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The Scope of Industrial .Economics and its History

1.1

INTRODUCTION
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Industrial economics is a distinctive branch of economics which deals with the economic problems of firms and industries, and their relationship with society. In economic literature it is known by several names with marginal differences such as 'Economics of Industries', 'Industry and Trade' 'Industrial Organization and Policy' 'Commerce' and 'Business Economics' etc. The name 'Industrial Economics' was adopted in the early fifties perhaps through the writings of P.W.S. Andrews. 1 Although this name is becoming popular day by day some authors, particularly in the American circle, prefer 'Industrial Organization' as a title of the subject? At present there is no clear-cut consensus on the name of the subject. There are two broad elements of industrial economics. The first one, known as the descriptive element, is concerned with the information content of the subject. It aimsat providing the industrialist or businessman with a survey of the industrial and commercial organizations of his own country and of the other countries with which he might come in contact.

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It would give him full information regarding he natun l resources, industrial climate in .the country. situation the i frastruct~re including lines of traffic, supplies of factors of production, tr de and commercial policies

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of the governmen~ and the degree ~f COt, ~etition the business in which he opcrates.l!n short, tt deals with th, mfof':,nation about the competitors. naturaJ resources and factors Of pro .iction and government rules and regulations related to the co~cerned ind stry. TIle :iecond clement of the subject is concerned with the business olicy and decision-making. This is the analytical part dealing with topics such as market analysis, pricing, choice of techniques, location of plant, investment planning, hirin~ and firing of labour, financia~ decisions, product diversification and so on)lt tS a vital part of the subject and much of the received theory of industrial economics is concerned with this.[However. !h\s does not mean that the first dement, i.e. descriptive industrial cconorni lS. j, less importanL(rhe (\\l) elements arc interdepe~dent, ~ince wi thou adequate informarion no one can take proper deCISIOn abbut any aspec t of business. How decision-making problems arise in industries? To rnswer this question, we have to go back to the core of economics. According to L Robbins, "Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses".3 As implicit in this definition, an economic problem arises because of scarcity of means and their alternative uses in relatior to the needs of an individual or a group or society as a whole. For examble, the income (i.e. resources) of a consumer is generally limited but hi~ wants are u~limited. In this

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situatio~ he has to a.do.pt some criterion to ~~hieve ~a~im~+ ~ain from his income. ThIs IS the problem of utllty maxlmlzatlO~ In the theory

of consumer behaviour. Similarly, for a pr ducer, the reSO~.~rice_S.like land, raw materials, labour, capital, etc. are scar e. Given such s arcity, he has ~o take decisions about producti~n and di~ttbuti~n __ There al. several basic Issues on which the producer WIll be taktn deCISIOns such \ IS: what commodities he should produce, what shouldjbe the level of output of each, what type of technology he should adopu where should h produce the goods what should be the size of his factory, what price he 'ould charge, how much wages he should pay, how much he should spend on advertisement, should he borrow from banks or elsewhere. etc. All s ich decisions explain the producer's behaviour in the different market situ tions. which J . we endeavour to study in industrial ec010mics. In rrncroec norrucg also we study producer's behaviour in relation lO scarcity resources.

Because of this tact, some economists would regard~al econo{\lics as being primarily an elaboration of, and development from the traditional theory of the firm taught under microeconomics. In fact, Stigler emphatically argued that the field of industrial economics doesnot really exist. Jt is nothing more than a slightly differentiated microeconomk,s.4 Tirole in the opening paragraph of his book. considered industrial organization as . f ,.J[;.:.lh. """ . . 5 stud of the f unctIon 0 markets, a central concept in mIcroeconomICS. To ev.Qndustrial economics a development of microeconomics is quite unde.rsGlndable. (i3o~h are concerned with the economic aspects of firms and industries S~tng to analyse their behaviour and draw normative implications. However, there are some differences between the two. Microeconomics is a formal, deductive and abstract discipline. Industrial economics on the other hand is less formal, more inductive in nature. Microeconomics by and large assumes profit maximization as the goal of the firm and tells us to maximize it subject to given constraints. It is passive in approach. Industrial economics. does not believe in single goal of profit maximization)rt~als of -the firm from the.revealed facts. It concentrates on the constraints which impede the achievement of the goals and tries to remove them. It is an active discipline in this sense. Microeconomics. being abstract, does not go into operational details of production, distribution and other aspects of the firms and industries. Industrial economics does go into th~ dePQ!...QLsuch details. Further, the conclusions derived from the microeconomics may not be testable empirically and therefore we may not assess their predictive efficiency. Industrial economics is free from such limitation because of its emphasis on empiricism. Public policy implications are taken care of in industrial economics but microeconomics may shun them if necessary. It is true that the theory of firm (i.e. microeconomics) provides the main theoretical basis for the study of industrial-economics, but several important influences from outside have given a totally different character to industrial economics. In the light of such influences the conventional theory of the firm is bound to be re~d.

