition to establish heavy industries such as machinery manufactures and equipment industries. This pattern of industrialization was followed by the Western industrial countries. Industrial Economics - Baker Shtayeh - 2012-2013

  15. Industrial Strategies:2. The type of industry (heavy or light) b. Heavy manufacturing strategy: It is based on starting and establishment of heavy capital industries, like machinery and equipment. This strategy believe that supply of such capital goods will generate demand in the future, because it will encourage the setting up of consumer and intermediate industries that use these machines and equipments. such a strategy relies mainly on the expected market in the future not on the current market . States that have followed this strategy are the socialist countries (Soviet Union). Industrial Economics - Baker Shtayeh - 2012-2013

  16. Industrial Strategies:3. The production technique (Labor or Capital Intensive) Production technique reflects the ratio of production factors use in the production process. Labor Intensive technique depends on using labor (relatively) more than using capital, and vice versa. That depends on many factors such as: • The relative prices of production factors. • Whether the industry is heavy or light. • The availability and ease of substitute the production factors (Labor and Capital) Industrial Economics - Baker Shtayeh - 2012-2013

  17. Industrial Strategies:4. The target market: a. The local market target (Import Substitution Industrialization) Local production of goods to replace the goods imported from abroad or that could be imported if we didn't produce. Industrial Economics - Baker Shtayeh - 2012-2013

  18. Industrial Strategies:4. The target market: The tools applied by developing countries to implement the strategy of import substitution: - Tariff barriers against imported consumer goods. - Reduce the cost of production of consumer goods through the reduction or elimination of tariffs on the import of machinery and equipments and production requirements for the manufacture of consumer goods. Industrial Economics - Baker Shtayeh - 2012-2013

  19. Industrial Strategies:4. The target market: Advantages of import substitution strategy: (arguments based on this strategy): - This strategy could help in treating the deficit in payment balance. - This strategy could help in reducing the unemployment rates. - This strategy is the easiest way to develop the industrial sector and increase its percentage contribution in economic activity, and to diversify the production structure in developing countries. Industrial Economics - Baker Shtayeh - 2012-2013

  20. Industrial Strategies:4. The target market: Disadvantages of import substitution strategy: - It could raise the market power, where some producers will make use of tariffs imposed on imports, which prices will be higher than before. - When this strategy was applied in most of developing countries, it found that it did not effectively reduce unemployment rates, because of wildly usage of capital intensive production techniques. - Most of developing countries that applied this strategy where failed in reducing the deficit in its payment balances, because of the increased demand on imports of machinery and equipment and production requirements for the manufacture of consumer goods. Industrial Economics - Baker Shtayeh - 2012-2013

  21. Industrial Strategies:4. The target market: b.The foreign market target (Export Oriented Industrialization Strategy) Some developing countries, especially where the local market constraints, have tended to follow this strategy, such as: South Korea, Taiwan, Singapore, Hong Kong and Malaysia. Industrial Economics - Baker Shtayeh - 2012-2013

  22. Industrial Strategies:4. The target market: The export oriented strategy is based on the following basis: • Encouraging foreign target industries, besides producing for the local market. • Encourage the participation of foreign investors, to take advantage of advanced technology, and to help in abroad marketing of products, and to participate in financing heavy export industries. • Laws and regulations encouraging foreign investment and providing the appropriate circumstances, such as providing low rate services and labor,free transfer of profits abroad and tax and tariff exemptions. Industrial Economics - Baker Shtayeh - 2012-2013

  23. Industrial Strategies:4. The target market: Advantages of Export Industrialization Strategy: • Expansion of production, which make benefit from economies of scale, reaching the optimal size of the project and thus lower the average cost per unit of product, which means high production efficiency. As we know, small size of the market is the most important constraint facing manufacturing in the developing countries. • It could raise the level of production efficiency and improve product quality, because of the competitiveness power. • It helps to encourage make benefit from comparative advantages for that developing countries, especially the availability of raw materials. • This strategy could help in treating the deficit in payment balance. • This strategy helps in diversifying the export structure, and not to rely on the raw materials export only. Industrial Economics - Baker Shtayeh - 2012-2013

