Introduction to industrial organization / Luís M.B. Cabral. Author. Cabral, Luís M. B., (author.) Edition. Second edition. Published. Cambridge, Massachusetts. 1. Industrial Organization, ECON Introduction and Basic Microeconomics. 1 Introduction to Industrial Organization. Industrial Organization is the study of the. Industrial Organization - Matilde Machado. Introduction. 2. Syllabus of the course. 1. Introduction. 1. Concentration Measures. [Tirole ; Cabral ; Clarke pp.
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Introduction to Industrial Organization - Free ebook download as PDF File .pdf), Text File .txt) or read book online for free. Luis M. B. Cabral - Introduction to. Request PDF on ResearchGate | On Jan 1, , Stefan Bühler and others published Introduction to Industrial Organization (by Luis M. Cabral). Find all the study resources for Introduction to Industrial Organization by Luís M. B. Cabral.
One can say that the goal of industrial organization is to address the following four questions: This text is as up-to-date as possible. The name of the game is therefore to move down the learning curve as quickly as possible. Because quantity demanded decreases when price increases— and vice versa—it is common to append a minus sign before the value of the ratio given earlier. Let us go back to the. What are the rationality assumptions implicit in this equilibrium? The best way to model games with sequential choices is to use a game tree.
Based on this approach. In ten of these airports. Over the years. In areas where only one chain operates. ONdigital reacted by saying it also will provide free set-top boxes. One way is through legal protection from competition. Sun Jet. The latter have responded to this entry by engaging in an aggressive price war—to the delight of consumers. These would not necessarily be representative of what takes place in every market.
Protected industries are deregulated. To be sure. Imitation takes place. Fares on the route 7.
In American did manage to drive out three competitors: Patents expire. Creating market power is only one part of the story. Firm strategy may also play an important role in establishing market power. Japan deregulated its airline industry. In May Xerox developed the technology of plain-paper photocopying and patented it. Its competitors include ONdigital. What can incumbents do to maintain their position? The airline industry provides an example.
BSkyB introduced an aggressive package that includes a free set-top decoder box. For example. Further examples could be supplied. Skymark Airlines and Air Do entered a market that. By rent seeking. What Are the Implications of Market Power? In different chapters of this text. From a social welfare point of view—or from a policymaker point of view. To a great extent. High airfares. In addition to a transfer effect. From a social point of view. More generally.
One has two dead bodies in it. After Vanguard exited. The preceding discussion supports the view that market power. In the context of industrial organization. Why not? It depends on whom you ask. As soon as we go into the details and inquire into the individual items in which progress was most conspicuous. The threat never really materialized.
Like the Chicago school. This summer. Sun Microsystems. Public policy in this area can be broadly divided into two categories: It is examined in greater detail in chapter On the other side of the pond. The overall rationale is to prevent and remedy situations where market power may reach unreasonable levels. As was stated before. The Times followed very aggressive pricing strategies that nearly drove some of its rivals to bankruptcy.
Over the course of the next chapters. As Milton Friedman.
The previous two examples provide an idea of the variety of situations that may fall under the scope of public policy. Over a period of six or seven years. The claim is that. Because we all believed in competition 50 years ago. The Daily Telegraph. A couple of examples may help. Sun Microsystems and Netscape. Lee Raymond and Lucio Noto. Right now. It is their competitors. The OFT decided not to impose any penalty. Whereas the latter attempt to promote competition.
The goal of industrial policy is very different from that of regulation and antitrust. But together with the success stories. Part one provides some of the tools required for the study of IO: A frequent argument in support of industrial policy is the example of MITI. Within these. Part two deals with the extreme cases of monopoly and perfect competition.
In practice. Of particular importance is industrial policy. Insofar as industrial organization is the study of imperfect competition. Industrial policy is generally not favored by economists. Parts one and two are introductory in nature. Airbus is now competing head-to-head with Boeing. Industrial Policy In addition to regulation and antitrust or competition policy. As suggested at the beginning of the chapter. In chapter Causality also works in the reverse direction.
In chapters 9 and And higher prices have the performance implications discussed in the previous section. Underlying this system is the belief that there is a causal chain between the preceding different components: Throughout most of the text.
