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New Perspectives on Industrial Organization

With Contributions from Behavioral Economics and Game Theory

Authors: Victor J. Tremblay, Carol Horton Tremblay

Publisher: Springer New York

Book Series : Springer Texts in Business and Economics

Part of: Springer Professional "Wirtschaft+Technik" , Springer Professional "Wirtschaft"

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About this book

This book covers the main topics that students need to learn in a course on Industrial Organization. It reviews the classic models and important empirical evidence related to the field. However, it will differ from prior textbooks in two ways. First, this book incorporates contributions from behavioral economics and neuroeconomics, providing the reader with a richer understanding of consumer preferences and the motivation for many of the business practices we see today. The book discusses how firms exploit consumers who are prone to making mistakes and who suffer from cognitive dissonance, attention lapses, and bounded rationality, for example and will help explain why firms invest in persuasive advertising, offer 30-day free trials, offer money-back guarantees, and engage in other observed phenomena that cannot be explained by the traditional approaches to industrial organization.

A second difference is that this book achieves a balance between textbooks that emphasize formal modeling and those that emphasize the history of the field, empirical evidence, case studies, and policy analysis. This text puts more emphasis on the micro-foundations (i.e., consumer and producer theory), classic game theoretic models, and recent contributions from behavioral economics that are pertinent to industrial organization. Each topic will begin with a discussion of relevant theory and models and will also include a discussion of concrete examples, empirical evidence, and evidence from case studies. This will provide students with a deeper understanding of firm and consumer behavior, of the factors that influence market structure and economic performance, and of policy issues involving imperfectly competitive markets. The book is intended to be a textbook for graduate students, MBAs and upper-level undergraduates and will use examples, graphical analysis, algebra, and simple calculus to explain important ideas and theories in industrial organization.

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Table of Contents

Frontmatter

Introductory and Review Material

Frontmatter

Chapter 1. Introduction

Abstract

The field of industrial organization encompasses a host of intriguing questions. Why do cell phone companies charge a fixed fee for a given number of minutes and a high price for each additional minute? Why do firms produce a vast number of brands? If advertising persuades consumers to buy something, are they better off? If two large firms merge, is society better or worse off? What if one of the firms is failing? These are just a few of the questions that are addressed in the book.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 2. Demand, Technology, and the Theory of the Firm

Abstract

One of our goals is to understand the forces that influence firm behavior. The principal constraints derive from consumers (demand), nature (technology), and competitors. Demand derives from consumers who strive to maximize their utility or satisfaction within their budget and other constraints. When tastes are under the full control of consumers, firms take market demand as given. That is, demand is exogenously determined. This is the basis of consumer sovereignty—consumer preferences determine what firms produce.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 3. Introductory Game Theory and Economic Information

Abstract

Strategic decisions are an integral part of our daily lives. Game theory provides a foundation for analyzing strategy, and as such, is a vitally important subject. At work, you may need to decide whether it is worth it to put in extra hours to earn a bigger bonus than your colleagues. Strategic decisions are especially common in competitive games, such as chess, tennis, football, and the TV show Survivor. These are considered games because strategic interaction is important to success. That is, to decide your best course of action, you must consider how others are likely to behave. Two examples make this point clear.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 4. Behavioral Economics

Abstract

In the previous chapters we discussed introductory consumer, producer, and game theory. There, consumers and producers are assumed to be perfectly rational, meaning that they act to achieve a goal given their constraints. In particular, consumers obtain the most beneficial combination of products that they can afford, and firms produce the amount of their product that gives them the highest profit based on consumer demand, technological conditions, and rival behavior.

Victor J. Tremblay, Carol Horton Tremblay

Perfect Competition, Monopoly, Product Differentiation, and Market Structure

Frontmatter

Chapter 5. Perfect Competition and Market Imperfections

Abstract

Competition is a fundamental concept in a market economy. We can think of competition as firm rivalry, where one firm battles to gain a strategic advantage over its competitors. For example, General Motors and Ford have been competing with one another for over a century to produce better cars at lower cost and to create more catchy marketing campaigns. We can also think of competition as a type of market structure. Both concepts are important in industrial organization. In later chapters, we analyze various forms of competitive behavior. In this chapter, we review the market structure of perfect competition.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 6. Monopoly and Monopolistic Competition

