Industrial Organization
Final Exam
Monday June 9, 2014

1:30 pm


 The final exam will be comprehensive.  You should review the material we covered for  Exam One and  Exam Two .  You will probably want a calculator for this exam.


 

I. Telecommunications

    A. Natural monopoly
        1. cheaper for one firm to serve market than for 2 or more firms
        2. large set up costs
        3. network externalities
            a. value to user increases as total number of users increase
            b. advantage to service with lead
        4. maintaining a large number of competing wire networks is not efficient
        5. natural monopoly not suited to break-up
            a. public ownership (Europe)
            b. regulation  (US)

    B. Regulation
        1. government approves telephone rates (prices), services, returns, investments
        2. Federal and State agencies
            a. FCC
            b. Public Service Commissions and Public Utility Commissions

    C. AT&T
        1. vertically integrated regulated monopolist
            a. Bell Labs (research)
            b. Western Electric (manufacturing)
            c. Long lines department (long distance telephone service)
            d. local operating companies (local phone service)
        2. only local service was true natural monopoly
            a. firms tried to enter other sectors
            b. AT&T responds aggressively
                i. selective price cuts
                ii. denies connection to Bell system
                iii. regulators suppress competition
        3. Policy
            a. early antitrust suits result in minor conduct agreements
            b. FCC rule changes
                i. competing equipment can be connected to system
                ii. long distance service
                    -MCI, Sprint (gradual entry after 1970)
            c. Section 2 monopolization case filed 1974
                i. long expensive case
                ii. Judge rules probable antitrust violation
                iii. AT&T agrees to break-up (1982)
        4. Divestiture
            a. largest antitrust break-up
            b. AT&T: Bell Labs, Western Electric, Long distance
            c. Regional Bell Operating Companies (RBOC)
                i. local phone service
                ii. 7 independent "Baby Bells"
                    - Nynex, US West, Bell South, Ameritech, Bell Atlantic, Pacific Telesis, Southwestern Bell
            d. effects of break-up
                i. quality remained high
                ii. long distance prices fell substantially
                    - MCI and Sprint gain market share by cutting price
                    - prices and market share stabilize: tight oligopoly
                iii. AT&T undergoes further restructuring
                iv. local Bells prosper
                v. innovation increases 

    D. Structural change
        1. new entry into long distance transmission
            a. firms specializing in data transfer
            b. internet backbone
            c. Qwest, WorldCom, and others        

        2. Telecommunications Act of 1996
            a. opened local markets to competition
                 i. Competitive Local Exchange Carriers
                 ii. CLEC
            b. allowed RBOCs to sell long distance service, once local competition was established
        3. mergers
            a. WorldCom merges with MCI
            b. Qwest buys US West
            c. RBOCs merge
                   i. Verizon formed by Nynex- Bell Atlantic merger
                   i. SBC purchases three remaining RBOCs
                   ii. SBC purchases failing parent company AT&T (and re-names itself at&t


E. Intellectual Property
           I. Patent
                1. protects ideas
                    a. novel
                    b. non-obvious
                    c. useful
        2. registration required
        3. short protection
            -- 20 years
        4. rights can be transferred
        5. use requires approval
  

   F. Development of cell phone industry
            a. slow development under pre-break-up AT&T
            b. RBOCs get cell service
            c. FCC auctions spectrum
                        i. goal: competition
                        ii. new entrants
            d. mergers
                        i. concentration increases
                            -- Verison, AT&T, Sprint, T-Mobile
                        ii. proposed AT&T T-Mobile merger blocked
                        iii. 2014 proposed mergers


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. Mainframes today

       1. large enterprise users
            a. banks
            b. financial markets
            c. government
            d. corporations
      2. batch processing
            a. power
            b. thousands to millions of transactions
            c. reliability

      3. Internet servers
            a. process large amounts of content (images, video, text, data)
            b. competition from clusters of low-cost microprocessors

 
III. Software

A. Economics
        1. software characteristics favor one dominant firm
            a. large economies of scale
                i. high set up costs
                ii. low marginal costs
            b. network externalities (for operating systems)
            c. Dominant firm

B. Microsoft
        1. Microsoft conduct
            a. exclusionary licensing
            b. technical incompatibilities
            c. tying
                i. Word, Excel, Powerpoint
                ii. Internet Explorer
            d. pre-announcement of programs
C. Microsoft Antitrust 
        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. treble damages
             c. pays large dollar amounts to settle claims by several firms


IV. 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
     C. Dominant firms
            1. Intel
 

V. Internet

            A. Communications protocol
                        1. standards for data transfer
                        2. set by committees
            B. Hardware

