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Industrial Organization - Matilde Machado. Introduction. 4. Syllabus of the course. 4. Product Differentiation. 1. Definitions. [Cabral, Luis ]. 2. Horizontal. Luis Cabral has updated his industrial organization textbook. The revision retains the strengths of the original: it is clear and succinct, with an emphasis on how. Introduction to industrial organization / Luís M.B. Cabral. Author. Cabral, Luís M. B., (author.) Edition. Second edition. Published. Cambridge, Massachusetts.
The Sequential-Entry Game. By retaliating. Suppose that. Because this game is a part of the larger game. The contract is such that. Player 2 is better off playing the left-hand-side subgame than the right-hand-side subgame.
Payoffs are the same in every case except one. As we then saw. If anything strategy b. This cost may result from breach of contract or from a different cause. Let us solve the left-hand-side subgame backward. Games and Strategy 57 Figure 4.
Player 2 would incur a penalty of If we believe that Player 2 is credibly committed to choosing r. The second point illustrated by the example is a methodological one. To conclude this section. This is when the game under consideration Figure 4.
This example illustrates two important points. The alternative. The value of commitment is 30 in this example. In so doing. And this is precisely what we get by placing the short-run choice in the second stage. In a real-world situation. When modeling this sort of strategic interaction. If we want to model this in a simple. This is not as complete and rigorous as the normal-form and extensive-form representations we saw before. Short-run variables are those that players choose given the value of the long-run variables.
In the following chapters. The same principle applies generally when there are long-run and short-run strategic variables. Direct inspection reveals that this game has two Nash equilibria: In repeated games. Although this third strategy leads to an extra Nash equilibrium. A strategy for Player 1 has to indicate what to choose in period 1 and what to choose in period 2 as a function of the actions that were taken in period 1.
We are referring only to equilibria in pure strategies. Player 1 has 3 times 3 to the power of 9. B for Player 1. C and B. In one-shot games. R for Player 2. Now suppose that this one-shot game is repeated twice. Because in this game each player chooses one action only once. In each period. The best Nash equilibrium yields each player a payoff of 4.
Does this proliferation of strategies add anything of interest that was not present in the one-shot version of the game? In many cases. Player 1 still has three actions to choose from. In period 2. The interesting question is whether there are equilibria of the repeated game that do not correspond to equilibria of the one-shot game.
Consider the following strategy for Player 1: Games and Strategy of the repeated game. A similar comparison is obtained if we consider other deviations from the designated strategies by either Player 1 or Player 2.
The implicit strategies that lead to such equilibrium of the repeated game are. Period 1 payoff would then be 6. Take Player 1: Choosing the action T. L is part of an equilibrium in the two-period game. In words. Because the latter also constitute an equilibrium of the one-shot game. Player 1 chooses M instead.
C in both periods is an equilibrium. Let us now check that these strategies constitute an equilibrium of the repeated game. Although this cannot be sustained in a one-shot game—both players would have an incentive to deviate—an arrangement can be made whereby T.
We conclude that the designated strategies constitute a Nash equilibrium. Total payoff is therefore 9. Because these actions form a Nash equilibrium of the one-shot game. R in period 2. Total payoff would therefore be 7.
Now suppose that. Player 2 is playing the designated strategy L in period 1. C in period 2. In analyzing games. Such procedure excludes strategies that are not credible. The equilibrium of a game indicates the strategies that one would expect players to choose.
A game is a model that depicts a situation of strategic behavior. Sequential games should be solved backward. Games may be represented in normal form matrix or in extensive form game tree. Committing to take a future action which is ex-post suboptimal may have an ex-ante strategic value. As we see in chapter 8. Simultaneous strategy choices should not be interpreted literally: The second version of the game corresponds to the assumption that Time is a more h In each cell.
As the payoff matrix suggests. Show how the tactic initiated by the U. Since its introduction in Nash equilibrium. Games and Strategy. In the United States. Department of Justice. Contrast this with the case of dominant strategies. Determine whether the game can be solved by dominant strategies. Mars turned down the offer.. As a result of the publicity created by this scene.
The makers of E. Determine all Nash equilibria. For each of the three versions of the game. Indicate clearly which assumptions regarding rationality are required in order to reach the solutions in a and b. Comparing the answers to a and b.
Discuss the strategic value of this action. If the equilibrium differs from the actual events. How would you model this new situation? What are the Nash equilibria of this new game? Describe the preceding events as a game in extensive form.
Determine the equilibrium as a function of b. Are there any dominant strategies in this game? What is the Nash equilibrium of the game? What are the rationality assumptions implicit in this equilibrium? By so doing. Extension Exercise 4.
Is this equilibrium reasonable? What are the rationality assumptions implicit in it? Explain in words why there may be equilibria in the two-period game that are different from the equilibria of the one-shot game.
In the payoff vectors. The monopolist sets price p and consumers demand quantity D p. To sell a quantity q. The intermediate case—oligopoly—is the object of a series of chapters beginning with chapter 7.
Campbell soup. In the next chapter. By producing q. Gillette razor blades. Examples include many electric. As predicted by equation 5. In what follows. It can be shown that this implies the well-known elasticity rule: It is not uncommon.
