Modern Industrial Organization

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1 Modern Industrial Organization For these Global Editions, the editorial team at Pearson has collaborated with educators across the world to address a wide range of subjects and requirements, equipping students with the best possible learning tools. This Global Edition preserves the cutting-edge approach and pedagogy of the original, but also features alterations, customization, and adaptation from the North American version. Global edition Global edition Global edition Modern Industrial Organization Fourth edition Dennis W. Carlton Jeffrey M. Perloff Fourth edition Carlton Perloff This is a special edition of an established title widely used by colleges and universities throughout the world. Pearson published this exclusive edition for the benefit of students outside the United States and Canada. If you purchased this book within the United States or Canada you should be aware that it has been imported without the approval of the Publisher or Author. Pearson Global Edition Carlton_ _mech.indd 1 23/01/15 10:07 AM

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3 Modern Industrial Organization, Global Edition Table of Contents Cover Title Copyright Brief Contents Contents Preface PART 1 Introduction and Theory CHAPTER 1 Overview Models Price Theory Transaction Costs Game Theory Contestable Markets Organization Basic Theory Market Structures Business Practices: Strategies and Conduct Information, Advertising, and Disclosure Dynamic Models and Market Clearing Government Policies and Their Effects CHAPTER 2 The Firm and Costs The Firm The Objective of a Firm Ownership and Control Mergers and Acquisitions Reasons for Mergers and Acquisitions Merger Activity in the United States Merger Activities in Other Countries Empirical Evidence on the Efficiency and Profitability of Mergers Cost Concepts Types of Costs Cost Concepts Economies of Scale Reasons for Economies of Scale Total Costs Determine Scale Economies A Measure of Scale Economies Empirical Studies of Cost Curves Economies of Scale in Total Manufacturing Costs Survivorship Studies Cost Concepts for Multiproduct Firms Adaptation of Traditional Cost Concepts for a Multiproduct Firm

4 Economies of Scope Economies of Scale and Economies of Scope Specialization in Manufacturing An Example of an Industry with Economies of Scope APPENDIX 2A Cost Concepts for a MultiproductFirm EXAMPLE 2.1 Value of Limited Liability EXAMPLE 2.2 Conflicts of Interest BetweenManagers and Shareholders EXAMPLE 2.3 Specialization of Labor EXAMPLE 2.4 Indiana Libraries EXAMPLE 2.5 The Baking Industry EXAMPLE 2.6 Electricity Minimum Efficient Scaleand Scope PART 2 Market Structures CHAPTER 3 Competition Perfect Competition Assumptions The Behavior of a Single Firm The Competitive Market Elasticities and the Residual Demand Curve Elasticities of Demand and Supply The Residual Demand Curve of Price Takers Efficiency and Welfare Efficiency Welfare Entry and Exit Restrictions on Entry Competition with Few FirmsContestability Definition of Barriers to Entry Identifying Barriers to Entry The Size of Entry Barriers by Industry Externalities Limitations of Perfect Competition The Many Meanings of Competition EXAMPLE 3.1 Are Farmers Price Takers? EXAMPLE 3.2 Restrictions on Entry AcrossCountries EXAMPLE 3.3 FTC Opposes Internet BansThat Harm Competition EXAMPLE 3.4 Increasing Congestion CHAPTER 4 Monopolies, Monopsonies,and Dominant Firms Monopoly Behavior

