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Managerial Economics

Managerial Economics. Joseph Francois Rotterdam School of Management Fall 2001. Managerial Economics. 8. Nature of Industry (Baye Chapter 7). Overview. I. Market Structure Measures of Industry Concentration II. Conduct Pricing Behavior Integration and Merger Activity

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Managerial Economics

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  1. Managerial Economics Joseph Francois Rotterdam School of Management Fall 2001

  2. Managerial Economics 8. Nature of Industry (Baye Chapter 7)

  3. Overview I. Market Structure • Measures of Industry Concentration II. Conduct • Pricing Behavior • Integration and Merger Activity III. Performance • Dansby-Willig Index • Structure-Conduct-Performance Paradigm IV. Preview of Coming Attractions

  4. Industry Analysis • Market Structure • Number of firms, size, etc. • Conduct • Pricing, advertising, R&D, etc. • Performance • Profitability, consumer surplus, social welfare.

  5. The Structure-Conduct-Performance Paradigm The Causal View • The Feedback Critique • No one-way causal link. • Conduct can affect market structure. • Market performance can affect conduct as well as market structure. Market Structure Conduct Performance

  6. Industry Concentration • Four-Firm Concentration Ratio • The sum of the market shares of the top four firms in the defined industry: C4 = w1 + w2 + w3 + w4 • Herfindahl-Hirshmann Index (HHI) • The sum of the squared market shares of firms in a given industry, multiplied by 10,000: HHI = 10,000 S wi2 • Limitations • Market Definition: National, regional, or local? • Global Market: Foreign producers excluded • Industry definition and product classes

  7. Rothschild Index • A measure of the elasticity of industry demand for a product relative to that of an individual firm: R =ET / EF • ET = elasticity of demand for the total market • EF = elasticity of demand for the product of an individual firm. • R has a value between 0 (perfect competition) and 1 (monopoly). • When an industry is composed of many firms, each producing similar products, the Rothschild index will be close to zero.

  8. Own-Price Elasticities of Demand and Rothschild Indices

  9. Pricing Behavior • The Lerner Index L = (P - MC) / P • A measure of the difference between price and marginal cost. • An index from 0 to 1. • Markup Factor • Rearranging the above formula, P = (1/(1-L)) MC • 1/(1-L) is the markup factor.

  10. Lerner Indices & Markup Factors

  11. Integration and Merger Activity • Vertical Integration • Where various stages in the production of a single product are carried out by one firm. • Horizontal Integration • The merging of the production of similar products into a single firm. • Conglomerate Mergers • The integration of different product lines into a single firm.

  12. DOJ/FTC Merger Guidelines • Based on HHI = 10,000 S wi2 • Merger may be challenged if • HHI exceeds 1800, or would be after merger, and • Merger increases the HHI by more than 100 • But... • Recognizes efficiencies: “The primary benefit of mergers to the economy is their efficiency potential...which can result in lower prices to consumers...In the majority of cases the Guidelines will allow firms to achieve efficiencies through mergers without interference...”

  13. Performance • Performance refers to the profits and social welfare that result in a given industry • Social Welfare = CS + PS • The change in these surpluses is an approximation of the change in the value of real national income. Hence, their maximization is akin to maximizing national economic efficiency.

  14. Preview of Coming Attractions • Discussion of optimal managerial decisions under various market structures, including: • Perfect competition • Monopoly • Monopolistic competition • Oligopoly

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