Intro to I/O

1. Intro to I/O

2. What is Industrial Organization (I/O)? The short answer is I/O is the study of business or firm behavior and industrial outcomes in markets that are imperfectly competitive. You may recall from other microeconomics courses the study of perfect competition and monopoly. We will review these ideas, but then we will spend a considerable amount of time on imperfect competition – mostly ideas about oligopolies. Ideas we encounter with imperfect competition: How many firms compete? Is one firm larger than the others? Do all firms sell the exact same product? Can new firms enter the market easily? Should companies try to “bundle” goods together or sell them separately? Firms are interdependent – meaning the actions of one have an influence on the others – something called strategic interaction. We will use game theory to study strategic interaction.

3. Some economic history as to why I/O developed: In 1890 in the US the Sherman Antitrust Act was passed. Although I/O was not really in existence, writers such as Adam Smith had warned of the problems of monopoly. As folks listened to Smith and others they said, “there ought to be a law against...” The first two sections of the Sherman Act are the main parts. Under section 1 of the act the Trans-Missouri Freight and Addyston Pipe & Steel cases established that collusive agreements to raise prices are a no no. But firms to this day are still enticed to fix prices. Price fixing is on its face an illegal act. Some folks say it is illegal, per se (by itself).

4. There is a notable outcome of the Standard Oil and Tobacco cases that deal with section 2. In the courts a “rule of reason” doctrine was established that basically means that not only does a firm have to be a monopoly to be guilty under section 2, but it must also have intended to monopolize or had to have exploited its monopoly power to be guilty. The Clayton Act was passed to include as offenses acts not covered in the Sherman Act. Section 7, for example, deals with anticompetitive mergers of firms. In the US Steel case the courts ruled that size is not an offense in itself. Microsoft, with 95% or so of the market, is not violating the law just by its mere existence.

5. The structure-conduct-performance (SCP) approach to I/O had the aim of providing the courts with information from industrial studies about industrial structures that would lead to bad conduct and performance. The Robinson-Patman Act of 1936 prohibited price discrimination that allegedly lessened competition. The Alcoa and American Tobacco decisions meant a sort of reversal of the US Steel decision in that size , or market domination, is an issue and this represented a sort of vindication for the SCP approach to I/O.

6. A weakness of the “SCP” approach was that other interpretations could actually explain the same findings. For example, firms with large market shares have been seen to have higher profit. But, instead of this being interpreted as a result of monopoly power, both could actually be the result of greater efficiency. Proponents of the “Chicago School” of I/O explained that many actions of firms are the result of strategy and lead to improved results for consumers. Well, from this brief history of antitrust and I/O we see that I/O has been very much involved in public policy. This will be a common theme for us this term.