5 Profit Maximization Market and Monopoly Power The Incentive for Efficient Operation Monopoly Behavior over Time The Costs and Benefits of Monopoly The Deadweight Loss of Monopoly Rent-Seeking Behavior Monopoly Profits and Deadweight Loss Vary with the Elasticity of Demand The Benefits of Monopoly Creating and Maintaining a Monopoly Knowledge Advantage Government-Created Monopolies Natural Monopoly Profits and Monopoly Is Any Firm That Earns a Positive Profit a Monopoly? Does a Monopoly Always Earn a Positive Profit? Are Monopoly Mergers to Eliminate Short-Run Losses Desirable? Monopsony Dominant Firm with a Competitive Fringe Why Some Firms Are Dominant The No-Entry Model The Dominant FirmCompetitive Fringe Equilibrium A Model with Free, Instantaneous Entry EXAMPLE 4.1 Monopoly Newspaper Ad Prices EXAMPLE 4.2 Monopolizing by Merging EXAMPLE 4.3 Controlling a Key Ingredient EXAMPLE 4.4 Preventing ImitationCat Got YourTongue? EXAMPLE 4.5 Protecting a Monopoly EXAMPLE 4.6 EU Allows Merger to Eliminate Losses EXAMPLE 4.7 Priest Monopsony EXAMPLE 4.8 Price Umbrella EXAMPLE 4.9 China Tobacco Monopoly tobecome a Dominant Firm CHAPTER 5 Cartels Why Cartels Form Creating and Enforcing the Cartel Factors That Facilitate the Formation of Cartels Enforcing a Cartel Agreement Cartels and Price Wars Consumers Gain as Cartels Fail Price-Fixing Laws

6 APPENDIX 5A The Effects of Cartel Size EXAMPLE 5.1 An Electrifying Conspiracy EXAMPLE 5.2 The Viability of CommodityCartels EXAMPLE 5.3 Concrete Example of GovernmentAided Collusion EXAMPLE 5.4 Relieving the Headache of Runninga Cartel EXAMPLE 5.5 Vitamins Cartel EXAMPLE 5.6 How Consumers Were Railroaded EXAMPLE 5.7 The Social Costs of Cartelization EXAMPLE 5.8 Prosecuting Global Cartels CHAPTER 6 Oligopoly Game Theory Single-Period Oligopoly Models Nash Equilibrium The Cournot Model The Bertrand Model The Stackelberg Leader-Follower Model A Comparison of the Major Oligopoly Models Multiperiod Games Single-Period Prisoners Dilemma Game Infinitely Repeated Prisoners Dilemma Game Types of Equilibria in Multiperiod Games Experimental Evidence on Oligopoly Models APPENDIX 6A A Mathematical Derivation ofcournot and Stackelberg Equilibria APPENDIX 6B Mixed Strategies EXAMPLE 6.1 Do Birds of a Feather Cournot-Flock Together? EXAMPLE 6.2 Oligopoly Welfare Losses EXAMPLE 6.3 Mergers in a Cournot Economy EXAMPLE 6.4 Roller Coaster Gasoline Pricing EXAMPLE 6.5 Copying Pricing EXAMPLE 6.6 Car Wars CHAPTER 7 Product Differentiation andmonopolistic Competition Differentiated Products The Effect of Differentiation on a Firms Demand Curve Preferences for Characteristics of Products The Representative Consumer Model A Representative Consumer Model with Undifferentiated Products A Representative Consumer Model with Differentiated Products Conclusions About Representative Consumer Models Location Models

7 Hotellings Location Model Salops Circle Model Hybrid Models Estimation of Differentiated Goods Models APPENDIX 7A Welfare in a Monopolistic CompetitionModel with Homogeneous Products APPENDIX 7B Welfare in a Monopolistic CompetitionModel with Differentiated Products EXAMPLE 7.1 All Water Is Not the Same EXAMPLE 7.2 Entry Lowers Prices EXAMPLE 7.3 The Jeans Market EXAMPLE 7.4 A Serial Problem EXAMPLE 7.5 Combining Beers EXAMPLE 7.6 Value of Minivans CHAPTER 8 Industry Structure andperformance Theories of Price Markups and Profits Structure-Conduct-Performance Measures of Market Performance Rates of Return Price-Cost Margins Measures of Market Structure The Relationship of Structure to Performance Modern Structure-Conduct-Performance Analysis Theory Empirical Research Modern Approaches to Measuring Performance Static Studies APPENDIX 8A Relationship Between theherfindahl-hirschman Index (HHI) and theprice-cost Margin APPENDIX 8B Identifying Market Power EXAMPLE 8.1 Supermarkets and Concentration EXAMPLE 8.2 How Sweet It Is PART 3 Business Practices: Strategies and Conduct CHAPTER 9 Price Discrimination Nonuniform Pricing Incentive and Conditions for Price Discrimination Profit Motive for Price Discrimination Conditions for Price Discrimination Resales