Alternative frameworks have been proposed for the same or similar purposes. Part six concludes the text by focusing on technology-intensive industries. It is best thought of as a guide that allows one to analyze and understand the workings of A Note on Methodology Most economists analyze industries with reference to a framework known as the structure-conduct-performance SCP paradigm.
These include price discrimination chapter Austrian school. Key Concepts. Chicago school. How about a second slice of pizza? Although one slice is the minimum necessary to survive through a movie. Figure 2. In this chapter. Imagine what would be the maximum price you would pay for one pizza slice. On the horizontal axis. Although this text is an introduction to industrial organization. Perhaps three dollars. If you were to buy a third slice. Pizza comes at a dollar a slice.
Putting all of this information together. How about a third slice? For most consumers. If you are going to watch a movie. On the vertical axis. Because the number of consumers is typically large. We can to do this in the following way. There are two things we can do with a demand curve. We start with the highest price for which anyone is willing to buy a slice of pizza and determine how many consumers would be willing to pay that much. This is the number of slices such that willingness to pay is greater than or equal to price.
From the individual demand curves of each consumer.
As in the case of an individual demand curve. Taking q as the dependent variable and p as the independent variable. The preceding analysis suggests that we can read the market demand curve in two ways. You would be willing to pay up to three dollars for one slice of pizza.
Then we consider a slightly lower price and ask the same question again. Because the pizza is the same in both cases. Alternatively, we can take p as the dependent variable and q as the independent variable.
Then the demand curve P q the inverse of D p gives the willingness to pay for the qth output unit. Demand Elasticity The demand curve indicates the quantity demanded at a given price. One practical question of interest is how much demand changes as a result of a price change. This is given by the slope of the demand curve, that is, the derivative of q with respect to p that is, the variation of q divided by the variation of p.
For example, the slope of the demand for oil depends on whether we measure price in dollars or in euros, and on whether output is measured in millions of barrels a day or thousands of barrels a day. The concept of demand elasticity allows the determination of how quantity demanded depends on price in a way that is not dependent on units of measurement.
Because quantity demanded decreases when price increases— and vice versa—it is common to append a minus sign before the value of the ratio given earlier. Cost analysis is important for a second reason. We begin this section by listing a number of important cost concepts: Marginal Cost MC: The cost of one additional unit. To illustrate all of these cost concepts, let us consider a very simple example, that of a small T-shirt factory.
The machine must be operated by one worker. The hourly wage paid to that worker is as follows: Finally, the machine—operated by the worker—produces one T-shirt per hour. Assuming that current output q is 40 T-shirts per week, we have the following: These cost values were computed for a particular value of output. However, both average cost and marginal cost depend on the value of output.
By computing the values of marginal cost and average cost for each value of output, we get the marginal cost and average cost functions. What is the use of all of these cost concepts?
Consider the following application. Moreover, Benetton is willing to buy as many T-shirts as the factory wants to sell at that price. Given this offer, should the factory operate on Saturday? It might seem that, for this reason, it is worth it to operate on Saturdays as well: What is relevant for the decision of whether or not to operate on Saturdays is the comparison between price and marginal cost, not the comparison between price and average cost.
It can be checked that, no matter what the output level is, price is below average cost. That is, no matter how much the factory produces, it will lose money. It follows that the optimal decision would be to not produce at all. Marginal cost is the appropriate cost concept to decide how much to produce, whereas average cost is the appropriate cost concept to decide whether to produce at all.
Box 2. For values of p greater than p, the optimal output level is given by the marginal cost function. More on this in section 2.
Opportunity Cost and Sunk Cost Opportunity cost is a very important concept in decision making. The total capacity of the machine is pens per day red or blue. At this point, an accounting consultant was hired to create a system of cost allocation across product lines.
What went wrong in the shutdown decisions? How do the concepts presented in section 2. The concept of opportunity costs is also referred to as imputed cost. Suppose that retail company X owns some real estate in downtown Chicago and is planning to use it to open a new store. Because company X already owns the property, no actual payment will be made. From an economic point of view, such opportunity costs should be taken into account when making a decision.
