Industrial Organization: Volume 9

This chapter provides empirical evidence on the extent of producer heterogeneity in the output market by analyzing output price and price-marginal cost markups at the plant level for thirteen homogeneous manufactured goods. It relies on micro data from the U.S. Census of Manufactures over the 1963–1987 period. The amount of price heterogeneity varies substantially across products. Over time, plant transition patterns indicate more persistence in the pricing of individual plants than would be generated by purely random movements. High-price and low-price plants remain in the same part of the price distribution with high frequency, suggesting that underlying time-invariant structural factors contribute to the price dispersion. For all but two products, large producers have lower output prices. Marginal cost and the markups are estimated for each plant. The markup remains unchanged or increases with plant size for all but four of the products and declining marginal costs play an important role in generating this pattern. The lower production costs for large producers are, at least partially, passed on to purchasers as lower output prices. Plants with the highest and lowest markups tend to remain so over time, although overall the persistence in markups is less than for output price, suggesting a larger role for idiosyncratic shocks in generating markup variation.

This chapter utilizes the results of Deneckere ·& Kovenock (1988, 1989, 1992, 1996) on price setting games with capacity constraints and different unit costs up to capacity to analyze the effects of quotas and tariffs in a model in which a domestic market for a homogeneous product is supplied by a duopoly consisting of a domestic and a foreign firm. A model of the timing of price setting is constructed in which the existence of price leadership, as well as the identity of the leader, depends upon the vector of unit costs and capacities (k1, k2, c1, c2). With firm 1 the foreign firm and firm 2 the domestic firm, the levying of a tariff raises the foreign unit cost of production up to capacity to c1t = c1 + t, while the imposition of a ‘binding’ quota reduces capacity from k1 to k1q (the level of the quota). The effects of quotas and tariffs on the equilibrium in the game of timing are examined starting from an initial vector in which costs are identical, c1 = c2 = c. It is shown that, due to the endogeneity of price leadership, trade restrictions can have surprising effects. In addition to the traditional view that quotas hurt the foreign firm and help the domestic firm, and the results of Harris (1985) and Krishna (1989) that quotas may help both firms, we show that with endogenous timing a quota can make the domestic firm worse of and the foreign firm better off (by altering the identity of the price leader). However, a quota will always (weakly) increase price. In contrast, a tariff always (weakly) hurts the foreign firm and (weakly) helps the domestic firm but may, by affecting the leadership role, lower price. The question of the equivalence of quotas and tariffs is also examined. In contrast to the result of Deneckere & Kovenock (1989) for the simultaneous price setting game, we show that with the endogenous timing of price-setting there are certain initial conditions (k1, k2, c1, c2) for which the prices and quantities generated by a ‘binding’ quota can be duplicated by a tariff (and vice versa). It is possible, however, that a quota that reduces the foreign capacity slightly is equivalent only to a very severe tariff. We conclude by showing how the model allows for simple welfare comparisons in environments in which protection is likely.

We develop a model of pricing and advertising for e-commerce. N identical sellers, selling an homogeneous product, each choose a price and a web-based advertising policy. Buyers have usual demand functions and search optimally on the Internet. A Symmetric Nash Equilibrium (SNE) is derived and characterized. If the marginal cost of advertising exceeds a critical level, then the monopoly price with zero advertising is the unique SNE; otherwise, there is a mixed-strategy SNE which can be expressed as a price distribution and an advertising policy conditional on price. Remarkably, as the number of sellers increases without limit, the SNE converges to the monopoly price and advertising per seller vanishes. On the other hand, the mean price at which sales occur is less than the monopoly price. Still for some advertising technologies, total social welfare is declining in the number of sellers. This results cast doubt on the consumer benefits of e-commerce.

We characterize vertical contracts in oligopolistic markets where each upstream firm may contract with multiple downstream firms (divisions). If the number of divisions is chosen before the terms of fee-and-royalty contracts, each upstream firm minimizes the number of its downstream firms. When the contracts are chosen sequentially, it is the leader that minimizes the number of divisions. Lastly, if the contracts are chosen before the number of divisions, or if the contracts involve either only fees or only royalties, then upstream firms do not have an incentive to minimize the number of their respective divisions.

If people take due care, they will not be found negligent under the Rule of Simple Negligence. Moreover, under this rule, investment in due care is privately and socially optimal. These results jointly imply that liability insurance should not exist. But it does. One explanation relies on errors in the administration of tort law or in the imperfect observation of care. We offer an alternative explanation. Our model is one of symmetric uncertainty where establishing due care requires information on the individual's risk type, which is a random variable. Even though we assume that information on type is costless, we find that, by pooling across risk classes, liability insurance permits risk averse individuals to avoid the classification lottery that arises from establishing type. Insurance also has subtle effects on an injurer's private costs, which depend on the concavity or convexity of the demand for precaution. Given parameter variability across individuals, one would expect to observe a segmented market with some insuring while others choose to become informed and take due care. Moreover, we show that the voluntary purchase of liability insurance is Pareto improving.

