Industrial Organization
Exam One
Friday, April 25
Spring 2008
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. Deficiency payments, countercyclical
payments, and target prices
a. aid to farmers without
generating surpluses
b. if market price is below
target price, farmers receive payment
c. payment based on acreage
and historic levels of production
i. decouples aid from production decisions
ii. direct subsidy, not a per bushel subsidy
d. largest subsidies to
biggest farms
6. Agricultural Market Transition Act of 1996
a. "Freedom to
Farm"
b. transition payments
support income without affecting level of production
c. gradual elimination of
payments planned but not completed
i. plan to phase out farm subsidies
ii.
Congress granted emergency aid
7. Farm Security and Rural Investment Act of
2002
a. continuation of
support policies
b. government
payments remain a significant part of farm income
c. de-coupling of
payments and production
8. 2007 Farm Bill
a. Not passed into law as of Spring 2008
b. minor modifications proposed but basic structure continues
E. 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. 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. current prices are high due to strong world demand for
oil
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. 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
4. OPEC can not maintain prices, above a
certain level, in the long run
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 (
c. CFP [Total] (
6. Recent structural change
a. mergers of majors
b. vertical
integration of nationalized oil companies
A. Structure
1. many gasoline
stations,
2. differentiated
products
3. franchise
B. Conduct
1. local
interdependence and strategic behavior
2. game theory
a. strategies & payoffs
b. Nash equilibrium
c.
cooperative equilibrium
A. History
1. US Steel
a. mergers and control of the market
b. economies of scale
c. barriers to entry
d. pricing
2. Entry and oligopoly
B. Dominant firm price leadership
1. competitive fringe
and dominant residual demand
2. high prices and
profit
3. entry and market
share erosion
a. US Steel loses
dominant position
b. antitrust case
4. alternatives
a. limit pricing
i.
discourage entry
ii. trade-off : current profit or long-run earnings
b. oligopoly pricing
i.
coordination
ii. pricing formulas
iii. price fixing cases
C. Technological change
Diffusion and obsolescence
1. new plants use
new technology
2. old
plant-- optimal replacement time
3. slower
adoption of new technology
4. Minimills
a. electric
arc furnaces
b. new competitors
c. gain
market share at expense of old rivals
D. Labor
1. unions
share oligopoly profits
2. manufacturers
pass costs on to consumers
3. imports
grow
a. strikes
and fear of strikes
b. pricing
E. Import restrictions
1. Quotas
a. defined
by weight
b. foreign
producers switch to specialty steels
2. Antidumping measures
a.
selling below fair price
i. what is fair price?
ii. often politically determined
b. penalties
c. Byrd Amendment
i. Continued Dumping and Subsidy Act of 2000
ii. fines given to competing US firms
iii. steel industry major beneficiary
3. Recent Policy
a. 30%
tariff on imported steel Spring 2002
i. tax increase
ii. steel industry protected
(higher prices, profits, employment)
iii. consuming industries (autos, appliances, etc) hurt
b. trading
partners complain to WTO
c. WTO
declares these tariffs are illegal
d. US repeals tariffs December
2003
e. WTO declares Byrd
Amendment is illegal
i. US given time to remove act
ii. US
does not
iii. sanctions okayed on US exports
iv.
Congress removes Byrd Amendment
Industrial Organization and Public
Policy
Chuck Stull
Department of Economics
Kalamazoo College