The graph on the left shows a low-elasticity demand curve. Aside from utilities. Dominant Firms Pure monopolies are fairly rare. Until the early to mid s. Table 5. Examples include the mainframe computer industry in the s and s. Whichever price was set. The January Consider a third example. February Apple is the monopoly supplier of the MacIntosh PC. Monopoly and Monopoly Power d For a while. Are there any monopolies? In the beginning of the chapter. Or is it? Consider the case of Apple Computer.
Long-distance telecommunications is not a homogeneous product. In reality. But most of these have been deregulated in most countries.
This results in an optimal price pD and output qD. This caveat notwithstanding. It would probably make more sense to talk about the market. Given the residual demand DR. Apple is the sole manufacturer of the Apple MacIntosh line of personal computers. Monopoly and Regulation for personal computers. French discos argued that they were overcharged by Sacem. The demand elasticity depends on many factors—some static. In both cases. In September Even though.
In terms of market share. For instance. The general point is that: Microsoft in the market for operating systems. Article 86 of the Treaty of Rome states that a dominant position—presumably a reference to a large market share—is not illegal per se. In Europe. But why should we attach so much importance to market share when assessing a monopoly? Take for example. Simplistic as it might be. But does it truly have monopoly power?
Box 5. If Microsoft were to set a high price for Windows There is little doubt that Microsoft holds a position of near-monopoly in the market for operating systems. Microsoft has a near monopoly market share but virtually no monopoly power.
This sort of agreement. Unlike breakfast cereals and gasoline. Microsoft forced an agreement on Intuit Inc. The world depends on Windows. This issue is discussed in greater detail in chapter Justice Department is an interesting instance of the concepts of monopoly and monopoly power. Richard Schmalensee. Alleged anticompetitive practices include exclusionary agreements with PC makers and online service and content providers. PC users would simply carry on with Windows Because the social optimum would be to set price at marginal cost.
An increase in output would increase social welfare. Absent regulation. Let us start by considering the simplest case of monopoly regulation.
As for the monopolist. The price set by a monopolist is greater than marginal cost.
This is certainly the case when marginal cost is constant: An extreme situation is given by a natural monopoly. Much of the preliminary discussion seemed to mimic previous merger cases: Under this regime. By regulatory capture. As can be seen. To solve this problem. Roughly speaking. Monopoly and Regulation Figure 5. This mechanism provides maximum incentives for cost reduction: Price varies in the same exact measure as cost. In the terminology of regulation theory.
At the other extreme. This is the mechanism whereby price is set beforehand and does not change at all. Imagine that the regulator sets a price. During that period. Unable to increase price. The discussion is then focused on the length of the period that the regulator commits to a price-cap or a price path. A low price cap may not be sustainable. The question is then when and to what extent we are in a natural monopoly situation. A high-power regulation mechanism provides strong incentives for cost reduction but few incentives for quality provision.
Another problem with price-cap regulation is that it creates few incentives for the provision of product or service quality. This in turn casts some doubt about the effectiveness of price-cap regulation as an incentive scheme. Ten years would seem like a reasonable period.
In this sense. But the experience of several countries—including Great Britain. Gas and railways are also examples of industries in which only one part is subject to natural monopoly the gas transportation. It is generally agreed that the basic network for the transmission of electric power is a natural monopoly—the costs of having two parallel networks would be much too high. Competition was opened in the downstream markets long-distance. Some argue that not even the local network is a natural monopoly.
An airport. Monopoly and Regulation network and the railway track network. Consumers pay a higher price and have less product variety to choose from. The problem that typically arises is that these parts cannot exist independently from the part that is a natural monopoly: An electricity generator needs the distribution network to sell its power.
France Telecom owns the essential facility local network and competes in the market for long-distance telecommunications. Still another example is given by telecommunications.
Seen from this perspective. The regulation of essential facilities shares the same problems as those of monopoly regulation. By foreclosing its downstream competitors from the market. For one reason or another. As in many other instances of industrial organization. This type of situation raises a number of additional issues.
From a social welfare point of view. Before the interconnection decision was made in Germany. Both countries allowed new competitors to enter the market at about the same time. Both countries started from a similar initial situation. After one year of competition. The latter were required to pay a higher access fee. Beyond this. During the same period. This gave bare-bones resellers an advantage in Germany. In France. The German regulator followed an unexpected route: It took the average of the access fee in 10 countries and came up with the value of 2.
German customers wishing to try a new long-distance carrier can do so by simply dialing the access code and then the desired number. Deutsche Telekom asked for a fee of 6. They are billed in a single Deutsche Telekom statement. No such distinction was made in Germany. Competitors pushed for a one-pfennig rate.
The treatment of new competitors in Germany is more favorable in several respects. The point is that. This is the idea of the ECPR: Each mobile phone company has a marginal cost ci. Monopoly and Regulation Box 5.
