Industrial Organization

1. Industrial Organization Introduction

2. Day 1 • Introduction – survey, getting to know each other • What is this course about? • How will this course work? • Course Overview

3. Industrial Organization • Focus on supply and market power: • Strategic interaction among firms (e.g. price, advertising, product introduction) • Imperfections: monopoly, oligopoly, etc. • Factors that contribute to imperfection: e.g. technology, transaction costs, product differentiation. • But, certain analysis require sophisticated demand models

4. Industrial Organization • “Organization Economics”: An IO branch dealing with the theory of the firm: • Firm size • Boundaries of the firm • Transactions within a firm • Will not address this

5. Industrial Organization • Theoretical IO: • Supply parameters (e.g. costs) and demand parameters (e.g. elasticity) exogenous • Focus on market equilibrium. Examples: • Ex: Equilibrium P and Q, advertising levels, entry • Assumptions to simplify reality (often extreme). • Ex: All consumers are identical • Objectives: Mathematical simplification to obtain broad qualitative predictions (comparative statics): • A price increase reduces quantity demanded • Entry decreases prices

6. Industrial Organization • Empirical IO (structural approach): • Consumers’ and firms’ actions are observed: quantity, price, advertising are data • A theoretical model of demand and supply is assumed • Model parameters are estimated (econometrics) • Objective: Estimates of a particular strategy/action, status quo, or cunterfactual. Ex: • Price elasticity (% Δ P → % Δ Q?) • Market power (P-MC) • Welfare effects of product introductions

7. Industrial Organization • Focus of the Course: • Study market imperfections (market power) • Monopoly (pricing strategies), oligopoly models, collusion, vertical issues, product differentiation, advertising, entry

8. Industrial Organization • Focus of the Course: • Theory: • Main theoretical models and predictions are formally presented • Empirics: • Empirical papers and examples presented and discussed in class • Projects

9. Class Format Syllabus: http://courses.umass.edu/resec732/index.shtml • Contact: email • Reading material: scanned for you to print • PPT: posted on website • Grades: • 3-4 Problem sets (theoretical exercises) • 3 Class projects (price discrimination, demand estimation, merger) • Project proposal

10. Industrial Organization A Brief History

11. 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

12. Brief History • The Rebirth of Theoretical IO (1930-1950): • Chamberlin (1933): monopolistic competition and product differentiation; endogenous N • First Empirical IO Wave (1950-1980), little theory: • STRUCTURE-CONDUCT-PERFORMANCE paradigm (Mason, 1939, 1949)

13. SCP Approach (1950-1980) Basic Conditions: Technologies, Price Elasticity, Available substitutes, Type of Good, Location, Raw Materials Market Structure: # of Sellers and buyers, product differentiation, barriers of entry and exit, vertical integration HHI or C4 Conduct: Pricing strategies, product introduction, advertising, R & D, mergers, collusion Margin (P-MC) Performance: Profits, market share, production efficiency

14. SCP approach (1950-1980) • First Empirical IO Wave (continued): • Bain (1956): Regression analysis on Census (industry) data If β1>0, then concentration=high prices=profit=bad for consumers: anti-trust • Hundreds of results published • Weaknesses: • No theory (usually) • Market Structure endogenous

15. SCP approach (1950-1980) • 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 (i.e. no game theoretical models) • Mostly descriptive battle with S-C-P people Omitted variable

16. Brief History • Theoretical IO Lives again (1980-1990): • Game theory dominates the field • Understanding of strategic behavior with few players. • It is also a key component in empirical work • Theory predicts “too many” outcomes, • Example: folk theorem • Empiricists struggle with finding testable hypotheses

17. 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)

18. The Modern Empirical Work • Main Objectives: • Estimate parameters of a model of equilibrium behavior • Answer a (policy) question / test a model • Methods vary by industry, question and data available • Understand the industry • Collect data • Choose theory

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

20. 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)

21. Example : Nevo (2000)

22. 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)

23. Examples of Modern (Structural) Empirical Work • Optimal pricing strategies (project 1) • Measuring market power • Degree of market imperfection • Collusion • Product introductions (welfare measures) • Vertical integration (effects of) • Vertical contracts: franchising, exclusive contracts (anticompetitive?) • Dynamic Analyses (entry, investment, demand inventory)