(Recently, L~re 'has been considerable emphasis on managerial econorniCSin business or industrial management. This branch of economics deals \\ ith the concepts and analysis of demand, cost, profit, competition and so on. that are appropriate for decision-making. Such topics are also covered in industrial eCOnOmiC) Then. what are the differences between the two?

L. Robbin- --:- _ '<aturc and Significancellof Economic Selene]. .\bemillan. London. 1902. 1

G.J. Stigler. r~Organization or Industries. R.D. lrv in Inc .. Homewood, Chapter 1. J Tirole. op c.;.. p. I.

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Industrial Economics

The Scope of Industrial

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There are two striking differences.P First, ,manageri~1 economics by and large starts from' the assump~ion that the firm. aims .t<[maxi.~ize its profits and then proceeds to examine the manner In whic I decision rules and procedures of the firm should be formulated in orddr to achieve its goal. The approach of industrial economics is different from this where the main emphasis is placed upon understanding and e plaining the working of the existing system and thereby prediction of th: effects of changes in variables of the system. It is a branch of social scici ce which is interested in what actually happens (positive aspect) rather th n what should happen in hypothetical or ideal situations." Industrial econ rnics thus, has a positive approreh while managerial economics folk s the normative one. Secondly,~anagerial economics is more interdis: plinary in nature than industrial economics. Accountancy, Operations -..esearch, Psychology, Marketing, etc. are to be combined together with e onomics in managerial decision-making, Industrial economics does not g too far for its analysis / of -the problem.r It-may be mentioned here that the -study of industrial economics is the basic element in managerial ec nomics because it provides a knowledge of the structural constraints a/fecting the achievement of the management goals of a firm.) ~o far, we were looking at the problem of deci ion-making in an industry from the micro angle, but it has macro dime sions also. For a society as a whole, the resources for production are scr ce just as in the case of a producer. With scarce resources, the problem s to produce ,{arieties of goods and services in the current period and i future also. What commodities should be produced-'bread' or 'guns ? If 'guns' are preferred, then the series of problems faced by the SOCif y may be: what types of 'guns', what type of factory (large vs. small scale); where to produce (Iocational problem); how to distribute them, e . These 'are the questions which we have posed earlier for an individual roduceralso. But here we have to examine them from the social ang@ll e decisions in the context of society as a whole may be at variance wit the decisions by an individual producer. If this is so a state will clear specify the pohcy framework in which the individual producers will riction, In other words, to achieve the broader policy objectives, a state w: Iregulate industries 'through varieties of ways such as nationalization, at i-trust policies, control on prices ~nd outputs, credit controls, taxes, de A study of all such instr~ments of industrial regulation is very much a art of industrial e.;onomic~

How they affect the performance of the firms is a crucial aspect to be examined under industrial economics. Such information is useful for' the regulatory agency of the government to assess the success of its industrial policy. Concluding this section, we may say that industrial economics is predominantly an empirical discipline having micro and macro aspects. It has a strong theoretical base of microeconomics. It provides useful applications for industrial management and public policies and has acquired the status of a specialist subject.