Consistent with the ECPR. Rates in France have also dropped. From the preceding equation. Rates in Germany have gone from among the highest in the world to among the lowest in the world. In most European countries. In contrast. To motivate these ideas. At this wholesale price. Deutsche Telekom was barred from launching a low-cost online service unless it were also to lower its access fee. In March of Whichever amount M2 sells. Says the president of the regulatory authority: This implies that.
Clear Communications argued that Telecom ought to charge an access price in line with the actual cost of providing access. Telecom in turn wished to apply the ECPR rule. In the early s. The most clear example of application of the ECPR rule is. Monopoly and Regulation. Based on a statistical study of calling patterns. Sprint estimates that it faces a constant elasticity of demand for long-distance calling by residential customers of 2.
How much additional contribution to overhead. At this price. Based on this information. Sprint sells million minutes of calling per day.
Market research indicates that the elasticity of demand for Ageless is 1. Would you expect the elasticity of demand you face for Ageless to rise or fall when your patent expires? You will market this drug under the brand name of Ageless. What about the Intel Pentium microprocessor? To what extent does the discussion in section 5. We begin the chapter by reviewing the assumptions and the results of the perfect competition model.
This observation suggests an extension of the model into a framework of competitive selection. Although examples of pure competition are rare.
This leads to the model of monopolistic competition. Chapter 5 shows that there are very few examples of pure monopolies. An alternative change to the model of perfect competition is to introduce product heterogeneity. In section 6. Because of free entry. Similarly to the case of monopoly. The model of perfect competition shows that competition is a good thing. Market demand. This is a problem that we address in chapter At best. In the remainder of this section. Assuming plant-level cost functions are U-shaped.
The model of monopolistic competition section 6. The long-run equilibrium under perfect competition is a limit point that industries converge to by means of successive entry and exit. We then present two extensions of the basic model that account for the observed stylized facts. If the managerial costs of owning more than one plant are positive. Because technology i.. Perfect and Almost Perfect Competition 87 tition may not always be a good approximation.
The model of competitive selection section 6. The empirical evidence suggests that. From a sample of eight countries. For exiters.
For each subdivision. Empirical evidence suggests that the average size of entrants and exiters is much smaller than industry average size. Entry and Exit Rates The perfect competition model predicts that. The same occurs with respect to survival rates: As times goes by. Given the preceding elements. Similar results are obtained with sectoral distributions. Perfect and Almost Perfect Competition 89 Figure 6. These differences may result from a variety of factors.
By selection. Together with the previous results. At this point. This industry is an interesting example because 1 it illustrates a source of variation across. No news is better than bad news. This model of competitive selection is consistent with several of the stylized facts described in the previous section. As a result. Heterogeneity of. We return to this sort of model in chapter This is where the model of perfect competition fails. A central planner who attempted to maximize total surplus would not be able to do better than the market.
Both of these examples feature a large number of sellers: These observations would suggest perfect competition as the relevant model. Examples of this include small restaurants and shampoo. The basic idea is the same as in the model of perfect competition: Chamberlin proposed the model of monopolistic competition as an alternative reference point with respect to the model of perfect competition.
AC qSR. To account for this type of industry.
One of the main learning points of the monopolistic competition model is that abandoning the assumption of product homogeneity implies abandoning some of the results of the perfect competition model. This is a feature of the particular short-run equilibrium we are considering. Whichever is the case. The fact that price is greater than marginal cost implies that. The fact that price is greater than the minimum of average cost implies that. In addition to updated examples, this edition presents a more systematic treatment of public policy implications.
It features added advanced sections, with analytical treatment of ideas previously presented verbally; and exercises, which allow for a deeper and more formal understanding of each topic. The new edition also includes an introduction to such empirical methods as demand estimation and equilibrium identification. Supplemental material is available online. Luis Cabral has updated his industrial organization textbook.
The revision retains the strengths of the original: The many new examples ensure the relevance of the material. William R. Kenan Jr. Introduction to Industrial Organization is a rare commodity: Cabral manages to communicate difficult ideas precisely while keeping the focus squarely on issues that matter for the real world. It is the ideal introduction for undergraduates, MBA students, or anyone else looking for a non-technical overview of the field.
Cabral's Introduction to Industrial Organization is clear, precise, relevant, even fun. This delightful volume is your best choice for crisp and accessible coverage of IO theory. The second edition sparkles just like the first. To be sure, in a large number of industries, rms hold little or no market power see chapter 6. The point is that there are some industries where market power exists to a signicant extent.
Market power translates into higher prots. Creating and maintaining market power is therefore an important part of a rms value-maximization strategy. How do rms acquire market power? One way is through legal protection from competition, so that high prices can be set without new competitors entering the market. For example, in the s, Xerox developed the technology of plain-paper photocopying and patented it. Given the legal protection provided by Xeroxs patents, it could raise prices to a signicant level without attracting competition see box Firm strategy may also play an important role in establishing market power.
Its competitors include ONdigital, which is based on terrestrial broadcasting, and a consortium of cable operators. Still, there is concern that BSkyBs move may trigger a price war that could hurt the prots of every rm in the industry.
In fact, ONdigital reacted by saying it also will provide free set-top boxes. Creating market power is only one part of the story.