A common practice among utility companies is to offer discounts to consumers who use a rival's services in an attempt to induce them to switch suppliers. This chapter examines a two-period model of price competition on a Hotelling line that captures this type of price discrimination. In the first period, firms have no information about individual consumers' preferences and, therefore, they post a single price. In the second period, each firm gains information about consumers' first-period purchase decisions. We show that firms have an incentive to use this information to price discriminate. A firm charges a lower price to its rival's customers (`pays consumers to switch') whenever the firm is not too disadvantaged with respect to its marginal cost. Even when consumers' switching costs are non-trivial, a re-segmentation of the market prevails in the unique subgame-perfect equilibrium to the game. An analysis of the impact of this kind of price discrimination on consumer surplus, firm profits, and social welfare is also presented.

This chapter discusses the logic, hypotheses, empirical methods, and principal findings of the transaction-cost approach to economic organization as a foundation for analyzing the organization of agricultural transactions. In contrast to textbook characterizations of agriculture as the quintessential spot market, agricultural transactions display a broad range of governance arrangements. The chapter traces the use of these arrangements to the location-specific nature of investments and, especially, to temporal specificities associated with the perishability of many agricultural products. Case studies of the governance of fruit, vegetable, and dairy processing; the emergence of multinational firms in the banana trade; the evolution of contractual relations between tuna harvesters and processors; and the governance of transactions between cattle feedlots, slaughtering, and beef fabrication operations illustrate the arguments.

This chapter analyzes the link between adaptive R&D and the timing of new technology adoption in a strategic search model with heterogeneous firms. It is shown that the subgame-perfect equilibrium is in stopping rules with a reservation property. The model is used to examine the effect of rivalry, and whether R&D and adoption subsidies can increase social welfare and generate strategic advantage in international technological competition. It is found that the answers depend critically upon the relative magnitude of first-mover and second-mover advantages in the timing of adoption.

The imposition and social welfare consequences of maximum resale price fixing are analyzed when there is successive monopoly and a non-contractible service is provided downstream. An elasticity condition that weighs maximum resale price fixing's opposing effects on quantity, through the effects on final price and service provision, determines whether it is adopted. Wholesale price is increased along with the practice of resale price fixing, and the net effects on quantity and social welfare are ambiguous. This points to an output test and a rule of reason in the antitrust evaluation of this practice, consistent with the Supreme Court's overruling of Albrecht.

A consumer in the real world typically must visit (e.g. by phone) a monopolist to observe its price, even though the consumer may have correct expectations about that price. This causes monopoly prices to be higher and stickier than is predicted by the textbook model. If visiting costs are small, and consumers do not observe the firm's costs, then prices conform to the textbook model when costs are high but are downwardly rigid when costs drop below a threshold. Price flexibility increases as the fraction of ignorant consumers, who observe their idiosyncratic valuations of the product only after visiting the firm, increases. In a repeated game, a ‘ratchet’ equilibrium, in which price increases are permanent and price decreases temporary within a certain band, supports equilibria for which price is rigid on the equilibrium path but which Pareto dominate the fluctuating one-shot equilibrium. The ratchet equilibrium has the advantages that price is a continuous function of past prices near the equilibrium path and the price coordination problem is solved in a natural way: the equilibrium price is the lowest price that can be sustained by such a ratchet. This equilibrium price exceeds but is close to the average prediction of the textbook model. Additional results are derived for the case in which costs are fixed.

Labels that provide information about the environmental attributes seem to be designed to encourage firms to compete over environmental quality. However, it is sometimes possible to enhance the environmental attributes of products at the expense of other desirable product attributes. This chapter examines the effect of product labeling when environmental enhancements come at the expense of other desirable attributes. I find that hoped for competition over product quality may not result. I go on to analyze the impact of a supplemental regulation of a minimum quality standard. I show that a minimum quality standard, if properly imposed, may benefit all consumers and improve social welfare.

This chapter contains a model of strategic delegation from owners to managers in a Cournot duopoly where firms compete under incomplete information on the rival marginal costs and the relations between owners and managers are characterised by moral hazard It is shown that despite incomplete information the owners are able to use strategically the delegation of the output decision by making the managers' incentive schemes observable. Strategic delegation enhances the equilibrium level of the managers' effort, decreasing all firms' marginal costs and so increasing expected output. When moral hazard results in under-provision of effort, strategic delegation has a counter-balancing effect on the loss of productivity due to agency costs. On the other hand, collusive agreements are shown to weaken the disciplinary role on managers of product market competition. In the linear demand case is also shown that the equilibrium industry output in each state of nature is lower with strategic delegation than otherwise, so that the equilibrium price is distorted toward the monopoly price. Therefore, the expected output increase is all due to the better states of nature becoming more likely. However, at difference from what happens with strategic delegation under complete information in the output setting game, in this model consumers may not benefit from strategic delegation, since consumer's surplus is convex in output.