Abstract

In this chapter, we discuss the market structures of monopoly and monopolistic competition. Unlike perfect competition which has many sellers, a monopoly market has just one seller. In this sense, it is the polar opposite of perfect competition.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 7. Product Differentiation

Abstract

In our discussion of monopolistic competition in the previous chapter, competing firms produced differentiated products. This occurs when firms sell products that vary slightly from one brand to another. Two loaves of wheat bread may be the same in every way except that one is thin sliced and the other is thick sliced. Although a Mazda Miata and Porsche 911 are both sports cars, they differ in terms of style, power, and fuel economy. This is in contrast to perfectly competitive markets, where products are perfectly homogeneous.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 8. Market Structure, Industry Concentration, and Barriers to Entry

Abstract

In economics, we normally classify markets into four market structures: perfect competition, monopoly, monopolistic competition, and oligopoly. In this chapter, we are interested in understanding why real markets are structured so differently. For example, most agricultural commodities approximate competitive markets, as they have many producers of homogeneous or nearly homogeneous goods. In contrast, the market of computer operating systems is nearly monopolized by Microsoft. In 2009, Microsoft Windows had a market share of approximately 92%, while its nearest competitor, Mac, had a market share of just over 5%.

Victor J. Tremblay, Carol Horton Tremblay

Oligopoly and Market Power

Frontmatter

Chapter 9. Cartels

Abstract

We have seen in previous chapters how equilibrium price is substantially higher in monopoly than in perfectly competitive markets. In this chapter, we begin to investigate how price and output are determined in oligopoly markets that lie between these polar extremes. There are two types of oligopoly models, those that assume cooperative behavior and those that assume noncooperative behavior. In this chapter, we focus on cooperative settings or cooperative games. In the next two chapters we discuss noncooperative models.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 10. Quantity and Price Competition in Static Oligopoly Models

Abstract

We saw in the previous chapter that there are two types of oligopoly models, those that assume cooperative behavior and those that assume noncooperative behavior. In Chaps. 10 and 11, we develop the classic models of oligopoly where firms behave noncooperatively. These models represent the most abstract material that is found in the book. Here you will see how some of the great figures in history have thought about the oligopoly problem.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 11. Dynamic Monopoly and Oligopoly Models

Abstract

Table 10.1 in the previous chapter identifies 12 classic models of oligopoly. In Chap. 10 we analyzed the static Cournot, Bertrand, and Cournot–Bertrand models. We also investigated the case where firms could choose whether to compete in output (as in Cournot) or price (as in Bertrand). These are labeled models M1–M4 in Table 10.1.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 12. Market Power

Abstract

In previous chapters, we discussed the static efficiency of markets from a theoretical perspective. We learned that a market is allocatively efficient when total (consumer plus producer) surplus is maximized and price equals marginal cost. A firm is said to have monopoly or market power when it can profitably raise price above marginal cost. Theory tells us that market power will be present in unregulated monopoly but not perfectly competitive markets. The extent of market power in oligopoly markets will depend on the specific characteristics of the market.

Victor J. Tremblay, Carol Horton Tremblay

Other Business Strategies

Frontmatter

Chapter 13. Product Design, Multiproduct Production, and Brand Proliferation

Abstract

One of the most important decisions a firm must make is the style and qualities that its product will possess. Up to this point, we have taken product or brand characteristics as given. The main reason for this is that it can take a considerable amount of time to come up with something innovative, such as a new style of automobile or a more powerful laundry detergent. Nevertheless, when developing a new car a firm must answer a number of design questions—should the company produce an economy or a sports car, should the body style be traditional or cutting-edge, should it have a front-wheel, rear-wheel, or all-wheel drive train.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 14. Price Discrimination and Other Marketing Strategies

Abstract

A perfectly competitive firm has no need for marketing. Price and firm demand are exogenously determined, making price competition impossible. Expensive advertising campaigns are unprofitable because advertising can have no effect on firm demand. The only thing the firm must decide is how much output to produce and bring to market.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 15. Advertising

Abstract

In consumer goods markets, advertising is almost as important as price competition. Every day firms bombard us with ads on television, radio, newspapers, billboards, and the Internet. A concern raised by critics is the amount of money spent on advertising. In the USA, for example, $280 billion dollars was spent on advertising in 2007. This amounts to about 2% of gross domestic product (GDP), money that could have been spent in other ways. Figure 15.1 plots annual advertising spending as a ratio of GDP from 1919 to 2007. The advertising/GDP ratio fluctuates over time but has hovered around 2% since the end of World War II.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 16. Advertising and Welfare