8 Types of Price Discrimination Perfect Price Discrimination Each Consumer Buys More Than One Unit Different Prices to Different Groups Other Methods of Third-Degree Price Discrimination Welfare Effects of Price Discrimination APPENDIX 9A An Example of Price Discrimination:Agricultural Marketing Orders EXAMPLE 9.1 Coupons EXAMPLE 9.2 Thank You, Doctor EXAMPLE 9.3 Halting Drug Resales from Canada EXAMPLE 9.4 Vertical Integration as a Means ofprice Discrimination: Alcoa Shows Its TrueMetal EXAMPLE 9.5 A Discriminating Labor Union EXAMPLE 9.6 Does Competition Always LowerPrice? CHAPTER 10 Advanced Topics in Pricing Nonlinear Pricing A Single Two-Part Tariff Two Two-Part Tariffs Tie-in Sales General Justifications for Tie-in Sales Tie-in Sales as a Method of Price Discrimination Package Tie-in Sales of Independent Products Interrelated Demands Quality Choice Other Methods of Nonlinear Pricing Minimum Quantities and Quantity Discounts Selection of Price Schedules Premium for Priority Auctions APPENDIX 10A The Optimal Two-Part Tariff APPENDIX 10B Nonlinear Pricing with an Example EXAMPLE 10.1 Football Tariffs EXAMPLE 10.2 You Auto Save from Tie-in Sales EXAMPLE 10.3 Stuck Holding the Bag EXAMPLE 10.4 Tied to TV EXAMPLE 10.5 Not Too SuiteMixed Bundling EXAMPLE 10.6 Price Discriminating on ebay CHAPTER 11 Strategic Behavior

9 Strategic Behavior Defined Noncooperative Strategic Behavior Predatory Pricing Limit Pricing Investments to Lower Production Costs Raising Rivals Costs Welfare Implications and the Role of the Courts Cooperative Strategic Behavior Practices That Facilitate Collusion Cooperative Strategic Behavior and the Role of the Courts APPENDIX 11A: The Strategic Use of Tie-in Salesand Product Compatibility to Create or MaintainMarket Power with Applications to Networks EXAMPLE 11.1 Supreme Court Says AllegedPredation Must Be Credible EXAMPLE 11.2 Evidence of Predatory Pricing intobacco EXAMPLE 11.3 The Shrinking Share of DominantFirms EXAMPLE 11.4 And Only a Smile Remained EXAMPLE 11.5 Strategic Behavior and RapidTechnological Change: The Microsoft Case EXAMPLE 11.6 Value of Preventing Entry EXAMPLE 11.7 The FTC versus Ethyl et al. EXAMPLE 11.8 Information Exchanges: TheHardwood Case CHAPTER 12 Vertical Integration andvertical Restrictions The Reasons for and Against Vertical Integration Integration to Lower Transaction Costs Integration to Assure Supply Integration to Eliminate Externalities Integration to Avoid Government Intervention Integration to Increase Monopoly Profits Integration to Eliminate Market Power The Life Cycle of a Firm Vertical Restrictions Vertical Restrictions Used to Solve in Distribution The Effects of Vertical Restrictions Banning Vertical Restrictions Franchising Empirical Evidence Evidence on Vertical Integration Evidence on Vertical Restrictions EXAMPLE 12.1 Outsourcing

