Industrial
Organization
Exam Two
Friday May 16
Spring 2008
.
I. Semiconductors
A. Characteristics
1. integrated
circuits on microchip
2. rapid
technological advance
3. Economies of scale
a. research and
development
b. set up
costs
B. Learning curves
1. production
process improves with experience
a. costs
inversely related to total production (over time)
b. marginal
cost may be substantially less than material costs
2. cost
advantage to industry leader
a. strategic
pricing
b. dominant
firm
3. limits
to learning curve advantage
a. eventual
flattening of learning curve
b. buyers
desire second source
c. spillover
d.
production constraints during early stages
II. Computers
A. Mainframes
1. product
differentiation
a.
incompatible systems
b. software
lock in
2. technological
change
3. economies
of scale
a. research
and development
b. high set
up costs
4. network
externalities
a.
usefulness increases with total number of users
b. advantage
to industry leader
5. Dominant firm
B. IBM
1. fast
second strategy
2. pre-announcement
of products
3. tying
4. price
discrimination
5. aggressive
response to entry
C. Antitrust case (IBM)
1. Sherman Act
Section two (monopolization)
2. filed
1969
3. dropped
1982
4. unresolved
issues
a. when is
pricing predatory
b. how much
power can a dominant firm use against rivals
D. Microcomputers
1. IBM late
entrant in market
2. chooses
open architecture
a. network
externalities
b. microchip
from Intel
c. operating
system from Microsoft
3. IBM market share peaks at 80%
4. entry
a. rivals
buy Intel chip, Microsoft software
b.
compatible computer
c. IBM's
market share erodes rapidly
5. hardware
manufacturing becomes very competitive
a. low cost
producers displace IBM
b. low
margin, commodity business
E. Microsoft
1. software
characteristics favor one dominant firm
a. large
economies of scale
i. high set up costs
ii. low marginal costs
b. network
externalities
2. conduct
a.
exclusionary licensing
b. technical
incompatibilities
c. tying
i. Word, Excel, Powerpoint
ii. Internet Explorer
d. pre-announcement
of programs
F. Antitrust (Microsoft)
1. consent
decree (1994)
2. monopolization
case (1998)
3. Microsoft found guilty of
violating Sherman Act
a. court
orders break up
b. appeal
c. break-up
reversed
d.
settlement (2001)
e. States
argue for stricter remedy (most cases settled 2003)
4. European antitrust case
a. similar grounds
b. Microsoft guilty:
large fine
5. Private cases
a. guilty finding
hurts Microsoft's defense
b. pays large dollar amonts to settle claims by several firms
III 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
5. elements of vertical integration
C. Economies of scale
1. standardization, specialization
2. set-up costs are high for body
stamping
3. advertising
4. service network
5. diseconomies of scale
D. Product differentiation
1. market segments
2. model years
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
IV. Airlines
A. Industry Conditions
1. moderate
concentration nationally
2. very high
concentration in some airports and routes
3. cyclical demand
a. recession
b. terrorist attacks
c. bankruptcy of major
carriers (reorganization)
d. Federal bail-outs
B. Vertical elements
1. Aircraft
a. duopoly
i.
Boeing
ii. Airbus
b. used market
c. large economies of scale
2. Airports and Air Traffic Control
a. public provision: FAA, State
and Local govt
b. taxes
3. Very limited vertical integration
a. reservations systems
b. baggage handling
C. Economic Regulation
1. Civil Aeronautics Board (1938)
a. response to
industry complaints about "destructive" competition
b. not a Natural
Monopoly
c. CAB determines
rates and service
i. high prices
ii.
high profits
iii. minimal competition
iv.
little entry
2. non-price
competition
a. each additional
passenger was very profitable
b. attract passengers
through service and quality
i. meals
ii.
stewardesses
iii. frequent flights
c. excess capacity
d. elevated costs
D. Deregulation
1. Airline Deregulation Act (1978)
a. eliminate price
regulation
b. allow free entry
c. eliminate CAB
2. Entry
a. 60 new carriers (by
1983)
b. expansion of
regional carriers
3. Prices fall
4. Hub and spoke network
a. efficiency gains
b. less convenient
for travelers
5. Quality falls
6. Price discrimination
a. "yield
management" systems
b. no arbitrage
c. very profitable
7. Frequent Flier programs
a. non-price
competition
b. principal agent
issue
E. Oligopolistic behavior
1. concentration
increased
a. mergers
b. failures
2. Price
leadership (AA)
3. Price coordination
through reservation systems
F. Contestable markets
1. assumes no
barriers to entry
2. fear of entry
would keep monopolist's prices low
3. influential
theory but not applicable broadly
4. Are airlines contestable?
a.
capital mobility (planes)
b. barriers to entry
i. slots
ii.
gates
iii. retaliation by incumbents
G. Predation
1. Strategic behavior aimed at causing
rivals to exit
2. Predatory pricing
a. pricing below cost
b. widespread
accusations in the airline industry
3. competing
theories
a. predation is
irrational
b. predation may be
rational, but it's too costly
c. reputation effect
i. predatory pricing as an investment
ii.
accept losses now
iii. discourage future competition
iv.
"irrational" behavior can maximize long-run
profits
4. American Airlines case
a. Legend airlines and
other low cost carriers
b. American's
aggressive response to entry
c. entrants fail
d. American raises
prices
e. Court finds
insufficient evidence
H. Open Skies
1. International
Competition
2. How open?
Industrial Organization and Public
Policy
Chuck Stull
Department of Economics
Kalamazoo
College