HANDBOOK OF INDUSTRIAL ORGANIZATION

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1 EtEIEIBEIBBEIEHEIBEIBEIEHEtEIEIEIEIBBEIE HANDBOOK OF INDUSTRIAL ORGANIZATION VOLUME 3 Edited by MARK ARMSTRONG Department of Economics, University College of London and ROBERT PORTER Department of Economics, Northwestern University NORTH HOLLAND Amsterdam Boston Heidelberg London New York Oxford Paris San Diego San Francisco Singapore Sydney Tokyo

2 CONTENTS OF VOLUME 3 Introduction to the Series Contents of the Handbook Preface to the Handbook v vii xi Chapter 27 Recent Developments in the Theory of Regulation MARK ARMSTRONG AND DAVID E.M. SAPPINGTON 1557 Abstract 1560 Keywords Introduction Optimal monopoly regulation Aims and instruments Regulation with complete information Regulation under adverse selection Extensions to the basic model Dynamic interactions Regulation under moral hazard Conclusions Practical regulatory policies Pricing flexibility Dynamics The responsiveness of prices to costs Regulatory discretion Other topics Conclusions Optimal regulation with multiple firms Yardstick competition Awarding a monopoly franchise Regulation with unregulated competitive suppliers Monopoly versus oligopoly Integrated versus component production Regulating quality with competing suppliers Conclusions Vertical relationships One-way access pricing 1669

3 xvi Contents of Volume Vertical structure Two-way access pricing Conclusions Summary and conclusions 1684 Acknowledgements 1687 References 1687 Chapter 28 The Economic Analysis of Advertising KYLE BAGWELL ^ 1701 Abstract 1703 Keywords Introduction Views on advertising Setting the stage The persuasive view The informative view The complementary view Summary Empirical regularities The direct effects of advertising The indirect effects of advertising Summary Monopoly advertising The positive theory of monopoly advertising The normative theory of monopoly advertising Summary Advertising and price Homogeneous products Differentiated products Non-price advertising Loss leaders Summary Advertising and quality Signaling-efficiency effect Repeat-business effect Match-products-to-buyers effect Quality-guarantee effect Summary Advertising and entry deterrence Advertising and goodwill Advertising and signaling Summary 1802

4 Contents of Volume 3 xvii 8. Empirical analyses Advertising and the household Advertising and firm conduct Summary Sunk costs and market structure Main ideas Econometric tests and industry histories Related work Summary New directions and other topics Advertising and media markets Advertising, behavioral economics and neuroeconomics Other topics Summary Conclusion 1828 Acknowledgements 1829 References 1829 Chapter 29 Empirical Models of Entry and Market Structure STEVEN BERRY AND PETER REISS 1845 Abstract 1847 Keywords Introduction Why structural models of market structure? Entry games with homogeneous firms A simple homogeneous firm model Relating У to the strength of competition Observables and unobservables Demand, supply and endogenous N Firm heterogeneity Complications in models with unobserved heterogeneity Potential solutions to multiplicity Applications with multiple equilibria Imperfect information models Entry in auctions Other kinds of firm heterogeneity Dynamics Conclusion 1884 References 1884

5 xviii Contents of Volume 3 Chapter 30 A Framework for Applied Dynamic Analysis in 10 ULRICH DORASZELSKI AND ARIEL RAKES 1887 Abstract 1889 Keywords Introduction Model Equilibrium Existence Characterization Multiplicity Introduction to computation Gaussian methods Computational burden Equilibrium selection Alleviating the computational burden Overview Continuous-time models Stochastic approximation algorithm Function approximation methods Oblivious equilibrium Computing multiple equilibria Applications and extensions Empirics Capacity and advertising dynamics Mergers Learning-by-doing and network effects Collusion Topics for further study Conclusions 1961 Acknowledgements 1961 References 1962 Chapter 31 Coordination and Lock-In: Competition with Switching Costs and Network Effects JOSEPH FARRELL AND PAUL KLEMPERER 1967 Abstract 1970 Keywords Introduction Switchingeosts Network effects Strategy and policy Switching costs and competition 1977

6 Contents of Volume 3 xix 2.1. Introduction Empirical evidence Firms who cannot commit to future prices Firms who cannot discriminate between cohorts of consumers Consumers who use multiple suppliers Battles for market share Entry Endogenous switching costs: choosing how to compete Switching costs and policy Network effects and competition Introduction Empirical evidence Under-adoption and network externalities The coordination problem Inertia in adoption Sponsored price and strategy for a single network Sponsored pricing of competing networks Endogenous network effects: choosing how to compete Network effects and policy Conclusion 2055 Acknowledgements 2055 References 2056 Chapter 32 An Empirical Perspective on Auctions KEN HENDRICKS AND ROBERT H. PORTER 2073 Abstract 2075 Keywords Introduction Model and notation Structural analysis of second-price auctions Theory Estimation Identification Structural analysis of first price auctions Theory Estimation Identification Tests of private versus common values Tests of the theory Pure common value auctions Revenues and auction design Multi-unit auctions 2119

