New Perspectives on Industrial Organization

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1 Victor J. Tremblay Carol HortoiiTremblay New Perspectives on Industrial Organization With Contributions from Behavioral Economics and Game Theory fyj Springer

2 Contents Part I Introductory and Review Material 1 Introduction The Origins and Methods of Industrial Organization Early Theoretical Foundations Institutional and Empirical Traditions The Structure-Conduct-Performance Paradigm Competing Paradigms and Public Policy Game Theory and the New Theoretical Industrial Organization New Empirical Industrial Organization Behavioral Economics and Industrial Organization Public Policy and Industrial Organization Economic Theory, Models, and Mathematics Theory, Models, and Reality Modeling and Mathematics Approach of the Book Summary 22 2 Demand, Technology, and the Theory of the Firm The Short Run and the Long Run Consumer Theory and Demand The Introductory Model of Consumer Choice Market Demand Demand Elasticities Total Revenue, Marginal Revenue, Average Revenue, and Price Elasticity Nonfunctional Demand and Behavioral Economics 35

3 < Contents 2.3 Technology and Costs The Theory of the Firm Firm Motives The Boundaries of the Firm Summary Review Questions 51 3 Introductory Game Theory and Economic Information Describing a Game Static Games of Complete Information Fundamental Types of Static Games Static Game Equilibria Dynamic Games of Complete and Perfect Information Dynamic Games of Complete and Perfect Information Repeated Games Bargaining and Fair Allocations Games with Incomplete, Asymmetric, and Imperfect Information Concluding Remarks Summary Review Questions 98 4 Behavioral Economics Why Do We Make Mistakes? Complexity, Information, and Bounded Rationality Of Two Minds: The Dual Systems Approach Salience Framing Effects Framing Effects and False Beliefs Anchoring Default Effects If It Makes You Happy Overconfidence Confirmation Bias Cognitive Dissonance Choice Under Risk and Uncertainty Reference Dependence Endowment Effects, Loss Aversion, and the Status Quo Uncertainty and Signals of Quality 110

4 Contents xi 4.6 Time-Inconsistent Preferences Ill Discounting Ill Neuroeconomics and Self Control Impulsivity Addiction and Cues Who Are You? Economics and Identity Summary Review Questions 118 Part II Perfect Competition, Monopoly, Product Differentiation, and Market Structure - ' 5 Perfect Competition and Market Imperfections The Assumptions of Perfect Competition Firm Behavior in Perfect Competition Firm Demand and Revenue Functions Profit Maximization Market Equilibrium and Long-Run Supply Comparative Statics Efficiency and Welfare Market Failure and the Limitations of Perfect Competition Summary Review Questions..." Monopoly and Monopolistic Competition Monopoly \ Firm Behavior and Market Equilibrium No Supply Curve in Monopoly Allocative Inefficiency X-inefficiency and Rent-Seeking Behavior Dynamic Considerations: Addiction and Product Durability Social Benefits of Monopoly Monopolistic Competition Summary.A Review Questions Product Differentiation Types of Product Differentiatioa Product Differentiation and Firm Demand Multicharacteristic Product Differentiation Horizontal Product Differentiation Vertical Product Differentiation 171

5 xii Contents 7.3 Product Differentiation and Firm Costs Product Differentiation and the Type of Good Summary Review Questions Market Structure, Industry Concentration, and Barriers to Entry The Delineation of Market Structure Industry Concentration The Meaning and Measurement of Industry Concentration T Definition of the Relevant Market The Extent of Industry Concentration in US Markets Aggregate Concentration Concentration for Selected Industries Changes in Concentration for a Single Industry The Determinants of Market Structure Gibrat's Law Concentration and Barriers to Entry Sutton's Theory of Sunk Costs and Concentration Survey and Empirical Evidence Summary Review Questions ". 209 Part III Oligopoly and Market Power 9 Cartels Cartel Theory Coordination: Output and Price Determination The Fundamental Weakness of a Cartel: The Cartel Dilemma Other Cartel Weaknesses Strategies That Facilitate Collusion Market Division Most-Favored-Customer Clause Meet-the-Competition Clause Trigger Strategy Empirical Evidence Case Studies of Cartels The Steel Industry The OPEC Cartel The International Vitamin Cartel Summary Review Questions 238

6 Contents xiii 10 Quantity and Price Competition in Static Oligopoly Models Cournot and Bertrand Models with Homogeneous Products The Cournot Model with Two Firms and Symmetric Costs The Cournot Model with Two Firms and Asymmetric Costs The Cournot Model with n Firms and Symmetric Costs The Bertrand Model Cournot and Bertrand Models with Differentiated Products ::..' The Cournot Model with Multicharacteristic Differentiation The Bertrand Model with Multicharacteristic Differentiation The Bertrand Model with Horizontal and Vertical Differentiation The Cournot-Bertrand Model The Choice of Output or Price Competition Strategic Substitutes and Strategic Complements Summary : Review Questions Dynamic Monopoly and Oligopoly Models Two-Period Monopoly arid Duopoly Models The Durable Goods Monopolist The Stackelberg (Dynamic Cournot) Duopoly Model A Dynamic Bertrand Model with Multicharacteristic Differentiation A Dynamic Quantity and Price Game Yields a Cournot Outcome A Dynamic Cournot-Bertrand Model with Multicharacteristic Differentiation Endogenous Timing and Choice of Strategic Variable Oligopoly Models in Repeated Games Finitely Repeated Duopoly Models Infinitely Repeated Oligopoly Models Strategic Substitutes, Complements, and Entry Barriers Summary Review Questions 308

