Industrial Organization
Exam One
Friday, April 25
Spring 2014
A. Price
Fixing
1. incentive
a. monopoly profits
b. q* MC = MR
2. welfare
effects
a. loss in consumer
surplus
b. deadweight loss
3. Antitrust law
a. criminal conspiracy
to fix prices
b. fines and prison
terms
B. Structure
1. market
structures
a. monopoly,
b. oligopoly
c. monopolistic
competition,
d. competition
2. market
concentration
a. CR4
b. Herfindahl
Index
3. product
differentiation
C. Economies of scale
1. large firms
have lower average costs
2. indivisibilities
a. fixed costs
b. set-up costs
c. reserve equipment
3. specialization
4. dimensional
economies
a. geometry
b. volume to surface
area relation
5. minimum
efficient scale
6. large
economies of scale imply concentrated markets
7. welfare
tradeoffs
a. efficiencies from
large size
b. deadweight loss
from monopoly or collusive pricing
D. Economies of Scope
1. multiproduct
cost savings
a. share common
equipment
b. joint production
2. multiplant
economies of scope
a. inputs shared
across plants
i.
corporate functions
ii.
distribution channels
E. Vertical organization
1. vertical
chain of production
2. make or buy?
a.
spot markets
b. long term contracts
c. vertical
integration
3. Why lose the advantages of markets?
a.
asset specificity
b. the hold up problem
F. Limits to firm size
1. technological
advantages are exhausted after some point
2. At some point, increase in cost
of managing exceeds benefits of larger firm
A. Competitive market structure
1. 2 million farms
2. thousands
producing each crop
3. price takers
B. Market Conditions
1. demand is
inelastic
2. supply is
inelastic, in the short run
3. supply shocks are
common
4. price
volatility
C. Market dynamics
1. food demand grows
slowly
2. farm productivity
has grown rapidly
a. technological innovation
b. research and development
c. increased scale of
operation
3. long run decrease
in the real price of food
4. decrease in farm
employment and number of farms
D. Policy
1. goal: improve farm
incomes
2. cartels
a. Antitrust exemption
b. ineffective without
government enforcement
c. cooperatives and
market orders
3. Support prices
a. price floor
b. surpluses
c. non-recourse loans
i. loan
price
ii.
storage
iii. repay loan by giving crop to government
4. Surpluses
a. international
b. acreage restrictions
i. set asides
ii. idle land
iii.
Conservation reserve program
5. Decoupling
a. payment based on acreage
and historic levels of production
i.
separates or “decouples” aid from production decisions
ii. direct subsidy, not a per bushel subsidy
b. largest subsidies to
biggest farms
F. International Aspects
1. Import restrictions
a. quotas
b. tariffs
c. tariff quota
2. Export subsidies
3. GATT
a. reduce barriers to trade
b. convert quotas to
tariffs
c. reduce production
subsidies
4. WTO
a. ongoing
negotiations
b. reduce tariffs and subsidies
c. non-trade concerns
A.
Vertical chain of production
1. Crude Oil ,
Refining, Marketing
2. vertically
integrated majors
3. smaller
independents
B. Exhaustible natural resource
1. use depletes
reserves, reducing supply, increasing price
2. trade-off
between current sales and future sales
C. Common pool problem
1. rule of
capture
2. race to
exploit resource
3. over
investment in drilling
4. oil extracted
faster than optimal rate-- price falls
5. pressure
decreases-- less oil recovered
D. Market Conditions
1. demand is
very inelastic
2. supply is
inelastic
3. demand grows
over time and varies directly with income
4. new
discoveries increase supply over time (and old fields are depleted)
5. price
volatility
E. Policy
1. Depression era policy
a. increase price of
oil
b. restrict production
c. smallest producers
exempt from output restrictions
2. Depletion allowance
a. tax break for oil
producers
b. encouraged
3. Import restrictions
a. quota allocated by
"tickets"
b. preferential
treatment for small refiners
c. caused more rapid
depletion of
4. Import restrictions dropped
a. US supply decreased
b. US demand increased
i.
income growth
ii.
transportation change
c. increased
dependence on oil imports
d. majors increase
imports from
A. Products
B. Economies of scale
C. Structure
1. Standard Oil Trust
a. control of market
b. strategic behavior
against rivals
c. market share 90%
(1880)
2. Sherman
Antitrust Act (1890)
a. Section One
i.
illegal to restrain trade
ii.
outlaws price fixing, collusion
b. Section Two
i.
outlaws monopolization
3. Standard Oil break up (1911)
a. 34 separate
companies
b. including several
major oil refineries
-- Exxon, Mobil, Chevron, Amoco, Arco, Conoco, Marathon
c. pipelines and other
products
4. state
antitrust laws prevent Standard Oil from controlling
--
Gulf, Texaco, Unocal
5. Other majors
a. Shell
(Netherlands/Great Britain),
b. BP (Great Britain)
c. CFP [Total]
(France)
6. Recent structural change
a. mergers of majors
b. vertical
integration of nationalized oil companies
A. Organization of Petroleum Exporting
Countries
1. founded 1960
2. members
i.
ii.
