Wk8 DQ - Managerial Eonomics

voyage

Baye_9e_Chapter_072.pptx

Home >Business & Finance homework help >Economics homework help >Wk8 DQ - Managerial Eonomics

The Nature of Industry

Chapter 7

Learning Objectives

Calculate alternative measures of industry structure, conduct, and performance, and discuss their limitations.

Describe examples of vertical, horizontal, and conglomerate mergers, and explain the economic basis for each type of merger.

Explain the relevance of Herfindahl-Hirschman index for antitrust policy under the horizontal merger guidelines.

Describe the structure-conduct-performance paradigm, the feedback critique, and their relation to the five forces framework.

Identify whether an industry is best described as perfectly competitive, a monopoly, monopolistically competitive, or an oligopoly.

Market Structure

Market structure factors that impact managerial decisions:

Number of firms competing in an industry

Relative size of firms (concentration)

Technological and cost conditions

Demand conditions

Ease of firm exit or entry

7-3

Market Structure

Industry Concentration

Measures the size distribution of firms within an industry.

Are there many small firms?

Are there only a few large firms?

7-4

Market Structure

Measuring Industry Concentration

Measures of industry concentration

Four-firm concentration ratio:

Herfindahl-Hirschman index (HHI):

7-5

Market Structure

Measuring Industry Concentration in Action

Suppose an industry is composed of six firms. Four firms have sales of $10 each, and two firms haves sales of $5 each. What is the four-firm concentration ratio for this industry?

Answer:

Total industry sales are .

Sales of the four largest firms are $40.

The four-firm concentration ratio is:

The four largest firms in the industry account for 80 percent of total industry output.

7-6

Market Structure

7-7

Market Structure

Limitations of Concentration Measures

Factors that impact and limit industry concentration measures include:

Global markets

National, regional and local markets

Industry definitions and product classes

7-8

Market Structure

Technology

Industries differ in regard to the technologies used to produce goods and services.

Labor-intensive industries

Capital-intensive industries

Within a given industry if the available technology is:

the same, firms will likely have similar cost structures.

different, one firm will likely have a cost advantage.

7-9

Market Structure

Demand and Market Conditions

Industries with

low demand may imply few firms.

high demand may imply many firms.

Elasticity of demand varies from industry to industry.

The Rothschild index measures the sensitivity to price of a product group as a whole relative to the sensitivity of the quantity demanded of a single firm to a change in its price.

7-10

Market Structure

Demand and Market Conditions in Action

The industry elasticity of demand for airline travel is -3, and the elasticity of demand for an individual carrier is -4. What is the Rothschild index for this industry?

Answer:

The Rothschild index is:

7-11

Market Structure

7-12

Market Structure

Potential for Entry

Optimal decisions by firms in an industry will depend on the ease with which new firms can enter the market.

Several factors can create barriers to entry (or make entry difficult).

Capital requirements

Patents

Economies of scale

7-13

Market Structure

Conduct

Behavior of firms:

Price markup over costs

Integration and merger

Advertising expenditures

Research and development expenditures

7-14

Conduct

Pricing Behavior

Lerner index

A measure of the difference between price and marginal cost as a fraction of the product’s price.

rearranging this equation yields

where is the markup factor over marginal costs.

7-15

Conduct

Pricing Behavior in Action

A firm in the airline industry has a marginal cost of $200 and charges a price of $300. What are the Lerner index and markup factor?

The Lerner index is

The markup factor is

7-16

Conduct

7-17

Conduct

Integration and Merger Activity

Integration

Uniting productive resources of firms.

Can occur during the formation of a firm.

Merger

Two or more existing firms “unite,” or merge, into a single firm.

Reasons firms merge:

Reduce transaction costs.

Reap benefits of economies of scale and scope.

Increase market power.

Gain better access to capital markets.

7-18

Conduct

Types of Integration

Vertical integration

Various stages in the production of a single product are carried out in a single firm.

Horizontal integration

Merging two or more similar final products into a single firm.

Conglomerate mergers

Integration of two or more different product lines into a single firm.

7-19

Conduct

Research and Development

Research and development

Expenditures made by firms to gain a technological advantage, with the aim of acquiring a patent.

7-20

Company	Industry	R&D as Percentage of Sales
Bristol-Meyers Squibb	Pharmaceuticals	19.7
Ford	Motor vehicle and parts	4.1
Goodyear Tire and Rubber	Rubber and plastic parts	2.0
Kellogg	Food	1.5
Proctor & Gable	Soaps and cosmetics	2.5

Conduct

Expenditures made by firms to inform or persuade consumers to purchase their products.

7-21

Company	Industry	Advertising as Percentage of Sales
Bristol-Meyers Squibb	Pharmaceuticals	4.9
Ford	Motor vehicle and parts	3.2
Goodyear Tire and Rubber	Rubber and plastic parts	2.5
Kellogg	Food	9.2
Proctor & Gable	Soaps and cosmetics	11.7

Conduct

Performance

Refers to the profits and social welfare that result in a given industry

Performance

Dansby-Willig Performance Index

Ranks industries according to how much social welfare would improve if the output in an industry were increased by a small amount.

7-23

Industry	Dansby-Willig Index
Food	0.51
Rubber	0.49
Textiles	0.38
Apparel	0.47
Paper	0.63
Chemicals	0.67
Petroleum	0.63

Performance

The Structure-Conduct-Performance Paradigm

Structure:

Factors like technology, concentration and market conditions.

Conduct:

Individual firm behavior in the market. Behavior includes pricing decisions, advertising decisions and R&D decisions, among other factors.

Performance:

Resulting profit and social welfare that arise in the market.

Structure-conduct-performance paradigm

Model that views these three aspects of industry as being integrally related.

7-24

The Structure- Conduct-Performance Paradigm

The Casual View

Market structure “causes” firms to behave in a certain way.

… this behavior, or conduct, “causes” resources to be allocated in certain ways.

… this resource allocation leads to “good” or “bad” performance.

7-25

The Structure- Conduct-Performance Paradigm

The Feedback Critique

There is no one-way causal link among structure, conduct and performance.

Firm conduct can affect market structure;

Market performance can affect conduct and market structure.

7-26

The Structure- Conduct-Performance Paradigm

Five Forces Framework

7-27

The Structure- Conduct-Performance Paradigm

Looking Ahead

Perfect competition

Many, small firms and consumers relative to market.

Firms produce very similar products.

No market power (P = MC).

Monopoly

Sole producer of good or service.

Market power (P > MC).

Monopolistic competition

Many, small firms and consumers relative to market.

Firms produce slightly different products.

Limited market power.

Oligopoly

Few, large firms tend to dominate market.

Price/marketing strategies are mutually interdependent with other firms in the industry.

7-28

Overview of the Remainder of the Book