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Lecture 1Introduction
L12418 Industrial Economics
Dr Matthias Dahm
January 2014University of Nottingham
School of Economics
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L12418 Industrial Economics
Lecturer: Dr Matthias Dahm
Office hour in SCGB B47: email for appointment(but most weeks Wednesdays 11-12 a.m.)
Teaching methods
18 Lectures
Tue. 11 a.m. (LASS-B63) & Wed. 10 a.m. (LIFESCI B3)
slides: will be available on Moodle before lecture
3 Tutorials: weeks 23, 25 and 27 - sign up via Moodle
Alex Possajennikov teaches some tutorials
aim is to deepen understanding of material via exercises
aim is to make students think – some exercises are challenging
students are expected to prepare answers before the tutorials
tutorial sheets/solutions: will be available on Moodle
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L12418 Industrial Economics
Method of assessment: 2 hour written exam (100%)
answer two questions (one compulsory, one out of three)
previous examination papers and feedback for all modules canbe viewed online in Moodle
feedback exercises toward the end of the module
Marking criteria
questions have analytical & theoretical part
answers should be rigorous and show modeling skills
requires to work through the exercises
answers should show perspective on module content
requires to do the reading assignments
Pre-requisite: L12302 Microeconomic Theory
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L12418 Industrial EconomicsModule Texts
PRN Pepall, L., Richards, D. & Norman, G. (2010).Contemporary Industrial Organization: a quantitativeapproach. Wiley.
LWG Lipczynski, J., Wilson, J.O.S. & Goddard, J. (2013).Industrial Organization: competition, strategy, policy.4th edition. Pearson.
M Martin, S. (2010). Industrial Organization inContext. Oxford University Press.
CW Church, J.R. & Ware, R. (2000) Industrial Organization: A StrategicApproach. McGraw-Hill.Available at: http://works.bepress.com/jeffrey_church/23
CP Carlton, D.W. & Perloff, J.M. (2005). Modern IndustrialOrganization. 4th edition. Pearson Addison-Wesley.
C Cabral, L.M.B. (2000). Introduction to Industrial Organization. MITPress.
BP Belleflamme, P. & Peitz, M. (2009). Industrial Organization.Cambridge University Press.
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L12418 Industrial EconomicsAim of Module
Comprehensive and coherent overview of Industrial Economics
Empirical and theoretical approaches (but emphasis on latter)
Topics may include:
Market StructuresFrom Perfect competition to Monopoly via Oligopoly, includingProduct Differentiation
Strategies and Conduct of FirmsCollusion; Price discrimination; Entry deterrence; Verticalrelationships; Advertising; Research & Development
Regulation of IndustriesRegulation of monopolies; Antitrust laws; Public policy
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What is Industrial Economics?
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What is Industrial Economics?BBC on 16 January 2014 “Labour to force bank break-ups”
Labour officials say:
“. . . Britain has one of the most concentrated banking systemsin the world, with just four banks controlling 85% of smallbusiness lending. . . excessive market power of banks”
“. . . break up of the UK’s largest retail banks. . . ”
“. . . create two new large banks to challenge the existing bigbanks. . . ”
“. . . expect the new challenger banks to each have at least 6%of the personal current account market. . . ”
“. . . A new maximum threshold for market shares which wouldtrigger future CMA investigations if banks grow above thatsize. . . ”
“. . . and an automatic ban on any takeover that created abank bigger than the threshold.”. . . ”
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What is Industrial Economics?BBC on 16 January 2014 “Labour to force bank break-ups”
Bankers say:
“. . . this would lead to what they call a perverse outcome. . . asthey approached the maximum size they would dumpcustomers they deemed low quality or loss-making. . . ”
The governor of the Bank of England, Mark Carney says:
“. . . just breaking up an institution doesn’t necessarily create amore intensive competitive structure... It’s not just about oneaspect. You need to look at the entire business model and riskprofile.”
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What is Industrial Economics?BBC on 16 January 2014 “Labour to force bank break-ups”
Key questions:
What is the relationship between market structure andeconomic performance?
If we observe that there are only a few large banks, can weconclude that they have excessive market power?
LWG p. 18: Case study on market structure and performance inEuropean banking.
PRN p.14:
“The reason we study industrial organization is tounderstand market competition in all its dimensions andto develop appropriate public policy when the marketimperfections in that competitions yield unsatisfactoryoutcomes.”
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What is Industrial Economics?
Industrial Economics is a synonym for Industrial Organization
The study of real world markets:
market for operating systems
computer ship market
soft drink market
. . .
These are not markets with numerous small firms
The perfectly competitive model does not apply
Industrial Economics is the study of imperfect competition
Industrial Economics provides the basis for regulation andcompetition policy
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How do we study Industrial Economics?Who won last year’s Nobel Prize in Economics?