  24. Industrial Strategies:4. The target market: Disadvantages of Export Industrialization Strategy: • Its dependence on foreign markets. • The high competition from the industrialized countries. - The establishment of strategic industries in developing countries is not easy. It requires conditions, such as tax and customs exemptions, Provision of basic services at low prices and economic and political stability, which are difficult to be captured in such countries. Industrial Economics - Baker Shtayeh - 2012-2013

  25. Introduction • The field of industrial economics developed as an offshoot of microeconomic theory. • Industrial economics emphasizes the behavior of firms as compared with the behavior of industries more than does traditional microeconomic theory. • The two traditional approaches to the study of industrial economics are: 1) The Structure – Conduct – Performance approach (SCP) 2) The Chicago School approach, which emphasize the use of price theory. • Modern industrial economics emphasizes the use of game theory to explore Oligopoly behavior. Industrial Economics - Baker Shtayeh - 2012-2013

  26. Introduction Usefulness of the (SCP) Model: • Provides a systematic way of analyzing markets & industries • Consistent with microeconomic theory’s approach • Policy implications for regulation & competition policy – targeting structure or/and conduct Industrial Economics - Baker Shtayeh - 2012-2013

  27. Introduction • Structure • Concentration – market power of firms measured by market shares (sales, assets, employees) • Product differentiation – uniqueness of products (brands, actual or imagined) • Size of firms – in relation to market size and minimum efficiency scale (& exploitation of scale economies) • Entry conditions – entry barriers that places potential entrants at a disadvantage • Vertical integration – extent of upstream-downstream integration of production Industrial Economics - Baker Shtayeh - 2012-2013

  28. Introduction 2. Conduct • Policy objectives – profit, growth, sales or non-financial objectives • Pricing objectives – price in relation to MC, or other types e.g. price discrimination, predatory pricing, penetration pricing, limit pricing etc. • Marketing strategies – product differentiation, advertising • Research and development – innovation activities (product, process) Industrial Economics - Baker Shtayeh - 2012-2013

  29. Introduction 3. Performance • Profitability (producer surplus) • Efficiency (scale of production) • Product Quality • Technical Progress (Innovation) Industrial Economics - Baker Shtayeh - 2012-2013

  30. Industrial Economics - Baker Shtayeh - 2012-2013

  31. Cost Theory and Estimation (Revew) • Empirical Estimation Functional Form for Short-Run Cost Functions Theoretical Form Linear Approximation Industrial Economics - Baker Shtayeh - 2012-2013

  32. Cost Theory and Estimation (Revew) Empirical Estimation Theoretical Form Linear Approximation Industrial Economics - Baker Shtayeh - 2012-2013

  33. Common Math Functions Used in Economics Industrial Economics - Baker Shtayeh - 2012-2013

  34. Graphical Concepts (Variable Relationships) • Y axis: a vertical line in a graph along which the units of measurement represent different values of, normally, the Y or dependent variable. • Y axis intercept: the value of Y when the value of X = 0, or the value of Y where a line or curve intersects the Y axis; = ‘a’ in Y = a + bX Industrial Economics - Baker Shtayeh - 2012-2013

  35. Graphical Concepts (Variable Relationships) • X axis: a horizontal line in a graph along which the units of measurement represent different values of, normally, the X or independent variable • X axis intercept: the value of X when the value of Y = 0, or the value of X where a line or curve intersects the X axis Industrial Economics - Baker Shtayeh - 2012-2013

  36. Graphical Concepts (Variable Relationships) • Slope: • = the steepness of a line or curve; a +(-) slope => the line or curve slopes upward (downward) to the right • = the change in the value of Y divided by the change in the value of X (between 2 pts on a line or a curve) • = Y/X = 1st derivative (in calculus) • = Y/ X using algebraic notation • = the ‘marginal’ effect, or the change in Y brought about by a 1 unit change in X • = b if Y = a + bX Industrial Economics - Baker Shtayeh - 2012-2013

  37. Market Structure • Market structure – identifies how a market is made up in terms of: • The number of firms in the industry • The nature of the product produced • The degree of monopoly power each firm has • The degree to which the firm can influence price • Profit levels • Firms’ behaviour – pricing strategies, non-price competition, output levels • The extent of barriers to entry • The impact on efficiency Industrial Economics - Baker Shtayeh - 2012-2013