1.2

HISTORY OF THE FIELD

(It is difficult to know the true beginnings of the field because of nonli'v.ailability of facts. There is, of course, some evidence according to which monopolistic practices and other el~me~ts of the industrial economics were in operation as far back as 2100 BC.8 It may not be useful for our purpose to go back into the antiquity' of e subject. We 'shall rather see the evolution of modern industrial economics in the last two hundred years for which necessary data and documents are available. TIle cutoff point for our purpose isCi226 when the 'Wealth of Nations,9 of Adam Smith appeared on the scene. This book laid down a strong foundation for the economic theOJ~hich we know by the name of classical economics. The early theory 0 the firm which we mfY regard as the mother of the contemporary industrial economics was born at this stage as an integral part of the classical economics'. Since then there has been a steady growth of the field, particularly during the last fifty years. A brief review of Chis is presented below: Adam Smith's 'Wealth of Nations' is a treatise dealing with the basic philosophy' and thereby implicit principles of ecohomic theory. It has assumed competitive conditions for the economy in which 'invisible hands' operate to maximize their own self-interest. Given this kind of market environ~ent and "qatural propensity to truck, barter and exchange" of one thing-for anotheUdam Smith propounded the principle of division of labour. According to him: "The greatest improvement in the productive powers of labour and the greater part of the skill, dexterity, and judgement

8 M. Harnphrey,

The Economics

of Ancient Greece. of Industrial

\1c;nillan, Organization.

Ke\\ York, 1940; Prentice-Hall,

Managerial Economics' A New Frontier? pers and Proceedings. ~ L~ .960. P.W.S. Andrews, Journal of Industrial

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Asso-, iation: Pa9

and WG. Shepherd. The Economics England Cliffs, 1979. p. 14.

Eco:lOlJic;. 1952, op. cit.

Adam Smith. An lnq .. f) into the Nature and Cause. London. 1776.

of the We8.Jtf: of Nations,

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with which it is directed, or applied, seem to!have be)'n the effects of the division of labour. to To support his conten ion, Adam Smith gave .the famous example of pin-making, whereby di~ ision of labour, productivity went up manifold. This principle has a fundi{mental bearing for industrial economics and now-a-days, particularly in mlbdern larg\: corporations, production is impossible without division of labour (or machines) as a way of production. Apart from division of labot.:r Adam Smith's contribution -' to the field of industrial economics is the analysis of product pricing. He regarded a product having two prices 'market price' a' which it changes hands and 'natural price' or 'value' determined by the labour required to make the product. Much of his analysis was devoted to the determination of 'natural price', ignoring the market pricer altogcther.Ifhough he is criticized on this c?unt, y~t his :vork is rega!ded .as a pirne~ring study of price-cost margins for industries under competitive coi-ditions. After Adam Smith, the historical dev eloement of the :fconomic analysis of industrial activities was subjected to methodolohcal division'. One school of thought led by Jevon followed abstract, dedJ.~tive reasoning to derive testable hypotheses in the theory of the firm, whil~ the other, known as Historical School, followed inductive or empirical ~fProach for study of the economic behaviour of the firm and industry. S . .T~,'onII , al most 100 years after Adam Smith, developed the lh~ory of demard in terms of the present utility theory. In addition to this. t~was able to r;fi-ncthe concepts Of costs and the aZtors of roducti n. F~ and his follcwer Edgeworth'?" were a~e to establish t~e conditions for equating priC{;~t-nd aver~ge co~t of a product and thus, eilmll1atlon 01 ttreyxCessproTIill irkl3 carried their :mJrk further and Knig.htl4 was able to -dne the Derf;;;- c mnctitivc model wrucn WI; ,IX at present. From this stage, the theory of firm stJ[;ed taking a Si~~lificant turn. The assumption of perfect competition was found inappro iate to describe the true behaviour of the firm. Staffa's I cscription of tll I laws of returns under competitive conditions+ was perhaps the turning oint. Thereafter came the stumbling blocks of Joan /Robinson's theo y of imperfect competition 16 and Chamberlin's analysis of monopolistic competition. i7 These two theories particularly of Chamberlin's opened altogether new venues for the industrial economics. Doupoly, oligopoly, product diversification, advertisement behaviour, research and development, pricing policy, etc., became burning topics for analysis. More realism was infused in the traditional theory of the firm. The impact of Chamberlin's work on industrial economics was so profound that it was regarded as the single most important antecedent of contemporary industrial economics. IS Along with the line of Chamberlin, Hotclling'? developed the stability conditions for competition by taking differentiated goods and spatial dimensions. His work and Chamberlin's theory, together intluenced Lancaster'? who has developed altogether a new theory of consumer demand which is very much relevant for industrial economics. An independent development in the theory of firm was seen during the decade of the 1940's, when Von Neumann and Morgenstern published their work on the game theory." Economists accepted this as a break-through in the study of market-structure under conflicts. Tn the context of industrial economics, this theory has many potential uses. Martin Shubik22 in fact, demonstrated some of them, but the full empirical analysis based on game theoretical approach is yet to come. Along with the deductive stream of thoughts discussed above, the alternative methodology of inductive reasoning was in extensive use right from the time of Adam Smith, to develop a meaningful and realistic theory of industrial economics. The need for such an approach was felt mainly because the method of logical deduction being too abstract failed to analyse the economic behaviour of the firms as seen in real life. That is, the