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How do we study Industrial Economics?Jean Tirole’s approach (Royal Swedish Academy of Sciences)
“He has created a unified framework for IO theory andregulation, founded on a rigorous analysis of strategicbehavior and information economics”
“By deploying a consistent conceptual framework over a widerange of issues, he became a leader in the creation of the firstencompassing and coherent theory of IO”
“his rigorous thinking has overturned previous conventionalwisdom”
“Tirole has shown how the justifications for publicintervention frequently boil down to problems of informationasymmetries and credible commitments. These general lessons- together with a catalogue of specific applications - form arobust foundation for policy analysis”
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How do we study Industrial Economics?
Formal mathematical modeling allows
careful thinking about complex world
to see how each assumption influences the outcome
to derive testable predictions
Game theory allows
analysing strategic interaction between firms
when decisions are interdependent
Tool kit contains different models, as markets are different:
a few large firms or one large and several small firms
differentiated products or identical ones
price competition or non price competition (like advertising)
. . .
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“Traditional Industrial Organization”
The field of industrial economics emerged:
Context of antitrust policy in U.S.
Tried to give guidelines to competition policy
Aimed to make coherent argument to guide legal decisions
E.g. did U.S. Steel abuse monopoly power (1920)?
Can one infer illegal behaviour from firm size or structure?
“Traditional Industrial Organization” was based on thestructure-conduct-performance paradigm
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The structure-conduct-performance paradigm
Seminal early contributions (after 1930):
Identify links between market structure and market outcomes
Obtain data on prices, profits and market structure
Identify statistical relationships between structure andperformance
Basic principle:
There is a spectrum of market structures
At opposite ends are monopoly and perfect competition
All markets lie along this spectrum
Determine from observable evidence whether industry inquestion is closer to monopoly or perfect competition
Provide road map for policy, like by how much raises a bitmore concentration prices above costs?
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The structure-conduct-performance paradigm
Lipczynski, Wilson and Goddard, Industrial Organization PowerPoints on the Web, 4th edition © Pearson Education Limited 2013
Slide 1.2
Figure 1.1 The structure–conduct–performance paradigm
LWG, Figure 1.1
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The structure-conduct-performance paradigm
Lipczynski, Wilson and Goddard, Industrial Organization PowerPoints on the Web, 4th edition © Pearson Education Limited 2013
Slide 1.2
Figure 1.1 The structure–conduct–performance paradigmLWG, Figure 1.1
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Main criticisms of the SCP paradigm
1) Empirical findings can be interpreted in different ways.
SCP researchers produced vast amount of empirical findingslike firms with large market shares tend to earn greater profit.
SCP researchers: collusion hypothesisthe higher market share, the greater monopoly power, thehigher profit
Chicago school: efficiency hypothesisSome firms have superior technology and talent (are moreefficient, as costs lower) and have thus both larger size andhigher profits
Implies: punishing largest firms means punishing success
Cournot model in which costs differ across firms supportslatter view
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Main criticisms of the SCP paradigm
2) Strategic interaction has important role.
The nature of rivalry between firms determines marketoutcomes
Even markets with only two firms can produce verycompetitive outcomes
Bertrand model supports latter view
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Main criticisms of the SCP paradigm
3) Structure is itself endogenous.
Conduct affects structure: e.g. firms deciding to mergegenerate higher concentration
Performance affects structure: e.g. firms making losses haveto exit the market
The direction of causality is not clear
Market structure is not exogenous and treating it as suchleads to misspecification of regressions and biased orinconsistent results
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Main criticisms of the SCP paradigm
4) There are measurement issues.
Performance: accounting profit vs economic profit
Definition of the relevant market
Variables might belong to several categories (e.g. productdifferentiation is structure or strategy and thus conduct?)
Quantification of variables (e.g. how do we quantifycollusion?)
. . .
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Beyond the SCP paradigm
Although SCP paradigm is useful in a number of ways (e.g. toorganise information or even to organise the analysis . . . ),the response to the criticisms was recognition that structure is notthe most important determinant of the level of competition.Instead:
examine the logic and reasonableness of a firm’s conduct
explore strategic behaviour on a consistent basis
at the same time an analytic framework for examiningstrategic interaction emerged: Game theory
development of theories that focus primarily on strategy andconduct
field has been transformed, some call it: “New IndustrialOrganization”
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Main source for lecture today
Pepall, L., Richards, D. & Norman, G. (2010). ContemporaryIndustrial Organization. Wiley.Chapter: 1
Lipczynski, J., Wilson, J.O.S. & Goddard, J. (2013). IndustrialOrganization. 3rd edition. FT Prentice Hall.Chapter: 1
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