2014 Syllabus

This is the FULLY REVISED (Fall 2014) syllabus, except for minor editing.

Industrial Organization: The Economics of Strategic Behavior, Fall 2014, Econ 243
1:25 pm – 2:20 pm MWF in Huntley 220

Overview:

The proposed takeover of Tim Horton by Burger King is in the news. Does it make sense? More generally, does the merger of two firms in a four firm industry improve the merging firms profitably? In standard models, no! – and it is just such counterintuitive findings where industrial organization is most valuable.

Let me give a few more examples. When does it make sense for firms to bundle goods? What should the strategy of a dominant firm such as GM [now Toyota?!] be towards new entrants? When does franchising make sense? “Industrial Organization” addresses these and many other questions, generally examining them from the standpoint of firms or producers; it provides the framework that undergirds corporate strategy (while leaving the operational issues to the relevant subfields in Business Administration). If you have an industry you like (we examine beer brewing among others) or want a better foundation for thinking about strategy, then this is a course for you.

In the real world the perfect competition of Economics 101 does not exist. At the same time, pure monopoly – something again typically examined in “Principles” – is unusual. IO (industrial organization) focuses on the normal (but messy) world that lies in between these two extremes. It also deals with advertising, patents and technology, price discrimination and other issues that have no place in a world of perfect competition. The combination of complexity and a real-world focus makes it fascinating.

To rephrase: competitive firms have no need of strategy. In contrast, strategic behavior is the essence of IO. We assume that firms observe their rivals and adjust their behavior in anticipation of how they expect rivals to respond. A wheat farmer neither advertises nor engages in R&D, nor can it set price. Ford Motor Company or SABMiller [in the US, MillerCoors] constantly worry about their rivals, their pricing, new product portfolios, future technologies, advertising, and other strategic choices.

One focus of the course is the analytics of oligopoly, with the accompanying formal models and associated jargon (Nash-Cournot equilibria, Bertrand competition). We build on these rich models to examine a series of related topics, including price discrimination, advertising, product differentiation, vertical structure (such as franchising), network externalities [Windows 8?!] and R&D.

Case studies are central to the course, to put theory to work. You will write two, one an overview of an industry and its structure, another a research paper on a specific issue or aspect of that industry. In addition, you will be responsible for organizing and leading a class discussion at the end of the term. These will be complemented by a midterm and a final covering the basic models, the textbook material.

Objectives:

As potential managers you aren’t attracted to competitive markets, where rivalry pushes (economic) profits to zero. It’s best to work at a monopolist, but finding one that isn’t regulated is a challenge. Most likely, then, you must forge your way through the dross of oligopoly. This course focuses on that world and attendant issues.

This is a list of key “take-aways” for which you will be assessed through your understanding as reflected in exams, class discussion and writing assignments.

  • be comfortable with the monopoly model, the engine that drives all other IO models
  • be able to work with the Bertrand and Cournot oligopoly models;
  • be able to apply the basic price discrimination, bundling and two-part tariff models;
  • be able to relate IO models to empirical features that make them more (or less) useful for analyzing a particular industry;
  • be able to discuss strategies firms employ to enhance their market power, through tacit collusion, the creation of entry barriers, product differentiation and advertising;
  • be able to identify and discuss the key “new economy” concepts and issues of research & development, intellectual property, and networks and standards.

This course will not devote time to antitrust and regulatory policy; our 12 week term is simply too short. Martin’s book however provides a particularly good platform for your own exploration, since it covers both US and EU policy and so provides a breadth missing in (all!) other texts.

Prerequisites: Principles of Microeconomics (Economics 101)

You do not need to be an economics major. Industrial organization theory provides the core for strategy (e.g., Michael Porter’s work is built on simple IO models). It is thus highly appropriate for business majors. However, our focus is on analysis, not prescription or operational implementation. IO remains an economics course.

