Industrial Organization is the area of economics that studies the markets as institutions, the state of competition and strategic interaction among firms, the industrial policy and the business decisions firms make within the market framework. The course looks at the markets from three different perspectives: the economic theory, the applied business perspective and the institutional and legal perspective. The focus of the course is split equally between the economic theory and business perspective but there is a significant legal component incorporated in various topics. The course includes economic modeling, game theory, numerous real life examples and several case studies. We explore interesting topics of market organization such as negotiations, antitrust, networks, platforms, electronic markets, intellectual property, business strategies, predation, entry deterrence and many others.
The basic objective of the course is to enable the student to understand the structure of markets and the nature of strategic competition. Knowledge in this course will be valuable for the students in acquiring managing and governance skills, enriching their understanding of the institutional framework of business, and improve their analytical ability in negotiations.
Prerequisites: The course requires understanding of basic economic modeling, knowledge of intermediate microeconomics (especially production/cost theory), knowledge of basic concepts and methodologies of game theory, intermediate econometrics and basic calculus.
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Our first lecture is devoted to building a microeconomic foundation, which is necessary for understanding the lectures to come. In the beginning segment we will say a few words about the course and, then, we will focus on the concept of the firm. We will try to define what a firm actually is and why business is organized based on the notion of the firm. We will talk about technology, economies of scale, concentration, informational asymmetries, hold-up and we will present our first case study: GM vs. Fisher Body. It may seem to you that you have heard some of this lecture’s terms before, or you already know them, but reviewing them and deeply understanding them will be essential for the continuation of the course.
Game theory foundations
In this lecture we will focus on the principles of strategic interaction. The most important tool to understand strategy is game theory. We will define and explain different categories of games. The ultimate goal of this lecture is to enable you to use game theory so that you can model interaction and negotiations. We will talk about equilibrium in dominant strategies, which is a non-strategic equilibrium, the Nash equilibrium and the prisoner’s dilemma. We will get acquainted with static, repeated and dynamic games. I will tell you a real story of prisoner’s dilemma and we will have an extended example on firm interaction with “Energon vs. Orange”.
The topic of this lecture is short-run competition. That is, interaction that lasts only for one period. Static competition is not the most usual form of competition but it is not rare, either. Most of the principles that we will present in this lecture will carry over to the dynamic competition analysis later. There are two different kinds of static competition. The first is when strategic variables have a positive causative relationship, as in competition with prices. The second is when the strategic variables are negatively related, as in competition with quantities. We will cover interesting notions such as first-mover advantage, the Bertrand Paradox, capacity constraints, differentiated products, and will introduce the notion of collusion that will be of major importance for our future lectures.
We extend the analysis of competition introducing interactions with time depth. We will use several concepts from the previous lectures but here we have two important qualitative differences. When competition lasts for more than one period, players develop reputations and are given the opportunity to retaliate in case they are cheated upon. Reputation and retaliation may alter the outcome of interaction in comparison to interactions that last only for one period. We will talk about repetitive and dynamic interactions, collusion, renegotiation, price wars, antitrust and detection mechanisms.
Deterrence and predation
Our fifth lecture focuses on games where firms are in different stages of the competition game. In this setting there exists a monopolistic firm already in the market, while another firm considers entering this market in the future. We will examine how the incumbent firm will be affected by the prospect of entrance. We will cover all basic principles of deterrence for the protection of the incumbent’s territory. We will talk about, credibility, empty threats, preemption, contestability and strategic relevance. We will examine the four general business strategies for deterrence and we will see a very intriguing paradox that can teach us a lot about credibility and the importance of reputation.
The topic for this lecture is pricing. In general in economics, we are used in a paradigm in which firms set only one price for each of their products. Sometimes this is indeed the case but, often, we observe that firms charge different prices to different consumers or different occasions or different purchased quantities. In reality, when a firm has some market power and the consumers are each not willing to pay the same for every unit, the firm can price-discriminate to increase its profits. We will analyze the three degrees of price discrimination, tying, bundling and several other methods of advanced pricing. We will also present a brilliant pricing case study with Polaroid.
In our previous lectures we have come to the conclusion that when firms compete with price, the Bertrand paradox leads those firms to lose their entire market power. In today’s lecture we will try to resolve this paradox assuming that the firms can differentiate their products. Differentiation has two dimensions. The horizontal, where beliefs for the quality of the product are subjective; and the vertical, where beliefs for quality are objective. We will present two models for horizontal differentiation: the linear and the circular city. We will also cover the Nobel award winning model of differentiation in quality. We will talk about brand proliferation and will examine how it can be effective as a deterrence mechanism. Additionally, we will have two entertaining case studies on the costs of withdrawal and rebranding.
So far, we have mostly examined the markets in the context of the “firm – customers” relationship. In this lecture our analysis extends to more complicated relationships such that of “manufacturer – retailer – customers”. We will also generalize our setting to include all kinds of vertical relations between firms. When firms are vertically related, we observe an interesting phenomenon that creates tension between the two partners. This phenomenon is referred to as “double marginalization” and creates a vertical externality at the upstream market. Additionally, the opportunity of a retailer to provide demand stimulating pre-sale services may create a horizontal externality, causing the provision of service to end up sub-optimal. We will talk about resale price maintenance, exclusive dealing, exclusive territories and the importance of modern distribution systems. We will also present two interesting case studies: the Levi’s Strauss case and the “free corporate refrigerators” case.
Networks and platforms
Our ninth lecture explores a modern and quite useful topic. We will examine the economics of networks and platforms. In contrast with usual markets, networks have a key feature: the value of a network good to a consumer depends on the total number of consumers of this good. Platforms often exhibit network effects. That is, when a platform signs up one additional user, the increase in revenues exceeds the value of the subscription of the new user because the platform becomes more attractive for all other current or potential users. We will talk about cutting edge economic notions: stability of equilibrium, critical mass, path dependence and platform instruments. We will also present two fascinating case studies: the OS platforms and the video game platforms.
In our last lecture we will get acquainted with the concept of intellectual property and its institutional protection. Intellectual property becomes more and more relevant as our lives become more and more digital. IP is not a straightforward concept. Its definition can be complicated and tricky and its application may vary from one jurisdiction to another. In our lecture we will examine some basic principles that are internationally standard. We will understand the basics of copyright, patents, trade secrets and trademarks. We will talk about the international protection of IP and, of course, we will have several examples for all complicated notions. Also, this is our last lecture and our end segment is reserved for the “final note”.