Industrial Organization

Industrial Organization Minor 2013

1. Introduction

Two approaches to studying Industrial Organization

* Structure-Conduct-Performance paradigm

The SCP paradigm concentrates on empirical rather than theoretical analysis.

* Chicago School approach

Characterized by a strong belief in efficient markets & rationality of market participants

Static vs. Dynamic models

In most microeconomics courses strong focus on static models: all decisions are made simultaneously, time plays no role advantage: relatively simple. Industrial Organization also considers dynamic models, which deal with changes over time more realistic, but more complex.

2. The firm and its costs

Transaction costs economics; some transactions are done on markets, some within firms.

Coase’s proposal; using the market mechanism costs transaction costs for searching price/product information and negotiating contracts. Within the firm these costs are not incurred. However, an entrepreneur’s skills are also limited using managerial decision making also comes at a cost, which increases in the size of the firm. Therefore, an optimal firm size exists, beyond which the cost within the firm exceeds the transaction cost of the market.

Coase; transaction costs before a contract is signed. Williamson; transaction costs after contract is signed. Most contracts are incomplete. It is impossible to specify all contingencies. This creates opportunities for opportunistic behavior (=to act in self-interest).

One solution; integration. (= extending the boundaries of the firm to include this transaction within the firm) = merger/takeover. Ex. Specific investment in human capital/knowledge of one worker, which can only be used within that firm.

The resource-based theory of the firm is complementary to transaction cost theory, not a substitute. A firm governs two types of resources; property-based and knowledge-based resources (tacit vs. explicit). The more unique a resource is,...