Industrial Organization: contemporary theory
and practice (3rd edition)
Lynne Pepall
Dan Richards
George Norman
Industrial Organization: Chapter 1
1
Introduction
• How firms behave in markets
• Whole range of business issues
– price of flowers; payment to be official sponsor of
major events
– which new products to introduce
– merger decisions
– methods for attacking or defending markets
• Strategic view of how firms interact
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• How should a firm price its product given the
existence of rivals?
• How does a firm decide which markets to enter?
• Incredible richness of examples:
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Microsoft/Netscape/Sun
ADM (collusion)
Toys R Us (exclusive dealing)
American Airlines (predatory pricing)
Merger wave
• At the heart of all of this is strategic interaction
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• Rely on the tools of game theory
– focuses on strategy and interaction
• Construct models: abstractions
– well established tradition in all science
• physics
• engineering
– are SUVs safe?
– Do seat-belts/Volvos save lives?
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The New Industrial Organization
• The “New Industrial Organization” is something of
a departure
– theory in advance of policy
– recognition of connection between market structure and
firms’ behavior
• Contrast pricing behavior of:
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grain farmers at first point of sale
gas stations: Texaco, Mobil, Exxon
computer manufacturers
pharmaceuticals (proprietary vs. generics)
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• Do not say much about the internal organization
of firms
– vertical organization is discussed
– internal contracts are not
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Anti-trust Policy: an overview
• Developments in modern IO are sensitive to the
policy context
– Microsoft and ADM
• highlight aspects of developments in policy/law and economic
theory
• Need for anti-trust policy recognized by Adam
Smith (1776)
– “The monopolists, by keeping the market constantly
understocked, by never fully supplying the effectual
demand, sell their commodities much above the natural
price.”
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– “People of the same trade seldom meet together, even
for merriment or diversion, but the conversation ends in
a conspiracy against the public, or in some contrivance
to raise prices.”
• Sherman Act 1890
– Section 1: prohibits contracts, combinations and
conspiracies “in restraint of trade”
– Section 2: makes illegal any attempt to monopolize a
market
– contrast per se rule
• collusive agreements/price fixing
– rule of reason
• “unreasonable” conduct
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• Clayton Act (1914)
– intended to prevent monopoly “in its incipiency”
– makes illegal practices that “may substantially lessen
competition or tend to create a monopoly”
• Federal Trade Commission established in the same
year
• However, application affected by rule of reason
– proof of intent
– “the law does not make mere size an offence or the
existence of unexerted power an offence - it does not
compel competition nor require all that is possible.”
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• Robinson-Patman (1936)
– prohibits price discrimination that is intended to lessen
competition
– intended to prevent aggressive price discounting
• The Alcoa case (1945) was also important
– 90% market share
– expanded capacity in advance of market expansion
– inferred anti-trust violation from structure and conduct
without overt evidence
• More relaxed attitude in last two decades
– emergence of large firms: merger waves
– importance of global competition
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The New Industrial Organization
• Dissatisfaction with the structure-conductperformance approach
– collect profit data on firms in an industry
– explain differences using information on size,
organization, R&D, financial leverage etc.
– but what is the direction of causation?
• The “old” IO has limited treatment of product
differentiation
– representative firm, little strategic interaction
• New IO: strategic decision-making (Hotelling)
– scheduling of “blockbuster” and Disney movies
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