E. Market power in practice

    The focus of a field of its own, industrial organization
    Industrial organization approach--industry studies:
        (1) Structure
        (2) Conduct
        (3) Performance

    1. Structure

    Components of structure, playing off the assumptions of PC:
    --concentration
    --barriers to entry
    --product differentiation

    (1) Concentration

    Step 1: define the relevant market

    GM has a monopoly on Chevies--meaningful?
    Courts once sued GMAC under antitrust laws: It's a financing service. Courts defined GM cars as a market. (If you wanted a GM car, had to use its financing)

    All products face substitutes: can buy bottled water

    Step 2: determine concentration

    (a) Monopoly: Market share = 67%
    In this case, our diagram of monopoly power is inaccurate
    Kodak: developing / Caterpillar: tractors / Boeing

    (b) Oligopoly: "few" producers

    4-firm concentration ratio (CR4).
    Tight oligopoly => CR4 = 70%+ of the market
    Cigarettes / Aluminum / Beer

    (2) Barriers to entry (BtE)

    BtE = factors that allow existing firms to make economic profits without inducing entry. (Joe Bain)

    If BtE are low and CR high, called a contestable market instead of an oligopoly or monopoly

    BtE1: legal
    --franchise
    --patents often a major source of mkt power: Alcoa / Xerox / GE / AT&T

    BtE2: absolute cost barriers
    --Control of a scarce input
    Ex: Alcoa and bauxite

    --higher K costs from risk
    Ex: you and a steel loan

    --brand loyalty ex: GM / Bayer aspirin

    Key: ATC must be higher for new firms than for existing firms.

    Why is new firm's cost curve higher? For example, must convince customers not just to try a product but to try theirs.

    BtE3: Economies of scale--minimum efficient scale is large relative to the size of the market

    (3) Product differentiation

    = characteristics other than price which distinguish the output of various firms in an industry

    Ex: Jay Leno vs. David Letterman
    Bud versus Miller

    Significance of product differentiation:

    --Leads to non-price competition
        Quality: Volvo vs. Pinto
        Variety: Mexican versus Italian food

    --Affects entry conditions

        May contribute to barriers to entry
    --Brand loyalty as an absolute cost barrier
    --Advertising and promotion: raise E/S: beer
    --Brand profileration: cold cereal / toothpaste

        Can be a niche for entry:
    Ex: imported small cars / granola

    Empirically, seems to be important as a BtE

    2. Conduct

Conduct covered by U.S. antitrust laws:
    (1) Collusion--Sherman Act, Section 1

    Hard in practice due to incentives to cheat and new entry
    Ex: OPEC

    (2) Predation--Sherman Act, Section 2

    Called monopolization--includes exclusion of potential competitors

    Uncommon, since must absorb short-run losses before getting a chance to earn long-run profits
    Requires offsetting higher prices in LR which invites new entry, so likely to fail without high BtE

    Ex: NCR: turn of century: hired competitors' employees / hired spies / spread bankruptcy rumors / graveyard / sabotaged machines and sales / result: 95% market share after 20 yrs.

3. Performance

    2 efficiency concerns:
    --Static efficiency: welfare at one point in time
the usual welfare loss triangles we draw

    --Dynamic efficiency: growth and innovation over time

Basic idea: Quest for market power motivates innovation (rationale for patents)     Schumpeter: Creative destruction     Monopoly profits fund R&D     Evidence: lure of profits does prompt innovation.     Much by small fry: Polaroid: Land in bathtub / Xerox: Carlson, atty / CDC: Seymour Cray in garage / Apple: Jobs & Wozniak--as a hobby

    Overall:
    Loose oligopolies with moderate BtEs are most innovative
    PC: can't appropriate returns--no sustained R&D.
    High CR: less competitive pressure and protecting own position => keeping out outside innovations (AT&T blocked entry in long distance)
    Static/dynamic efficiency trade-offs remain subject of debate

    Market power is one cause of concern.
    The other: Market failure. We turn to that next.