3. cartel
to enhance price of oil
4. countries
nationalize ownership of oil production (throughout 1970s)
B. Oil Crisis
1. Yom Kippur War 1973
a. political
motivation for oil embargo
b. OPEC decreases
production
c. price increases
from $2.93 to $11.63
d. $100 billion
transfer from consuming nations to producers
i.
aggregate supply shock
ii.
inflation and recession
2. Iranian Revolution 1978
a. oil exports from
Iran stop
b. oil price increases
from $13 to $34
c. another
macroeconomic shock-- inflation, unemployment, wealth transfer
3. Another oil crisis?
a.
maturation and decline of non-OPEC reserves
b. conflict
in Middle East
c.
i. swing
producer
ii. vast reserves
d. concerted
effort by several OPEC nations or production change in
e. 2008 prices were high due to strong world demand for oil
f. recession decreased demand and prices fell.
g. economic recovery—prices rising
C. Cartel Behavior
1. incentive to
chisel
a. members increase
output to take advantage of high price
b. prices fall
2. punishment
a.
i.
expands production to crash prices
ii.
discipline other members
b.
3. Dominant firm price
leadership [model not covered 2014]
a.
competitive fringe and dominant residual demand
b.
high prices and profit
c.
entry and market share erosion
4. Complicating
factors
1. oil
is not homogeneous
2. OPEC nations have
different goals
3. OPEC controls only
part of the market
a.
other countries supply half world oil
b.
entry
c.
demand shifts
i. long run demand is more elastic
ii. energy efficiency and
conservation
5. OPEC can not maintain prices, above a
certain level, in the long run
A.
Oligopoly
1. "Big Three" market share peak: 94-98%
2. leading firms meet in
international markets
3. interdependence
4. transnational mergers and joint
ventures
B. Vertical chain of production
1. raw materials
2. parts and components
3. assembly
4. dealers and fleet sales
i. franchise
ii. long-term
contract
iii. separate
ownership gives dealers incentives to provide high quality service
5. elements of vertical integration
C. Economies of scale in auto industry
1. standardization, specialization
2. set-up costs are high for body
stamping
3. advertising
4. service network
5. diseconomies of scale
i. firms can be too big
ii. high
management costs
D. Product differentiation
1. model years
2. market segments
i. vertical differentiation
ii. horizontal
differentiation
3. features or fashion?
E. Cooperative Oligopoly
1. Price leadership
a. GM announces price
b. Ford and Chrysler match price
2. limited innovation
a. products
b. features
c. safety features
3. high union wages
4. low productivity
5. high profits
F. Industry Change (late '70s- early 80s)
1. Big Three become unprofitable
a. Chrysler bankruptcy
b. government bail out
2. macroeconomic effects
a. recession
b. inflation
i. interest rates
ii. COLA clauses
increased labor costs
3. oil prices
a. oil shock: recession and inflation
b. gasoline price increase-- demand for
small cars
i. less profitable
ii. more
imports
c. CAFE standards
4. imports
a.
b. Japanese producers become major
suppliers
i. higher productivity
ii. "just in time" inventory
iii. leaner management
iv. higher
quality
G. Import protection
1. voluntary export restraints
a. negotiated quotas
b. prices increase-- domestic and
imported
2. Japanese quality response
a. before quotas-- inexpensive, economy
class
b. after quotas-- midsize to luxury cars
3. transplants
H. Structural change
1. US firm close plants and layoff employees
2.
3. joint ventures
4. feature innovation
5. product innovation
a. minivans
b. SUVs
c. other new vehicle classes
6. more competition
a. emphasis on speed and flexibility
b. faster design times
c. vertical integration becomes
disadvantageous
I. Recent Problems
1. oil
prices
2. financial
crisis and recession
3. government
rescue: GM, Chrysler
a. bailouts
b. restructuring
i. bankruptcy
ii. new ownership
4. recovery
VI Unions
A. Theories
B. History
VIII Policy
A. Policy Analysis
B. Politics
1. concentration of costs
2. concentration of benefits
C. Good policies or bad policies?
Industrial Organization and Public
Policy
Chuck Stull
Department of Economics
Kalamazoo College