Another important cost concept in economics—and particularly in industrial organization—is that of sunk cost. A sunk cost is an investment in an asset with no. The owner of the plot did not own the rights to the minerals—the quarry did—but was entitled to a compensation for the loss of use of the land.
The quarry offered the farmer a compensation based on the value of the land used. The farmer further argued that this value underestimated his loss. The quarry, on the other hand, maintained that the farmer was using the wrong basis for compensation. No agreement was reached. The dispute was taken to arbitration and the tribunal ruled in favor of the quarry. The farmer did not accept the decision, however, and decided to take the case to court. What would your evidence be if you were called as an expert witness trained in economics?
In other words, a sunk cost is an asset with no opportunity cost. From the point of view of decision making, the main point is that sunk costs should not be taken into consideration in economic decisions. For example, suppose that a dam was built at a very high cost.
At the time of construction, the estimated cost of energy produced by the dam was Of these 10, 5 correspond to the amortization of the initial investment, and the remaining 5 to variable, recurrent cost.
Now suppose that, after completion of the investment, a new energy source is discovered that allows the production of energy at a cost of 7 per unit.
Should the dam be abandoned in favor of this alternative energy source? However, half the cost of 10 corresponds to a sunk cost: The cost of construction of the dam has already been incurred. For the purpose of actual decision making, the only relevant cost is the variable cost of 5 per unit. Because this is lower than 7, the dam should be used instead of the new energy source. To summarize:. Economic decisions should be based on the concept of economic cost.
Economic cost differs from actual expenditures in that it includes opportunity costs that do not correspond to actual expenditures, and excludes expenditures that correspond to sunk costs. It should be noted that whether a given cost is or is not sunk depends crucially on the time frame under consideration.
Let us go back to the T-shirt factory example. In computing average cost, we have included the weekly machine lease. Because the weekly lease is now a sunk cost, only the cost of labor should be included. More generally, it is important to distinguish between the short-run average cost function that excludes costs that are sunk in the short run and the long-run average cost function that includes all recurrent costs. Which one to use depends on the nature of each particular decision.
To conclude this subsection, it should be noted that, in the context of industrial organization, sunk costs are also important for their strategic commitment value.
For example, in industries where production capacity is largely a sunk cost, making such an investment may provide a credible commitment to be an industry player. The idea of commitment value is introduced in chapter 4. Economies of Scale and Economies of Scope A good characterization of the typical cost function in a given industry goes a long way toward enabling understanding of the structure of that industry.
If average cost is constant. We say there are economies of scope when the cost of producing outputs q1 and q2 together is lower than the cost of doing so separately.
First notice that. The value of MES is frequently expressed as a fraction of market size. One important characteristic of the top of a hill is that the terrain is level. What is the optimal output level. We say there are scale economies if average cost declines with output. Let us now consider. In newspaper publishing. In terms of the graph. From equation 2. Simplifying this expression. Basic Microeconomics 25 of the hill is zero.
Marginal revenue. In competitive markets. Increasing output by one unit thus implies that all units of output are sold at a lower price. This is intuitive: In a competitive market. If a function is concave.
Revenue is given by price times output: In summary: As we saw before. As the name suggests. This means the consumer receives a surplus of minus If we aggregate the surplus of each consumer who makes a purchase.
Just as justice is to law and health is to medicine. One important difference. Let us go back to the. But it is not only the consumer who gains from the transaction. Let us restate it using a different example. The total surplus measures the increase in value that results from production and trade. Consider a potential buyer of a personal computer who purchases an iMac.
For most practical applications. From the preceding analysis. In graphical terms. Take the case of personal computers. This is an implicit assumption when we consider a partial equilibrium analysis.
Of these consumers. So far.
This was especially true before the European deregulation process was initiated in the early s. Low productivity results from using excessive amounts of certain inputs or from using the wrong input mix. More important than having the right number of iMacs produced and sold. If resources were allocated from other sectors in the economy to the production of more iMacs. The area between the high marginal cost curve and the low marginal cost curve.
In some cases. For this reason. As we will see in the following chapters. One should also mention that.
