Microeconomics – industrial organization
Chapter
• 1
• 5.3-5.6
• 6.1-6.3 & 6.5
• 7.1
• 8.1
• 8.2-8.4
• 7.3
• 9
• 10
• 11
• 7.2
• 12
• 13
Recap and what are we going to do in this course?
Perfect competition: P=MC
1. First welfare theorem: perfectly competitive markets distribute resource in a Pareto-efficient
way.
2. Second welfare theorem: any Pareto-efficient outcome is a general equilibrium outcome for
some initial allocation of resources.
This is only true if some conditions are satisfied:
• Everyone is price-taker, no market power.
• There are not externalities, or public goods.
• Everyone knows everything, no asymmetric information.
• Everyone acts fully rationally.
But in real world, firms often have market power, driving a wedge between price and marginal costs.
We already know that a monopolist leads to a deadweight welfare loss.
➔ What would happen if a few firms interact who are not price taker but do take each other’s
actions into account.
➔ There is competition, but not perfect.
Chapter 1; What is industrial organization?
Industry: Any large-scale business activity.
Industrial organization: is concerned with the workings of markets and industries, in particular the
way firms compete with each other.
Market power = the ability to set prices above (marginal) cost.
Perfect competition:
• Many small buyers and many small sellers.
• Complete and perfect information
• Homogeneous products.
• Free and easy entry and exit.
, • In the long run, each firm charges price equal to marginal costs, and prices equal the
minimum of average costs.
• LI = 0
o Lerner index.
o = market power
▪ (Price-MC)/Price
5.3 monopoly
Monopoly:
Markup = percentage of a firm’s price that is greater than its marginal costs.
• The Lerner index is a measure of a firm’s markup, which indicates the degree of market
power the firm enjoys.
𝑃 − 𝑀𝐶
𝑃
,Profit maximization requires:
𝑀𝑅 = 𝑀𝐶
𝜕𝑃
𝑀𝑅 = 𝑃 + ∗ 𝑄 = 𝑀𝐶
𝜕𝑄
𝜕𝑃 𝑄
𝑃+( ∗ ) ∗ 𝑃 = 𝑀𝐶
𝜕𝑄 𝑃
𝜕𝑃 𝑄 1
( ∗ )= 𝑑
𝜕𝑄 𝑃 𝐸
𝑃 − 𝑀𝐶 1
= − 𝑑
𝑃 𝐸
➔ The degree of monopoly power is inversely related to the demand elasticity faced by the
seller.
➔ As demand becomes more elastic, the optimal markup falls
Elastic = flatter
Elastic > 1
➔ Lower markup.
Inelastic = steeper
Inelastic 0<E<1
Perfectly inelastic = 0
➔ Higher markup
Welfare effects of market power:
, 5.5 competition policy
Competition policy is essentially the same as antitrust policy. = public policy instruments that address
market failure due to monopoly power.
Competition policy is the term most commonly used in Europe, whereas antirust the term most
commonly used in the US.
Competition policy/Antitrust policy US:
Players:
• Department of justice.
• Federal trade commission.
• Sectoral regulators (e.g. FFC, FAA).
• District courts
• Supreme court
Sources:
• Sherman Act
o Section 1: Horizontal and vertical agreements
o Section 2: Abuse of dominant position
• Clayton Act. Illegal if substantially lessens competition:
o Section 2: Price discrimination
o Section 2: Exclusivity agreements
• Section 7: Mergers and acquisitions
• Federal Trade Commission Act
o Section 5: Unfair methods of competition are unlawful
• Regulations and guidelines:
o Merger guidelines
o Leniency program
Competition policy/Antitrust policy in Europe:
Players:
• DG Comp, part of the European Commission (EC)
• National competition authorities.
• Court of first instance (CFI).
• European court of justice (ECJ).
Differences between US and EU competition law:
• Criminal law.
• Importance of common market in the EU.
• Treble damages.
• EU competition law uses concept of market dominance.