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Adam Sfill,b. ooc!cu. op. 1 S. Jcvon, Theory of Political Econornv, London. 1871. Ie EY Edgeworth. Malh~malical Psychic : .'ndon. 188] :, J.B. Clark. The Distnouuon 0;" V;c:::it: .,,,.\ "urK. 1\'1'). iJ E Knight. Risk, Uncertainly and Prof'. York. 1921. I' P. Sraffa. 'The Laws of Returns under (~r'i'~lili\e Condui "'~ Economic Journal. 36, 1926. pp, 5~))5

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Joan Robinson, 'The Economics of Imperfect Competition', Macmillan. London, 1933. 17 E.I I. Chamberlin, The Theory of Monopolistic Competition, Harvard University Press, 1933. . .lR See, Donald, A. Hay and Drek, J. Morris, Industrial Economics: Theory and Evidence, Oxford University Press (19,9) for a full review of Chamberlin's impact on indusiiral economics. 1'lllotelling. 'Stability in Competition', Economic Journal, 39,1928, pp. 41-57. ~I) K. Lancaster, Consumer Demand: A ~e\\ Approach, New York, 1971. ~I von Neumann and Oskar Morgenstern. Theory of Garnes and Economic Behaviour, Princeton University Press. : ').;- . : .. I Ec.) AlSO See .1. Nash. 'The Bargaining Problem'. Econometrica 18. ;9-,). pp. 15562. \1anin Shubik, 'A Cur:'11ldgco~:s Guide IO Microeconomics', Journal of Ecoirrruc Literature, 8,1910, p. ,L) ..~Is~ see LG. Telscr. Cornpctition. CollUSIOn and Game Theory, Macmillan. Lc:l,k:-.. : 971.
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The Scope of Industrial Economics and its History 7 competition 16 and Chamberlin's analysis of monopolistic competition. i7 These two theories particularly of Chamberlin's opened altogether new venues for the industrial economics. Doupoly, oligopoly, product diversification, advertisement behaviour, research and development, pricing policy, ctc., became burning topics for analysis. More realism was infused in the traditional theory of the firm. The impact of Chamberlin's work on industrial economics was so profound that it was regarded as the single most important antecedent of contemporary industrial econornics.l'' Along with the line of Chamberlin, Hotelling!" developed the stability conditions for competition by taking differentiated goods and spatial dimensions. His work and Chamberlin'S theory, together intluenced Lancaster'? who has developed altogether a new theory of consumer demand which is very much relevant for industrial economics. An independent development in the theory of firm was seen during the decade of the 1940's, when Von Neumann and Morgenstern published their work on the game theory." Economists accepted this as a break-through in the study of market-structure under conflicts. In the context of industrial economics, this theory has many potential uses. Martin Shubik22 in fact, demonstrated some of them, but the full empirical analysis based on game theoretical approach is yet to come. Along with the deductive stream of thoughts discussed above, the alternative methodology of inductive reasoning was in extensive use right from the time of Adam Smith, to develop a meaningful and realistic theory of industrial economics. The need for such an approach was felt mainly because the method of logical deduction being too abstract failed to analyse the economic behaviour of the [urns as seen in real life. That is, the