In particular. We can summarize the preceding discussion by stating: It also measures the willingness to pay for the qth unit consumed. Total surplus. The demand curve measures the quantity demanded at a given price. By contrast. Opportunity costs should be taken into account in economic decisions.
Optimal output is obtained by equating marginal revenue to marginal cost. Marginal cost is the appropriate cost concept to decide how much to produce. More on this in chapters 16 and Assume now that you can sell as many chips as you make at the going market price per chip of p. You could sell the land. What is your cost function. Cigarettes U. Use a one-year planning horizon for this problem. Your facility has a maximum capacity of 10 million chips per year.
In addition. In addition to the cost of land. What is the average cost per train mile? What is the marginal cost per train mile?
To do so. Basic Microeconomics b. There are no other costs involved in this business. What is the marginal cost per passenger mile? What is the minimum price. What is the average cost per passenger mile? Based on these numbers. Until then. In January Old McDonald decided to start exporting processed tomato tomato pulp to Europe.
In December In addition to the machine cost. Old McDonald bought a machine capable of processing It is not expected that this price will change in the future. One accountant consulting for Old McDonald stated that as margins have declined drastically the farmer had better sell the machine right away and go back to producing unprocessed tomato. What would you advise Old McDonald to do? This machine has a useful lifetime of 2 years. Explain why or why not. In order to produce tomato pulp.
A few months later. At that time. Basic Microeconomics 33 2. What price generates the greatest revenues? You are risk neutral. You are not sure what bid your rival will submit. Call your bid B. Derive your marginal revenue schedule. This considerably decades or so. Is this a realistic assumption? We start this chapter by examining the arguments in favor of and against this basic assumption.
Much less so the third question. In general. How realistic is this assumption? In most modern corporations. Such contracts attenuate the agency problem of separation between ownership and management. Agency theory is the area of economics that deals with this class of strategic interaction. Because managers. At the opposite extreme. The board of directors has the discretion to appoint managers.
A critical result from agency theory is that.. For these reasons. At one extreme. Evidence from the U. On the independence of boards of directors. From a theoretical point of view. Under this solution. In the preceding example. Even if shareholders can and are willing to control managers.
Broadly speaking. The Firm Box 3. This reputation effect may help to provide managers with the proper incentives. These results are consistent with the following interpretation. What determines the relative composition of boards of directors? Consider the following empirical results: A board of directors is more independent the lower the number of insiders it includes. Insiders are those who either work in the company as managers or are otherwise close to the CEO. Outsiders are those who bear no relation to the company or the CEO.
The independence of the board of directors is the result of a negotiation process between the CEO and the shareholders.
Capital Market Discipline d Exercise 3. An example of this also from the banking industry. One possible answer is that the raider possesses information that shareholders do not: The idea is that. Lloyds TSB has acquired the reputation for being the most thrifty large bank in the world.
The idea is quite simple: Lloyds received a net return of Box 3. In that case. William R. Kenan Jr. Introduction to Industrial Organization is a rare commodity: Cabral manages to communicate difficult ideas precisely while keeping the focus squarely on issues that matter for the real world.
It is the ideal introduction for undergraduates, MBA students, or anyone else looking for a non-technical overview of the field. Cabral's Introduction to Industrial Organization is clear, precise, relevant, even fun. This delightful volume is your best choice for crisp and accessible coverage of IO theory. The second edition sparkles just like the first. This is a wonderful textbook: If you are looking for an intuitive treatment of industrial organization that is rigorous and yet doesn't bog you down in excessive detail, this is a great choice.
Luis Cabral's book covers all the basic topics in Industrial Organization in an easily accessible way. He has done the field a great service. Cabral introduces the theoretical ideas and frameworks of contemporary IO expertly, succinctly, and with flair.
Motivating examples and stylized facts bring the theories alive. The new edition of Introduction to Industrial Organization updates and improves the organization of the first, while keeping its expository charms. Public policy ch. Demand for differentiated products Competition with differentiated products Advertising and branding Consumer behavior and firm strategy Market structure and innovation incentives Diffusion of knowledge and innovations Innovation strategy Chicken and egg Innovation adoption with network effects Firm strategy Public policy.
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