Chapter
• 1
• 5.3-5.6
• 6.1-6.3 & 6.5
• 7.1
• 8.1
• 8.2-8.4
• 7.3
• 9
• 10
• 11
• 7.2
• 12
• 13
Recap and what are we going to do in this course?
Perfect competition: P=MC
1. First welfare theorem: perfectly competitive markets distribute resource in a Pareto-efficient
way.
2. Second welfare theorem: any Pareto-efficient outcome is a general equilibrium outcome for
some initial allocation of resources.
This is only true if some conditions are satisfied:
• Everyone is price-taker, no market power.
• There are not externalities, or public goods.
• Everyone knows everything, no asymmetric information.
• Everyone acts fully rationally.
But in real world, firms often have market power, driving a wedge between price and marginal costs.
We already know that a monopolist leads to a deadweight welfare loss.
➔ What would happen if a few firms interact who are not price taker but do take each other’s
actions into account.
➔ There is competition, but not perfect.
Chapter 1; What is industrial organization?
Industry: Any large-scale business activity.
Industrial organization: is concerned with the workings of markets and industries, in particular the
way firms compete with each other.
Market power = the ability to set prices above (marginal) cost.
Perfect competition:
• Many small buyers and many small sellers.
• Complete and perfect information
• Homogeneous products.
• Free and easy entry and exit.
, • In the long run, each firm charges price equal to marginal costs, and prices equal the
minimum of average costs.
• LI = 0
o Lerner index.
o = market power
▪ (Price-MC)/Price
5.3 monopoly
Monopoly:
Markup = percentage of a firm’s price that is greater than its marginal costs.
• The Lerner index is a measure of a firm’s markup, which indicates the degree of market
power the firm enjoys.
𝑃 − 𝑀𝐶
𝑃
,Profit maximization requires:
𝑀𝑅 = 𝑀𝐶
𝜕𝑃
𝑀𝑅 = 𝑃 + ∗ 𝑄 = 𝑀𝐶
𝜕𝑄
𝜕𝑃 𝑄
𝑃+( ∗ ) ∗ 𝑃 = 𝑀𝐶
𝜕𝑄 𝑃
𝜕𝑃 𝑄 1
( ∗ )= 𝑑
𝜕𝑄 𝑃 𝐸
𝑃 − 𝑀𝐶 1
= − 𝑑
𝑃 𝐸
➔ The degree of monopoly power is inversely related to the demand elasticity faced by the
seller.
➔ As demand becomes more elastic, the optimal markup falls
Elastic = flatter
Elastic > 1
➔ Lower markup.
Inelastic = steeper
Inelastic 0<E<1
Perfectly inelastic = 0
➔ Higher markup
Welfare effects of market power:
, 5.5 competition policy
Competition policy is essentially the same as antitrust policy. = public policy instruments that address
market failure due to monopoly power.
Competition policy is the term most commonly used in Europe, whereas antirust the term most
commonly used in the US.
Competition policy/Antitrust policy US:
Players:
• Department of justice.
• Federal trade commission.
• Sectoral regulators (e.g. FFC, FAA).
• District courts
• Supreme court
Sources:
• Sherman Act
o Section 1: Horizontal and vertical agreements
o Section 2: Abuse of dominant position
• Clayton Act. Illegal if substantially lessens competition:
o Section 2: Price discrimination
o Section 2: Exclusivity agreements
• Section 7: Mergers and acquisitions
• Federal Trade Commission Act
o Section 5: Unfair methods of competition are unlawful
• Regulations and guidelines:
o Merger guidelines
o Leniency program
Competition policy/Antitrust policy in Europe:
Players:
• DG Comp, part of the European Commission (EC)
• National competition authorities.
• Court of first instance (CFI).
• European court of justice (ECJ).
Differences between US and EU competition law:
• Criminal law.
• Importance of common market in the EU.
• Treble damages.
• EU competition law uses concept of market dominance.