with which it is directed, or applied, seem to/have been the effects of the division of labour. to To support his conten ion, Adam Smith gave the famous example of pin-making, whereby di, ision of hbour, productivity went up manifold. This principle has a fundamental bearing for industrial economics and now-a-days, particularly in rnlbdern larg corporations, production is impossible without division of labour (or machines) as way of production. Apart from division of labOL:f' Adam Smith's contribution ,., to the field of industrial economics is the analysis of product pricing. He regarded a product having two prices 'market price' a which it changes hands and 'natural price' or 'value' determined by the labour required to make the product. Much of his analysis was devoted to the determinati-on of 'natural price', ignoring the market price altogethcr.jf'hough he i~ criticized on this count, yet his work is regarded as a pioneering study of price-cost margins for industries under competitive coi-ditions. After Adam Smith, the historical dev eloprnent of the ,tconomic analysis of industrial activities was subjected ID the methodological division. One school of thought led by Jevon follo wed abstract, deductive reasoning to derive testable hypotheses in the theory of the firm, whillr the other, known as Historical School, followed inductiv e or empirical ~1pproach for study of the economic behaviour of the firm and industry. S . .TeiOn)), almost 100 years after Adam Smith, developed the treory of demard in terms of the present utility theory. In addition to this. t~was able to r,fu.;ethe concepts Of costs and the aC"tors of roduction. E,; and his follc wcr Edgeworth'? were able to establish the conditions for equating priCi.:'t'Zind average cost of a product and thus, ellmmallon 01 'ttre:X'cessprofil. C! ,rk)3 carried their ~k further and Kni!!htt4 was able to -e~:ine the Derf~ cI mnetitive model , , .... rucn WI; ~I;I; at present.

From this stage, the theory of firm SUf:ed taking a Sit}lificant turn. The assumption of perfect competition was found inappro iate to describe the true behaviour of the firm. Sraffas escription of tll laws of returns under competitive conditions" was perhaps the turning .oint. Thereafter came the stumbling blocks of Joan Robinson's theo y of imperfect

10

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Adam Smith. op. cit. S. Jcvon, Theory of Political Econorn., London. 187I. I: EY. Edgeworth. Math~malica! Psychic :~!ldcn, 188! :3 J.B. Clark. ThL Disinout.on 0:' Walt; .v c . '.ori- h':i'!. P E Knight. Risk, Unceriairuy and PrOl~"~W York. 1921. I' P. Sraffa. 'The Laws of Returns under ( ~~'i'~titi\'e CC''ldl!i)['~ Economic Journal. 36. 1926. pp. 535-55.

Joan Robinson, 'The Economics of Imperfect Competition', Macmillan. London, 1933. 17 E.H. Chamberlin, The Theory of Monopolistic Competition, Harvard University Press, 1933. . JR See, Donald, A. Hay and Drek, J_ Morris, Industrial Economics: Theory and Evidence, Oxford University Press (1979) for a full review of Chamberlin's impact on industiral economics. 1'1 Hotelling. 'Stability in Competition'. Economic Journal, 39, 1928, pp. 41-57. ~' K. Lancaster. Consumer Demand: A :\~\\ Approach, New York, 1971. von Neumann and Oskar Morgenstern. Theory of Games and Economic Behav.our, Princeton University Press .. ) - .:. I Ec.) Aiso See .I. Nash. 'The Bargaining Problem'. Econometrica IS. : 9-,l. pp. 155-62. -' \lanin Shubik. 'A Curmudgeon's GUide [Q Microeconomics", Journal of Eco1 mic Literature, 8, 19'10, p, 4:5 ..-\Is' <ee L.G. Telser. Cornpcuuon. Collusion .md Game Theory, Macmillan. Lc':lLi.:,-:.; 971.
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