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

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    Afrita de Lima
    This document provides an overview of managerial economics and industry analysis. It discusses market structure, conduct, and performance. Key topics covered include measures of industry concentration like the Herfindahl-Hirshmann Index, pricing behavior through Lerner indices and markup factors, and the structure-conduct-performance paradigm for analyzing industries. Mergers and integration are also addressed. The goal is to maximize social welfare and understand optimal decisions under different market structures.

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

    Uploaded by

    Afrita de Lima
    46 views13 pages
    This document provides an overview of managerial economics and industry analysis. It discusses market structure, conduct, and performance. Key topics covered include measures of industry concentration like the Herfindahl-Hirshmann Index, pricing behavior through Lerner indices and markup factors, and the structure-conduct-performance paradigm for analyzing industries. Mergers and integration are also addressed. The goal is to maximize social welfare and understand optimal decisions under different market structures.

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    07 Nature of Industry

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    This document provides an overview of managerial economics and industry analysis. It discusses market structure, conduct, and performance. Key topics covered include measures of industry concentration like the Herfindahl-Hirshmann Index, pricing behavior through Lerner indices and markup factors, and the structure-conduct-performance paradigm for analyzing industries. Mergers and integration are also addressed. The goal is to maximize social welfare and understand optimal decisions under different market structures.

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    Download as ppt, pdf, or txt
    46 views13 pages

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

    Uploaded by

    Afrita de Lima
    This document provides an overview of managerial economics and industry analysis. It discusses market structure, conduct, and performance. Key topics covered include measures of industry concentration like the Herfindahl-Hirshmann Index, pricing behavior through Lerner indices and markup factors, and the structure-conduct-performance paradigm for analyzing industries. Mergers and integration are also addressed. The goal is to maximize social welfare and understand optimal decisions under different market structures.

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    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
    III. Performance
    – Dansby-Willig Index
    – Structure-Conduct-Performance Paradigm
    IV. Preview of Coming Attractions
    Industry Analysis
    • Market Structure
    – Number of firms, size, etc.
    • Conduct
    – Pricing, advertising, R&D, etc.
    • Performance
    – Profitability, consumer surplus, social welfare.
    The Structure-Conduct-
    Performance Paradigm
    • The Causal View
    Market Conduct Performance
    Structure

    • The Feedback Critique


    – No one-way causal link.
    – Conduct can affect market structure.
    – Market performance can affect
    conduct as well as market structure.
    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 
     wi2
    • Limitations
    – Market Definition: National, regional, or local?
    – Global Market: Foreign producers excluded
    – Industry definition and product classes
    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.
    Own-Price Elasticities of Demand and
    Rothschild Indices
    Elasticity Elasticity
    Industry of Market of Firm’s Rothschild
    Demand Demand Index
    Food -1.0 -3.8 0.26
    Tobacco -1.3 -1.3 1.00
    Textiles -1.5 -4.7 0.32
    Apparel -1.1 -4.1 0.27
    Paper -1.5 -1.7 0.88
    Chemicals -1.5 -1.5 1.00
    Rubber -1.8 -2.3 0.78
    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.
    Lerner Indices & Markup Factors
    Industry Lerner Index Markup Factor
    Food 0.26 1.35
    Tobacco 0.76 4.17
    Textiles 0.21 1.27
    Apparel 0.24 1.32
    Paper 0.58 2.38
    Chemicals 0.67 3.03
    Petroleum 0.59 2.44
    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.
    DOJ/FTC Merger Guidelines
    • Based on HHI = 10,000  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...”
    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.
    Preview of Coming Attractions
    • Discussion of optimal managerial decisions
    under various market structures, including:
    – Perfect competition
    – Monopoly
    – Monopolistic competition
    – Oligopoly

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