7 xx Contents of Volume 3 8. Collusion Collusive mechanisms Enforcement Detection Collusion by sellers Further research issues Scoring rules Entry and dynamics 2134 Acknowledgements 2138 References 2138 Chapter 33 A Primer on Foreclosure PATRICK REY AND JEAN TIROLE 2145 Abstract 2147 Keywords Introduction What is foreclosure? Remedies Roadmap Vertical foreclosure A simple framework Restoring monopoly power: vertical integration Restoring monopoly power: exclusive dealing Further issues Horizontal foreclosure Entry deterrence in the tied market Protecting the monopolized market Innovation by the monopoly firm in the competitive segment Summary Exclusive customer contracts Exclusionary clauses as a rent-extraction device Scale economies and users'coordination failure Summary Potential defenses for exclusionary behaviors Efficiency arguments for (vertical) foreclosure Efficiency arguments for tying Concluding remarks 2204 Appendix A: Private incentives not to exclude 2206 A. 1. The protection of downstream specific investment: the 1995 AT&T divestiture 2206 A.2. Protecting upstream investment through downstream competition 2209 Appendix B: Excessive entry and vertical foreclosure 2210 Appendix C: Vertical foreclosure with Bertrand downstream competition 2211

8 Contents of Volume 3 xxi Vertical integration 2214 References 2215 Chapter 34 Price Discrimination and Competition LARS A. STOLE 2221 Abstract 2223 Keywords Introduction First-degree price discrimination Third-degree price discrimination Welfare analysis Cournot models of third-degree price discrimination A tale of two elasticities: best-response symmetry in price games When one firm's strength is a rival's weakness: best-response asymmetry in price games Price discrimination and entry Collective agreements to limit price discrimination Price discrimination by purchase history Exogenous switching costs and homogeneous goods Discrimination based on revealed first-period preferences Purchase-history pricing with long-term commitment Intrapersonal price discrimination Non-linear pricing (second-degree price discrimination) Benchmark: monopoly second-degree price discrimination Non-linear pricing with one-stop shopping Applications: add-on pricing and the nature of price-cost margins Non-linear pricing with consumers in common Bundling Multiproduct duopoly with complementary components Multiproduct monopoly facing single-product entry Demand uncertainty and price rigidities Monopoly pricing with demand uncertainty and price rigidities Competition with demand uncertainty and price rigidities Summary 2292 Acknowledgements 2292 References 2292 Chapter 35 Market Structure: Theory and Evidence JOHN SUTTON 2301 Abstract 2303 Keywords Introduction 2304

9 xxii Contents of Volume The bounds approach Scope and content The cross-industry literature Background: the Bain tradition Some preliminary examples A theoretical framework The price competition mechanism The escalation mechanism Markets and submarkets: the R&D vs concentration relation The size distribution Background: stochastic models of firm growth A bounds approach to the size distribution The size distribution: a game-theoretic approach The size distribution: empirical evidence Dynamics of market structure Dynamic games Learning-by-doing models and network effects Shakeouts Turbulence Caveats and controversies Endogenous sunk costs: a caveat Can'increasing returns'explain concentration? Fixed costs versus sunk costs Unanswered questions and current research 2359 Acknowledgements 2362 Appendix A: The Cournot example 2362 Appendix B: The Cournot model with quality 2363 References 2364 Chapter 36 Antitrust Policy toward Horizontal Mergers MICHAEL D. WHINSTON ^ 2369 Abstract 2371 Keywords Introduction Theoretical considerations The Williamson trade-off Static ("unilateral") effects of mergers Mergers in a dynamic world Merger laws and enforcement U.S. merger laws and the DOJ/FTC guidelines Merger control in the E.U Differences across other countries 2401

10 Contents of Volume 3 xxiii 3.4. Enforcement experience Econometric approaches to answering the Guidelines' questions Defining the relevant market Evidence on the effects of increasing concentration on prices Breaking the market definition mold Merger simulation Residual demand estimation The event study approach Examining the results of actual mergers Price effects Efficiencies Conclusion 2435 Acknowledgements 2436 References 2436 Author Index I-1 Subject Index 1-25