Aside:
Industrial organization is fun, in that it focuses on the rich variety of real-world behavior. Almost everyone has an industry they know, through hobbies or family or career aspirations; all are potential meat for our IO table. In my case, questions in graduate school at Yale about growth and technical change turned into a PhD dissertation (and then a book) on Japanese automotive suppliers; I’ve been an “car” person ever since. But I also have consulted on a steel industry project and on technology for a major HVAC manufacturer, and am writing about the evolving structure of retailing in Japan. However, despite our case study, I’m not much of a beer drinker.

Texts and class:

Our principle text is Industrial Organization in Context by Stephen Martin (Oxford University Press, 2010). Martin is (comparatively) non-technical, employing no formal game theory and little math beyond basic algebra and graphs; I will supplement the text with additional models and readings as the need arises. In addition, you will choose a specific industry to follow. I have a pre-selected list for which recent (inexpensive) studies are available that includes beer, steel, autos, farm machinery, toys and oil & gas. You may choose another industry, but that may mean more digging on your part.

Attendance:

Class discussion is central, though I present formal models from time to time. You thus need to prepare in advance. Because of the discussion focus, attendance is mandatory. We tentatively have one field trip, though the date is not yet firm; unless you have an away athletic event, I expect you to arrange with your schedule so that you can participate.

Submitting work:

Submit all work in hard copy; printing a clean final version is your responsibility. It is always a good idea to back up your work on Sakai.

Email, Sakai, WordPress:

Whenever possible I will post supplemental readings as links on WordPress. I rely on email to communicate details on the course, including changes to the schedule, alternate links to papers, and to arrange office hours. Please check regularly. We will also blog; I’ve set up this WordPress site for that purpose.

Papers:

If you have not yet written a research paper in economics, it’s time for that to change! Writing a successful paper requires systematic preparation. The key, in two words: start early. I expect each of you to set up at least one office hour session well in advance of each paper deadline. I urge you to submit a topic in writing, then a working bibliography and outline, and next your model, your analytic approach – and then schedule office hours to discuss. I place the onus on you, though I will note in class when it might be appropriate to submit one or another part of the project. I expect all written work to be proofread by someone other than yourself, which requires that you have a full draft complete before the deadline. I urge (but do not require) you to utilize the Williams School Writing Consultants in the basement of Huntley.

You will receive a written response to each paper, to which you will need to respond in a 2-5 page memo within one week. You may rewrite any paper to improve your grade; I only record that on the final version. However, if you wish to rewrite a paper, you need to contact me and set an explicit deadline for handing in the revision. No such work may be carried over into the final week of class.

I will hand out a detailed guideline writing a paper – organization, style, prose practice – later this term.

Grading:

Grading is on a letter basis. Final weights will be adjusted to reflect any ad hoc short assignments and homework exercises.

30% research paper (15-20 pages)
20% final exam
15% midterm
15% initial industry paper (8-10 pages)
10% blogging
10% in-class presentations
100% total

Honor code:

I take it as a given that you will uphold the honor code, as reflected in my use of take-home exams and self-grading on problem sets. No paper is solo. I will review with you standards for citing the work of others in your research paper — remember the Google Scholar motto, “on the shoulders of giants”. In addition, you hopefully will spend time discussing your paper with others, and have them help edit.

Special accommodations:

As per university policy, please speak to me in private at the start of the term.

Office hours:

Once the term begins and I better know my schedule I will post on WordPress when I am regularly busy. In principle all other times are available for office hours – which could be an early morning coffee or early evening session. Immediately before one of my classes or meetings is however generally a bad time.

My cell is (540) 460-6288. However, I prefer that you contact me via email rather than texting, and call if it’s something last-minute (eg to confirm which coffee shop).

Web site:

The web site is partially yours: you will be responsible for roughly 10 blog posts this term, one per week, and will be expected to comment on a large proportion of your classmates’ posts. I will shut down the blog at the start of the last week of class.