Abstract

In the previous chapter, we saw that approximately 2% of GDP is spent on advertising each year. For most of us, it is impossible to escape advertising, as it is found on television and radio, in movie theaters, and on the Internet. Advertising spending is especially prominent in consumer goods industries. The advertising-to-sales ratio exceeds 10% in many consumer goods industries, including liquor, perfume, and cosmetics, but is less than 1% in most producer goods industries, such as cement and industrial materials.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 17. Technological Change, Dynamic Efficiency, and Market Structure

Abstract

To this point, most of our discussion about economic performance has focused on static efficiency and assumed that technology is fixed. Yet economic growth requires that we make investments today to develop better products or new processes that lower the cost of production. Persistent long-run economic growth has led to a continued rise in our standard of living. For example, Elwell (2006) documents that from 1980 to 2004 that output per capita grew by about 2.3% per year in Great Britain and by about 2.0% in the USA, Japan, and other major European countries (Germany, France, Italy, and the Netherlands). Although these growth rates may seem inconsequential, a small increase in the growth rate can have a sizable cumulative effect. To illustrate, a 2% growth rate will double the standard of living in approximately 35 years, while a 3% growth rate doubles it in only about 23.5 years.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 18. Horizontal, Vertical, and Conglomerate Mergers

Abstract

The immediate and most dramatic way for a company to expand its size and influence market structure is to purchase another company. Historical examples abound. In the late 1800s, Standard Oil Company gained a 90% share of the petroleum market by purchasing more than 120 competitors. In the 1960s, ITT (International Telephone and Telegraph) became a diversified corporation by acquiring 52 domestic and 55 foreign companies, including such well-known businesses as Avis Rent-a-Car, Continental Baking (Wonder Bread), Hartford Insurance, and Sheraton Hotels. By 1968, ITT had become the 11th largest corporation in the USA. The recent financial crisis has forced a number of very large acquisitions. The largest of these occurred in 2008, with Bank of America purchasing Merrill Lynch, a provider of insurance and financial services, for $50 billion and Wells Fargo Bank purchasing Wachovia Bank for $15.1 billion.

Victor J. Tremblay, Carol Horton Tremblay

Economic Performance and Public Policy

Frontmatter

Chapter 19. Efficiency, Equity, and Corporate Responsibility in Imperfect Competition

Abstract

A crucial objective in industrial organization is to evaluate whether or not imperfectly competitive markets perform well from society’s perspective. As we discussed in Chap. 1, we focus on three dimensions of market performance: static efficiency, dynamic efficiency, and equity. Up to this point, we have spent most of our time discussing efficiency issues. We now begin this chapter with a review and assessment of what we have learned regarding imperfect competition and different types of inefficiency—market power (i.e., allocative inefficiency), X-inefficiency, rent-seeking behavior, and technological change (i.e., dynamic efficiency).

Victor J. Tremblay, Carol Horton Tremblay

Chapter 20. Antitrust Law and Regulation

Abstract

Laws and regulations touch nearly every aspect of our lives. Most states require children to wear a helmet when riding a bicycle. The US Department of Agriculture requires that your “cheese pizza” contain no more than 11% of a cheese substitute. Food containing more than one ingredient can be labeled “organic” only if at least 95% of its contents are organic. Your power company cannot raise its rates without regulatory approval.

Victor J. Tremblay, Carol Horton Tremblay

Chapter 21. Industry and Firm Studies

Abstract

In this chapter we use case studies to identify patterns of behavior that highlight what we have learned from studying industrial organization. We begin with an investigation of three US industries: brewing, cigarettes, and college sports. Rather than provide a comprehensive study of them, we focus on the most important forces that have shaped each industry and/or have influenced public policy. This will allow us to show how industrial organization theory is relevant and can help us understand reality.

Victor J. Tremblay, Carol Horton Tremblay

Backmatter

Title: New Perspectives on Industrial Organization
Authors: Victor J. Tremblay
Carol Horton Tremblay
Copyright Year: 2012
Publisher: Springer New York
Electronic ISBN: 978-1-4614-3241-8
Print ISBN: 978-1-4614-3240-1
DOI: https://doi.org/10.1007/978-1-4614-3241-8