10 EXAMPLE 12.2 Preventing Holdups EXAMPLE 12.3 Own Your Own Steel Mill EXAMPLE 12.4 Double Markup EXAMPLE 12.5 Blockbusters Solution to thedouble Marginalization Problem EXAMPLE 12.6 Free Riding on the Web EXAMPLE 12.7 Brewing Trouble: RestrictingVertical Integration in Alcoholic BeverageIndustries PART 4 Information, Advertising, and Disclosure CHAPTER 13 Information Why Information Is Limited Limited Information About Quality The Market for Lemons Solving the Problem: Equal Information Evidence on Lemons Markets Limited Information About Price The Tourist-Trap Model The Tourists-and-Natives Model Providing Consumer Information Lowers Price How Information Lowers Prices An Example: Grocery Store Information Programs APPENDIX 13A Market Shares in the Tourists-and-Natives Model EXAMPLE 13.1 Genetically Modified Organisms:Do Consumers Not Care or Not Read? EXAMPLE 13.2 Understanding ConsumerInformation EXAMPLE 13.3 Counterfeit Halal Meat EXAMPLE 13.4 Certifying Thoroughbreds EXAMPLE 13.5 Price Dispersion and SearchCosts in the Talmud EXAMPLE 13.6 Price Dispersion EXAMPLE 13.7 Tourist Cameras CHAPTER 14 Advertising and Disclosure Information and Advertising Promotions Search Versus Experience Goods Informational Versus Persuasive Advertising Profit-Maximizing Advertising Effects of Advertising on Welfare Price Advertising Increases Welfare Advertising to Solve the Lemons Problem When Advertising Is Excessive False Advertising Limits to Lying Antifraud Laws

11 Disclosure Laws APPENDIX 14A Profit-Maximizing Advertising EXAMPLE 14.1 Branding and Labeling EXAMPLE 14.2 Celebrity Endorsements EXAMPLE 14.3 Milk Advertising EXAMPLE 14.4 Social Gain from Price Advertising EXAMPLE 14.5 Welfare Effects of RestrictingAlcohol Ads EXAMPLE 14.6 Restaurants Make the Grade PART 5 Dynamic Models and Market Clearing CHAPTER 15 Decision Making Over Time:Durability How Long Should a Durable Good Last? Competitive Firms Choice of Durability The Monopolys Choice of Durability Costly Installation and Maintenance Renting Versus Selling by a Monopoly Resale Market Consumers Expectations Constrain the Monopoly APPENDIX 15A Multiperiod Durable Goods Monopoly EXAMPLE 15.1 United Shoe EXAMPLE 15.2 The Importance of Used Goods EXAMPLE 15.3 The Alcoa Case: SecondhandEconomics EXAMPLE 15.4 Leasing Under Adverse Selection EXAMPLE 15.5 Sales Versus Rentals EXAMPLE 15.6 Lowering the Resale Value ofused Textbooks CHAPTER 16 Patents and TechnologicalChange Patents, Copyrights, and Trademarks Patents Copyrights Trademarks Distinctions Between Patents, Copyrights, and Trademarks Incentives for Inventions Are Needed Imitation Discourages Research Patents Encourage Research Patents Encourage Disclosure Patents, Prizes, Research Contracts, and Joint Ventures Determining the Optimal Number of Firms No Government Incentives Government-Financed Research

12 Prizes Relaxing Antitrust Laws: Joint Ventures Patents Government Uncertainty Patent Holders May Manufacture or License Eliminating Patents Market Structure Market Structure Without a Patent Race Optimal Timing of Innovations Monopolies in Patent Races EXAMPLE 16.1 Piracy EXAMPLE 16.2 Patents Versus Trade Secrets EXAMPLE 16.3 Monkey See, Monkey Do EXAMPLE 16.4 Joint Public-Private R&D EXAMPLE 16.5 Prizes EXAMPLE 16.6 Mickey Mouse Legislation EXAMPLE 16.7 European Patents EXAMPLE 16.8 Patent Thicket CHAPTER 17 How Markets Clear: Theory and Facts How Markets Clear: Three Simple Theories Competition Oligopoly Models Monopoly Empirical Evidence on the Role of Price in Allocating Goods The Rigidity of Prices Movements in Prices and Price-Cost Margins over the Business Cycle Explaining the Evidence Extensions to the Simple Theory: The Introduction of Time Fixed Costs of Changing Price Implications of an Unchanging Price for Inventories Asymmetric Information and Moral Hazard Toward a General Theory of Allocation Market Structure Is More Than Concentration Produce-to-Order Versus Produce-to-Stock Transmission of Shocks in Industries with Fixed Prices EXAMPLE 17.1 Price RigidityIts the Real Thing EXAMPLE 17.2 How Much Is That Turkey in the Window? EXAMPLE 17.3 The Cost of Changing Prices EXAMPLE 17.4 Creating Futures Markets

