Industrial Organization 
Exam One
Friday, April 25
Spring 2014


 

I. Introduction

    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

II. Agriculture

    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

    E. Recent Agricultural market movements

        1. price

        2. oil prices

        3. demand in rapidly growing economies

        4. ethanol policy

    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

III. Oil

    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 US production
        3. Import restrictions
            a. quota allocated by "tickets"
            b. preferential treatment for small refiners
            c. caused more rapid depletion of US oil reserves
        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 Middle East

IV. Oil Refining

    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 Texas, California
                -- 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

V OPEC

    A. Organization of Petroleum Exporting Countries
        1. founded 1960
        2. members
            i. Iran, Iraq, Kuwait, Saudi Arabia, Venezuela,
            ii. Algeria, Libya, Nigeria, Qatar, United Arab Emirates, Ecuador, Angola
        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. Saudi Arabia
                i. swing producer
                ii. vast reserves
            d.  concerted effort by  several OPEC nations or production change in Saudi Arabia could result in another crisis

            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. Saudi Arabia (1985)
                i. expands production to crash prices
                ii. discipline other members
            b. Iraq invades Kuwait (1990)
      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
   

 

VI Automobiles

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. US firms lose market share
        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. US quality improves
    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
        1. cartel
        2. monopsony
            a. employer has buyer power
            b. unions provide countervailing power
        3. transactions costs
        4. productivity

    B. History
        1. goals
        2. Antitrust
            a. early 20th century cases: Sherman Act applied to Unions
            b. Clayton Act (1914) exempts Unions
    C. Labor law
        1. Wagner Act (1935)
            a. National Labor Relations Act
            b. unfair labor practices
        2. Taft Hartley Act (1947)
            a. unfair union practices
    D. United Auto Workers
        1. Recognition & Sit-down Strike
            a. General Motors  1937
            b. Chrysler 1937
            c. Ford 1941
        2. Strategy
            a. identify "strike target"
            b. contract negotiation
            c. apply terms to rest of Big Three
        3. Rise and Fall with Big Three automakers
            a. membership decline
            b. transplants usually non-union
            c. Crisis
                i) cooperate with bankruptcy and restructuring
                ii) ownership stakes in Chrysler & GM
                iii) concessions
                    - no strike
                    - work rule flexibility
                    - Two Tier Wage system

VIII  Policy

A. Policy Analysis

B. Politics

            1. concentration of costs

            2. concentration of benefits

C. Good policies or bad policies?
            1. some bad policies can be enacted
            2. not all good policies are implemented

 



 

Industrial Organization and Public Policy

Chuck Stull

Department of Economics

Kalamazoo College