                        1. network of networks
                        2. network costs paid by individual network
                        3. access fees
            C. Software/content/sites

         D. Copyright
            1. protects expression
            2. exists at creation
            3. lengthy protection
                a. corporate 95 years
                b. enters public domain after expiration
            4. rights can be transferred
            5. protection is narrow
                a. protects direct copies (“pirated”)
                b. does not protect function/feel

            E. History
                        1. public development
                        2. commercialization came later
            F. Disruptive technology
                       1. Creative destruction
                       2.
new competitors
                       3. copyright violations

                            - proposed legislation: PIPA, SOPA, ACTA

            G. Leading Internet sites
                        1. network externalities
                        2. set-up costs

                        3. intellectual property
            H. Agglomeration economies
                    1. spatial clustering
                    2. positive externalities
                            a. specialized labor markets
                            b. finance
                            c. specialized services   
                            d. information flow
             I. Net Neutrality

V. Beer

A. Economies of scale
        1. brewing: dimensional economies
        2. bottling
        3. small breweries (1-2 million barrels/year) face substantially higher costs than a 4 million brewery
        4. modest additional cost savings out to 8 million barrels/year 

B. Transportation cost
     1. originally many small local brewers
     2. technological change allows national shipping
            a. transportation cost: original source of price premium for shipping brewers
            b. premium image developed
            c. belief:  high price = high quality
            d. brand image advantage to early shippers

C. Structural change
        1. multiplant production
            a. lower transportation costs for national brewers
            b. premium image remains
            c. higher profits-- more advertising
        2. local and regional brewers squeezed out
        3. market concentration increases substantially
            a. Herfindahl index increases from H = 140 (1947) to H = 2789 (1998)
            b. tight oligopoly 

D. Beer mergers vs. internal growth 
        1. Anheuser Bush and American Brewing Co (Miami, 1958)
            a. court requires sale
            b. court restricts future mergers by Anheuser Bush for 5 years
        2. Pabst and Blatz (1958)
            a. court orders sale of Blatz (1959)
            b. Heileman buys remaining Blatz assets
       3. national leaders (A-B, Miller, Coors) grow by building new breweries
       4. regional and local mergers allowed
            a. locals unable to compete
            b. failing firm defense
        5. Consolidation
            a. Heileman acquires over a dozen brewers
            b. Stroh acquires Schafer, Schiltz, Heileman then fails
            c. Miller and Pabst split Stroh's brands and assets
            d. Pabst contracts all brewing to other manufacturers
            e. minor impact on market concentration
                    - mergers were an exit strategy for failing firms
        6. International mergers
          a. SAB purchased Miller (2002)
          b. Interbrew AmBev merger (2004)
          c. Molson Coors merger (2005)
          d. InBev purchases Anheuser-Busch (2008)
          e. Miller-Coors joint venture (2008)
          f. A-B-InBev purchased Modelo (2013)

E. Trademark
           a. intellectual property: name, symbol, device
           b. registration
         
 c. no expiration
           d. rights can be transferred
           e. protection is narrow
           f. economic reasons for protection
               i. information
               ii. quality
          g. trademarks are very valuable in beer industry

F. Product differentiation
        1. most American beer has a similar mild flavor (little horizontal differentiation)
        2. in blind taste tests, consumers can not distinguish brands
        3. but, consumers are willing to pay more for premium brands (vertical differentiation)
        4. price quality heuristic
        5. market segments
            a. Craft
            b. Imports
            c. Superpremium
            d. Premium
            e. Popular (economy/ value-priced)

G. Rise of horizontal differentiation
        1. Imports grow substantially
            a. transportation costs lead to higher price
            b. premium image develops
            c. some brands have stronger flavors
       2. Growth of craft brewing
            a. small breweries
            b. strong flavors
            c. high level of product differentiation

H. Craft beers
        1. microbreweries
            a. very high costs due to suboptimal scale
            b. product differentiation from strong flavor
            c. many avoid transportation costs and advertising costs
            d. high prices and super-premium image
        2. contract brewing
            a. make use of excess capacity of regional brewers
            b. costs above national brewers, less than microbreweries
            c. superpremium image
       3. Substantial growth
       4.
national firms imitate style
            a. Leinekugels (Miller)
            b. Kilian's Red, Blue Moon (Coors)
            c. Goose Island (purchase 2011) AB-InBev
       5. wide range of consumer choices

V Industrial Organization and Public Policy

 


Industrial Organization and Public Policy

Chuck Stull

Department of Economics

Kalamazoo College