7 xiv Contents 12 Market Power The Measurement of Market Power The Lerner Index in a Static Setting The Lerner Index in a Dynamic Setting Other Measures of Market Power and Industry Performance Estimating Market Power Estimating Marginal Cost The Price Response to a Change in Costs The New Empirical Industrial Organization Technique." The Stochastic Frontier Method of Estimating Market Power Estimating Game Theoretic Strategies or Behavior Estimating the Overall Efficiency Loss Due to Market Power Determinants of Market Power Theory Empirical Evidence Summary Review Questions." Part IV Other Business Strategies 13 Product Design, Multiproduct Production, and Brand Proliferation Product Design The Choice of a Vertical Characteristic (Quality) The Choice of a Horizontal Characteristic Mass-Market and Niche-Market Product Design Multiproduct Production Motives for Multiproduct Production Multiproduct Production in Monopoly Brand Proliferation Empirical Evidence Summary Review Questions Price Discrimination and Other Marketing Strategies Price Discrimination First-Degree or Perfect Price Discrimination Second-Degree or Nonlinear Price Discrimination 384

8 Contents xv Third-Degree or Segmented Price Discrimination The Welfare Effect of Price Discrimination Price Discrimination and Strategic Effects Other Pricing Strategies Intertemporal Pricing Strategies Damaged Goods and Quality-Dependent Pricing Two-Part Tariffs A Theory of Sales or a Mixed Strategy in Price Price Wars and Wars of Attrition Other Marketing Strategies Marketing with Framing and Anchoring Effects Bundling and Tying Contracts Marketing to Overconfident Consumers Thirty-Day Free Trials and the Endowment Effect Summary Review Questions Advertising Theories of Advertising and Product Type Informative Advertising Persuasive Advertising Advertising and Subjective Differentiation Advertising and the Type of Good ' Implications for Advertising Intensity Advertising, Demand, and Costs Advertising and Market Demand Advertising and Firm Demand The Cost of Advertising The Effect of Market Structure on Advertising Advertising and Perfect Competition Advertising and Monopoly Advertising and Imperfect Competition Summary of Implications and Empirical Evidence The Effect of Advertising on Market Structure Summary Review Questions Advertising and Welfare Advertising and Social Responsibility Advertising and Efficiency Advertising and Efficiency: A Graphical Approach Advertising and Efficiency: A More General Approach Using Calculus 474

9 xvi Contents Advertising and Efficiency When Advertising Lowers Consumer Search Costs Advertising and Efficiency: Empirical Evidence Advertising, Strategic Effects, and Cost Efficiency Summary Review Questions Technological Change, Dynamic Efficiency, and Market Structure Invention and Technological Change The Economics of Technological Change A Taxonomy of Research, Invention, and Technological Change Failure of the Market for Ideas The Effect of Market Structure on Technological Change Monopoly and Technological Change Competition Versus Monopoly Monopoly and a Potential Entrant Oligopoly and the Incentive to Innovate The Effect of Technological Change on Market Structure The Empirical Evidence Summary Review Questions Horizontal, Vertical, and Conglomerate Mergers A Brief History of US Mergers Main Motives for Merger Market Power Efficiency Other Horizontal Mergers The Market Power Motive for Mergers Efficiency Motive for Horizontal Mergers The Empirical Evidence Vertical Integration, Contracts, and Restrictions Efficiency Motive for Vertical Mergers and Restrictions Vertical Relationships and Anticompetitive Effects A Summary of the Empirical Evidence 551

10 Contents xvii 18.5 Diversification and Conglomerate Mergers Efficiency Motives for Conglomerate Mergers Conglomerate Mergers and Risk Reduction Conglomerate Mergers and Anticompetitive Effects Managerial Motives for Conglomerate Mergers Behavioral Economicsand Conglomerate Mergers Empirical Evidence Summary Review Questions ' :. 562 Part V Economic Performance and Public Policy 19 Efficiency, Equity, and Corporate Responsibility in Imperfect Competition Efficiency Static Allocative Inefficiency Other Sources of Static Inefficiency Dynamic Inefficiency Equity and Corporate Responsibility Corporate Social Responsibility Market Power and the Distribution of Income and Wealth Summary Review Questions.' Antitrust Law and Regulation An Introduction to Law and Economics The Philosophy of Law Arrow's Impossibility Theorem Legal Systems and the Evolution of the Law Antitrust Law Antitrust Legislation Enforcement Procedure and Remedies Important Antitrust Cases and Precedents Regulation and Deregulation The Role of Industry Regulation Natural Monopoly Regulation Economic Deregulation Social Regulation Pricing and Packaging Behavior Behavioral Economics and Credit Cards 631

11 xviii Contents Behavioral Economics and Libertarian Paternalism: Framing and Inertia Behavioral Economics and Asymmetric Paternalism: Selectively Limiting Choices Social Concerns with Advertising Advertising and Social Responsibility Advertising Bans and Regulations Summary Review Questions Industry and Firm Studies Industry Studies The US Brewing Industry The US Cigarette Industry ' The Economics of College Sports Firm Studies The Schlitz Brewing Company Microsoft General Motors Term Paper Topics on Industries and Firms. 666 Appendix A: A Review of Mathematics and Econometrics 669 Appendix B: Answers to Review Questions 701 Appendix C 749 References ' 753 Index 785

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