  38. Market Structure • Market structure as Models • Market structure deals with a number of economic ‘models’ • These models are a representation of reality to help us to understand what may be happening in real life • There are extremes to the model that are unlikely to occur in reality • They still have value as they enable us to draw comparisons and contrasts with what is observed in reality • Models help therefore in analysing and evaluating – they offer a benchmark Industrial Economics - Baker Shtayeh - 2012-2013

  39. Market Structure • Characteristics of each model: • Number and size of firms that make up the industry • Control over price or output • Freedom of entry and exit from the industry • Nature of the product – degree of homogeneity (similarity) of the products in the industry (extent to which products can be regarded as substitutes for each other) • Diagrammatic representation – the shape of the demand curve, etc. Industrial Economics - Baker Shtayeh - 2012-2013

  40. Market Structure Features of the four market structures Industrial Economics - Baker Shtayeh - 2012-2013

  41. Market Structure Perfect Competition • Characteristics: • Large number of firms • Products are homogenous (identical) – consumer has no reason to express a preference for any firm • Freedom of entry and exit into and out of the industry • Firms are price takers – have no control over the price they charge for their product • Each producer supplies a very small proportion of total industry output • Consumers and producers have perfect knowledge about the market Industrial Economics - Baker Shtayeh - 2012-2013

  42. 3. The typical firm can sell all it wants at the market price… 1. The intersection of the market supply and the market demand curve… Price per Ounce Price per Ounce Ounces of Gold per Day Ounces of Gold per Day 4. so it faces a horizontal demand curve 2. determine the equilibrium market price Perfect Competition • The Competitive Industry and Firm Market Firm S $400 $400 Demand Curve Facing the Firm D Industrial Economics - Baker Shtayeh - 2012-2013

  43. Perfect Competition • Computing the Total Revenue of a Price-taker • Since the perfectly competitive firm faces a constant price, the shape of its total revenue is an upward-sloping line. Total revenue changes only with changes in the quantity sold. Industrial Economics - Baker Shtayeh - 2012-2013

  44. Perfect Competition • The Totals Approach to Profit Maximization • To maximize profit, a producer finds the largest gap between total revenue and total cost. Industrial Economics - Baker Shtayeh - 2012-2013

  45. Perfect Competition • Profit Maximization Using the Marginal Approach Industrial Economics - Baker Shtayeh - 2012-2013

  46. Perfect Competition • Profit Maximization Using the Marginal Approach • Profit per unit equals revenue per unit (or price) minus cost per unit (or average total cost).($25 - $14) = 11 • Total economic profit equals:(price – average cost) x quantity produced($25 - $14) x 9 = $99 Industrial Economics - Baker Shtayeh - 2012-2013

  47. Dollars Price per Bushel Bushels per Year Bushels per Year Perfect Competition • Short-run Supply Curve (b) (a) ATC Firm's Supply Curve MC $3.50 $3.50 d1=MR1 2.50 2.50 d2=MR2 2.00 2.00 d3=MR3 AVC 1.00 1.00 d4=MR4 0.50 0.50 d5=MR5 1,000 4,000 7,000 2,000 4,000 7,000 2,000 5,000 5,000 Industrial Economics - Baker Shtayeh - 2012-2013

  48. Perfect Competition A Market in Long-run Equilibrium • The quantity of the product supplied equals the quantity demanded • Each firm in the market maximizes its profit, given the market price • Each firm in the market earns zero economic profit, so there is no incentive for other firms to enter the market • A market reaches a long-run equilibrium when three conditions hold: Industrial Economics - Baker Shtayeh - 2012-2013

  49. Perfect CompetitionA Market in Long-run Equilibrium • In long-run equilibrium, price equals marginal cost (the profit-maximizing rule), and price equals short-run average total cost (zero economic profit). Industrial Economics - Baker Shtayeh - 2012-2013

  50. Monopoly • Monopoly is a situation in which there is a single seller of a product for which there are no good substitutes. • When a monopoly exists, there are generally high barriers to entry into the industry. • What are the reasons for these barriers? Industrial Economics - Baker Shtayeh - 2012-2013

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