The Nature of Industry Flashcards
What factors impact managerial decisions?
- Relative size of firms
- Number of firms
- Tech and cost conditions
- Demand conditions
- Potential for entry
What is the N firm concentration ratio?
- CN = (S1 + S2 + … + SN) / ST
- i.e. Four-firm N = 4, typically used
- Answer will always be
What is the Herfindahl-Hirschman Index?
- HHI = 10,000 ∑(Si/ST)2
- Gives more weight than larger firms: more sensitive to industries with large variations in firm size
- Varies between 0 (perfect competition) and 10,000 (monopoly)
- Fewer firms and larger variations in market share increase H, indicating a greater degree of concentration
- More information than CN, but more difficult to calucalte
- HHI adjusts for variation in firm size, concentration ratio does not
What are the limitations of concentration measures?
- Global markets
- Does not take into account imports
- National, regional and local markets
- Relevant geographic market
- Industry definitions and product classes
- Technology differences within and among industries
- Demand, price elasticity and market conditions
What is true of differing technologies within industry?
- The same, firms will likely have similar cost strucutres
- Different, some firms may have cost advantage
What is the Rothschilds index and what does it imply?
- 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 it’s price
- R = Et/Ef
- Et = elasticity for total market, Ef is for the firm
- Varies between 0 and 1
- 0 - elastic 1 - inelastic
- in perfect competition most firms will have individual
elasticity approaching 0
- R = Et/Ef
What doe elasticity imply about differentiation?
A more elastic demand means less product differentiation
What factors affect potential for entry?
- K requirements
- Patents
- Economies of scale
- Networking effect - Facebook competitors
How is a firm’s price markup measured?
- Lerner Index
- A measures of the difference between price and MC as fraction of the product’s price
What is the Lerner Index?
- L = (P-MC)/P
- P = (1/(1-L))MC
- Perfect competition: 0
- Monopoly/inelastic goods: > 3,4
What is (1/(1-L)) in the Lerner Index?
the markup factor over marginal costs
Why might firms integrate?
- Reduce transaction costs
- Reap benefits of economies of scale or scopr
- Increase market power
- Gain better access to capital markets
What is horizontal integration?
- Merging two or more similar final products in a single firm
- Firms compete in the same market prior
- Reduces the number of competitors
What is a conglomerate merger?
- Integration of two or more different product lines into a single firm
- Also a merger between firms offering final products. But firms do not compete with each other in the same market before merger
What is structure in the Structure-Conduct-Performance Paradigm?
Factors like tech, concentration and market conditions
What is conduct in the Structure-Conduct-Performance Paradigm?
- Individual firm behaviour
- Pricing, advertising, R&D
What is true of the Structure-Conduct-Performance Paradigm?
- Assume a stable relationship and causality from structure → conduct → performance
- Since conduct is difficult to observe, structure → performance
- Structure should be exogenous variables
- Implies degree of symmetry in conduct across industries
What is a typical exercise in the Structure-Conduct-Performance Paradigm?
- Specify a measure of market performance
- Specify a set of observable sturcutal variables that are thought to explain inter-industry differences
- The aspect of market performance that has almost exlucsive interest is the exercise of market power
- The structural variables have typically been measures of seller concentration and barriers to entry
What do conditions of entry imply in the Structure-Conduct-Performance Paradigm?
- If there is free entry and exit, it will be difficult for existing
firms in the industry to maintain prices above MC - Without barriers to entry, there should not necessarily be any relationship between concentration and profits, at least in LR
What is the veracity of the Structure-Conduct-Performance Paradigm?
Empirically not super solid - weak coefficients, but relationship
What is the feedback critique?
- There is no one-way causal link among structure, conduct and perforamcen
- Firm conduct can affect market structure
- Market performance can affect conduct and market structure
How can the upper and lower bounds of the HHI be calculated?
- Given the sales of C4
- The lower bound would indicate that the remaining sales are spread out over such a large number of firms that each one carries a negligible weight on HHI
- i.e 10,000 x (S1/ST)2 + (S2/ST)2 + (S3/ST)2 + (S4/ST)2
- The upper bound would necessitate the remaining firms all to have sales equalling the lowest of the C4. The number of firms can be deduced by this from this sales figure and the total industry sales (the last firm may have less)
- i.e 10,000 x (S1/ST)2 + (S2/ST)2 + (S3/ST)2 + (S4/ST)2 +
(S4.1/ST)2 + (S4.2/ST)2 + … + (S5/ST)2
- i.e 10,000 x (S1/ST)2 + (S2/ST)2 + (S3/ST)2 + (S4/ST)2 +
When will the ACCC be likely to grant a merger?
HHI: less than 2000 or greater with ∆HHI less than 100
US merger guidelines:
- Small change in concentration: mergers involving ∆HHI100
- Unconcentrated merger: HHI below 1500, typically not an issue if post merger HHI falls within this range
- Moderately Concentrated Markets: HHI between 1500 and 2500, likely to raise concern if ∆HHI greater than 100
- Highly concentrated markets: HHI greater than 2500: 100 200, assumed to substantially lessen competition
What gives an incentive to set up more factories?
MC rising with Q
How does a firm choose the optimal number of factories and output at each?
MC1 = MC2
TOTAL Q must: MC = MR
Choose n & q to max π:
p.q - C
(a - nq)nq - n(FC + MC)