13 EXAMPLE 17.5 Oh Say Does That Star-SpangledBanner Yet Fly? PART 6 Government Policies and Their Effects CHAPTER 18 International Trade Reasons for Trade Between Countries Comparative Advantage Intra-Industry Trade in Differentiated Products Free Riding, International Price Differences, and Gray Markets Dumping Tariffs, Subsidies, and Quotas Competition Creating and Battling Monopolies Strategic Trade Policy Industries with Positive Externalities Empirical Evidence on Intervention in International Trade APPENDIX 18A Derivation of the Optimal Subsidy EXAMPLE 18.1 Gray Markets EXAMPLE 18.2 Timber Wars and Retaliation EXAMPLE 18.3 Foreign Doctors EXAMPLE 18.4 Being Taken for a Ride: Japanese Cars EXAMPLE 18.5 Wide-Body Aircraft EXAMPLE 18.6 Steeling from U.S. Consumers CHAPTER 19 Antitrust Laws and Policy The Antitrust Laws and Their Purposes Antitrust Statutes Enforcement Goals of the Antitrust Laws Who May Sue? Economic Theory of Damages The Use of U.S. Antitrust Laws Private Litigation Market Power and the Definition of Markets Market Power Market Definition Cooperation Among Competitors Price-Fixing and Output Agreements Not All Agreements Among Competitors Are Illegal Information Exchanges Among Competitors Oligopoly Behavior Mergers Exclusionary Actions and Other Strategic Behavior Competition Between Rivals Competitive Behavior Deemed Undesirable by the Court Vertical Arrangements Between Firms

14 Price Discrimination Price Discrimination Under Robinson-Patman Tie-in Sales Effects of Antitrust Laws on the Organization of Unregulated and Regulated Firms EXAMPLE 19.1 Using the Government to Create Market Power: Misuse of the Orange Book EXAMPLE 19.2 Conflict Between European and U.S. Antitrust Authorities: GE-Honeywell EXAMPLE 19.3 The Merger Guidelines EXAMPLE 19.4 Antitrust Laws in Other Countries EXAMPLE 19.5 Colleges and Antitrust: Does YourSchool Belong to a Cartel? EXAMPLE 19.6 The FTC Plays with Toys R Us CHAPTER 20 Regulation and Deregulation The Objectives of Regulators Market Inefficiencies Correcting Market Inefficiencies Capture Theory and Interest-Group Theory Making Monopolies More Competitive Government Ownership Privatizing Franchise Bidding Price Controls Rate-of-Return Regulation Quality Effects Making Competitive Industries More Monopolistic Limiting Entry Agricultural Regulations: Price Supports and Quantity Controls Deregulation Airlines Ground Transportation EXAMPLE 20.1 Pizza Protection EXAMPLE 20.2 Cross-Subsidization EXAMPLE 20.3 Legal Monopolies EXAMPLE 20.4 Public, Monopolistic, and Competitive Refuse Collection EXAMPLE 20.5 Rent Control EXAMPLE 20.6 Brewing Trouble EXAMPLE 20.7 Deregulating Electricity: California in Shock EXAMPLE 20.8 International and U.S. Deregulation in Telecommunications

15 EXAMPLE 20.9 European Deregulation of Airlines Bibliography Glossary Answers to Odd-Numbered Chapter 2 Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 Chapter 10 Chapter 11 Chapter 12 Chapter 13 Chapter 14 Chapter 15 Chapter 16 Chapter 17 Chapter 18 Chapter 19 Chapter 20 Legal Case Index Author Index Subject Index