Industrial Organization - Outline

Marc M¨oller Department of Economics, Universit¨at Bern

General Information

Industrial Organisation is the study of strategic competition. The first part of the course considers monopoly pricing as a benchmark. The standard model of monopoly that was introduced in Microeconomics is extended to allow for multiple products and discriminatory pricing. The second and main part of the course considers oligopolistic markets for homogeneous products. We distinguish between price competition and quantity competition and discuss two major concerns of antitrust authorities; entry deterrence and collusion. The final part of the course considers more advanced topics such as differentiated product markets, vertical industry relations and advertising. The course covers the basic theoretical concepts and presents empirical evidence. The course is self–contained and requires knowledge of basic game theoretic con- cepts. Language is English.

Books and Overviews • Cabral, L., Introduction to Industrial Organization, 2000, MIT Press.

• Belleflamme, P. and M. Peitz, Industrial Organization: Markets and Strategies, 2010, Cambridge University Press.

• Tirole, J., The Theory of Industrial Organization, 1989, MIT Press.

Problem Sets Each topic contains a set of problems. These problems should be solved by students (preferably in groups) at home. They will be discussed in the practical sessions.

1 Evaluation The (written) exam at the end of the course contributes 100% to the final grade. The exam contains two sections: A multiple choice section with short questions about the basic concepts and results of the course and a section with long questions similar to the ones contained in the problem sets.

Outline

0. Introduction What explains the large differences in car markups across European countries. Why are markups of Italian cars higher in Italy than in Germany while the opposite holds for German cars? We discuss an empirical study about European car markets in order to introduce the main issues of Industrial Organization. • Verboven, F., International Price Discrimination in the European Car Market, RAND Journal of Economics 27(2), 1996.

1. Monopoly Pricing We extend the standard model of monopoly to a firm that produces several products. The main result concerns the dependence of the monopolist’s market power on the existence of economies of scope and on whether his products are substitutes or com- plements. Using the analogy with a monopolist producing a single product in several periods, we offer two explanations for the common business practice of introductory discounts.

2. Price Discrimination Standard models of monopoly assume uniform pricing. We relax this assumption and consider the possibility of price discrimination. By allowing for different degrees of information on the side of the monopolist we distinguish between first, second, and third degree price discrimination. We discuss examples from airline and telecom markets.

3. Quantity Competition We extend the standard model of quantity competition due to Cournot by allowing for firm asymmetries. We show that firms have an advantage from being in a leadership

2 position by discussing the model of Stackelberg.

4. Entry What determines the number of firms in an industry? When do firms behave strate- gically in order to deter the entry of potential rivals? We discuss the Dixit model of entry deterrence. The main insight is a distinction between accommodated, deterred, and blockaded entry. • Dixit, A., The Role of Investment in Entry–Deterrence, The Economic Journal 90, 1980.

5. Price Competition We extend the standard model of price competition due to Bertrand in search for a solution of the Betrand paradox. We discuss the Edgeworth model as a potential solution based on capacity constraints. This leads us to the Kreps–Scheinkman view of competition: long run competition in capacities, short run competition in prices. • Kreps, D., Scheinkman J., Quantity Pre–Commitment and Bertrand Competition yield Cournot Outcomes, Bell Journal of Economics 14, 1983.

6. Collusion When firms compete repeatedly the threat of future sanctions may sustain a collusive agreement to maintain a high price. We model competition as an infinitely repeated game of complete information and discuss the conditions under which collusion is most likely to occur. The introduction of informational asymmetries allows us to understand reoccurring price wars not as an indication of the absence of collusion but as a necessary artifact. • Green, E., Porter R., Noncooperative Collusion under Imperfect Price Informa- tion, Econometrica 52, 1984.

7. Differentiated Products When products are differentiated competition is mitigated. We investigate this claim by introducing product differences into the Bertrand and Cournot model. The main result is that price competition is stronger than quantity competition independently of the degree of product differentiation.

3 8. Product Choice Firms not only set production levels and price but also choose the characteristics of their products. We introduce the Hotelling model as the standard model of competition with (horizontally) differentiated products. The main insight is that in their product choice, firms face a trade–off between a competition effect and a demand effect.

• Hotelling, H., Stability in Competition, The Economic Journal 39, 1929.

9. Product Variety and Quality We consider an extension of the Hotelling model of differentiated product choice that allows for an endogenous determination of the number of firms (varieties) in the market. The main result is that the market generates more variety than socially optimal. We also consider a simple model of vertical product differentiation to understand why products are offered with differing qualities.

• Salop, S., Monopolistic Competition with Outside Goods, The Bell Journal of Economics 10, 1979.

10. Vertical Industry Relations We consider intermediate good markets where one firm’s output constitutes another firm’s input.

11. Advertising Advertising can play an informative and/or a persuasive role. We derive the Dorfman- Steiner formula for the intensity of (monopolistic) informative advertising and compare it with empirical evidence. Subsequently we consider two simple oligopolistic models of informative and persuasive advertising.

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