Industrial Organization I

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Industrial Organization I

• Introduction

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Welcome to ResEc 732

• Who am I?
• Who are you?
• What is this course about?
• How will this course work?
• Course Overview

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Industrial Organization I

• Branch of Economics (Microeconomics)
• Study of markets (i.e. supply and demand)
• In Europe Industrial Economics
• Also Market Economics/Organization
• Some markets belong to other fields
• Labor, international, finance (applied micro)

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Industrial Organization I

• Focus on supply
• Strategic interaction among firms (price,
  advertising, product introduction)
• Imperfections monopoly, oligopoly, market power
• Factors that contribute to imperfection
  transaction costs, product differentiation, sunk
  costs.
• Regulatory intervention
• But, certain analysis require sophisticated
  demand models

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Industrial Organization I

• An IO branch theory of the firm (organization
  economics)
• Firm size
• Boundaries of the firm
• Transactions within a firm

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Industrial Organization I

• Theoretical IO
• Supply parameters (e.g. costs) and demand
  parameters (e.g. elasticity) are assumed to be
  exogenous
• Focus on market equilibrium. E.g.
• Equilibrium P and Q
• Optimal advertising levels
• Entry decision

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Industrial Organization I

• Theoretical IO
• Assumptions to simplify reality (often extreme).
  E.g.
• Utility of consuming 1 unit is x (for the whole
  population)
• Objectives Mathematical simplification to
  obtain broad qualitative predictions, e.g.
• A price increase reduces quantity demanded
• Entry decreases prices

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Industrial Organization I

• Empirical IO
• 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 Quantitative estimates of a particular
  strategy/action or status quo. E.g.
• Price elasticity ( ? P ? ? Q?)
• Market power (P- MC)
• Welfare effects of product introductions

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Industrial Organization I

• Focus of the Course
• Study market imperfections
• Price discrimination
• Oligopoly models (Bertrand/Cournot)
• Collusion
• Costly entry/exit
• Vertical control
• Product differentiation
• Market power
• Advertising

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Industrial Organization I

• Focus of the Course
• Theory
• Main theoretical models and predictions are
  formally presented
• Empirics
• Empirical papers and applications (WSJ) are
  presented and discussed in class

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Class Format

• Syllabus
• Contact
• Required texts
• Shy, 1995 IO theory
• Carlton and Perloff, 2005 (4th edition), 3rd is
  fine
• Supplemental texts
• Tirole, 1988, main theory IO reference
• Waldman and Jensen, 2005 (undergrad ref)

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Class Format

• Syllabus
• Website
• http//courses.umass.edu/resec732/

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Class Format
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Class Format

• Syllabus
• Grades
• Exams
• 2 midterms (March 13, April 22), 40 (25-15)
• Final (cumulative) 25
• Homework 4 assignments (15)

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Class Format

• IO in WSJ (10)
• 1 short 8-minute presentation (each student), 7
• Every Tuesday, starting Feb. 12 (1 student each
  week)
• Choose an important article from previous week
  (Tuesday-Monday)
• Summary and IO ideas/concepts
• 3 quick fire round of non-presenters (every
  other Thursday, I will remind you)

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Class Format

• Journal Article presentation (10)
• Present and write a report on article relevant to
  the class (I will assign these)
• 25 minutes, PPT
• Main ideas of the paper motivation, methodology,
  contribution, results, limitations, further
  research
• 65 presentation (my evaluation and others), 30
  report (2 pages), 5 participation
• I will let you know which paper you are
  presenting and when.

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Class Format

• Other details
• Syllabus may change as we move through topics.
• I will announce changes on course webpage.

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Class Overview

• Introduction
• Firm and costs
• Pricing with market power price discrimination,
  bundling
• Vertical control

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Class Overview

• Oligopoly Bertrand, Cournot
• Barriers to entry and entry deterrence
• Product differentiation
• Market power (empirical approaches)

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Class Overview

• Advertising
• Other topics peak-load pricing, durable goods,
  price dispersion
• Applications

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Industrial Organization I

• A Brief History

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A Brief History

• The Early Period (1800s early 1900s)
• 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 1900s

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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)

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Brief History

• First Empirical IO Wave (continued)
• Structure sellers buyers, barriers to entry
• Conduct type of price/advertising competition
• Performance profits, social welfare, variety
• OLS profitf(concentration)
• Concentrationbad for consumers anti-trust
• Weakness Market Structure endogenous

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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

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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, empirics
  struggle with finding testable hypotheses

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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)

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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

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The Modern Theoretical and Empirical Work (topics)

• Differentiated Product Markets (Choice product
  characteristics, mergers)
• Entry Models
• Vertical Contracts
• Advertising
• Price Dispersion/Discrimination
• RD
• Dynamic Analyses (entry, investment, inventories)