INDUSTRIAL ORGANIZATION

MAIN TAKEAWAYS:
1. IO is about markets, industries and how firms compete with each other.
2. IO answers questions: whether there is market power; how firms acquire and
maintain the market power; what are the implications of a market power; is
there a role for public policy for regard to market power.

TERMS:
1. Market power – ability to price over MC
2. Contestable markets – companies with few rivals behave in a competitively
when the market has weak barriers to entry.
3. Allocative efficiency – point where P = MR. Price that consumers are willing to
pay is equivalent to the marginal utility that they get.
4. Allocative inefficiency – pricing above MC due to holding of market power.
5. Productive inefficiency – increase in costs that results from market power.
6. Economic rent - economic wealth obtained through potentially manipulative
use of resources.
7. Rent seeking – unproductive resources spent to influence policy makers.
8. Industrial policy – strengthening the market position of a firm/industry with
respect to foreign firms.
9. Structure conduct performance paradigm – model which offers a causal
theoretical explanation for firm performance through economic conduct on
incomplete markets.
10. 5 forces framework – method for analyzing competition of a business (buyer’s
bargaining power, supplier’s bargaining power, threat of new entrants, threat
of substitutes).
CONSUMERS

MAIN TAKEAWAYS:
1. Demand curve gives quantity demand of a good as a function of price and
other factors; it’s derived from consumer preferences.
2. Movements ALONG the demand curve – change in price.
3. Other factors than price SHIFT the demand curve.
4. Demand elasticity is higher for luxuries, niche products and in the long run

TERMS:
1. Consumer surplus – difference between willingness to pay and price
2. PED - % change in quantity / % change in price
3. Consumer preferences – taste of consumers.
4. Indifference curve – combination of 2 goods between which consumer is
indifferent.
5. Budget line – all possible consumption bundles that someone can afford given
the prices of goods and the person's income level.
6. Utility maximization – attempt to get the greatest value possible from
expenditure of least amount of money.
7. Inverse demand function – inverse function of demand function where P
changes Q.
8. Willingness to pay – maximum price for which you’d like to buy the product
9. Cross price elasticity – measures responsiveness in quantity demanded of
one good when the price for another good changes.
10. Income elasticity – % change in quantity demanded / 1% change in income.
11. Inferior goods – negative income elasticity good (increase in income will lead
to a fall in the demand).
12. Normal goods – positive income elasticity good (increase in income will lead
to a rise in demand).
13. Necessities – elasticity between 0 and 1.
14. Luxuries – elasticity > 1.
15. Identification problem – inability in principle to identify a best estimate of the
value of one or more parameters in a regression.
16. Instrumental variables – used to estimate causal relationships when controlled
experiments are not feasible or when a treatment is not successfully delivered
to every unit in a randomized experiment.
17. Prospect theory – psychological theory of decision-making under conditions of
risk.
FIRMS

MAIN TAKEAWAYS:
1. Reflecting on decreasing marginal returns, isoquants are convex curves; the
closer complement 2 inputs are, the more convex the corresponding
isoquants are.
2. MC is appropriate cost concept to decide how much to produce. AC tells
whether to produce at all.
3. Profit maximizing output level: MR = MC.
4. The lower the PED, the higher the price-cost margin should be set.
5. Although management and ownership are normally separated, there are
reasons to believe that deviations from profit maximization cannot be too
large. These reasons include management incentive contracts, labor market
discipline, product market discipline.
6. Horizontal boundaries of firm are determined by cost considerations (including
managerial costs).
7. Vertical boundaries result from the balance between investment incentives
(specific assets) and performance incentives.
8. Firm performance varies a great deal. Firms are different because of
impediments to imitation, causal ambiguity, firm strategy, management
quality, historical events.

TERMS:
1. Production function – gives technological relation between quantities of
physical inputs and quantities of output of goods.
2. Isoquant – line that is drawn through points that produce the same quantity of
output, while the quantities of inputs are changed. The mapping of the
isoquant curve addresses cost minimization problems for producers.
3. Cobb Douglas production function – used to represent the technological
relationship between the amounts of two or more inputs and the amount of
output that can be produced by those inputs..
4. Productivity – efficiency of production.
5. Total factor productivity – represents growth in real output which is in excess
of the growth in inputs such as labor and capital.
6. Incremental revenue – additional revenue generated from an additional
quantity of sales.
7. Elasticity rule – the lower the elasticity, the higher the price-cost margin
should be set.
8. Margin – difference between the seller's cost for acquiring products and the
selling price
9. Raider – firm that seeks profit from failing and undervalued companies.
10. Tapered integration - producer might manufacture some of the input itself and
buy the remaining portion from independent firms.s
11. Franchising – ranchisor licenses its know-how, procedures, intellectual
property, use of its business model, brand, and rights to sell its branded
products and services to a franchisee.
12. Impediments to imitation – represents organizational arrangements or
characteristics which preclude competitors from successfully imitating new
firms strategies and resources (sunk costs).
13. Causal ambiguity – situation where it is hard or even impossible to relate the
consequences or effects of a phenomenon to its initial states or causes.
COMPETITION, EQUILIBRIUM, EFFICIENCY

MAIN TAKEAWAYS:
1. Rightward shift of demand curve leads to increase in quantity & price.
2. Rightward shift of supply curve leads to increase in quantity and decrease in
price.
3. In perfect competition long run equilibrium firms produce at min. AC and make
0 profit.
4. Variability of uncertainty about firm efficiency reconciles the competitive model
with empirical observation regarding simultaneous entry & exit, relative size of
entrants / exiters vis – a – vis incumbents.
5. Equilibrium profits under monopolistic competition are zero but firms don’t
produce at min. AC.
6. Allocative efficiency requires that such output be at the right level.
7. Productive efficiency requires that such output be produced in the least
expensive way given the available technologies.
8. Dynamic efficiency is improvement over time of products and production
techniques.
9. In a competitive market the equilibrium levels of output and price correspond
to the maximum total surplus.
10. Similarly to perfect competition, market equilibrium under competitive
selection is efficient.

TERMS:
1. Homogenous product – the product has essentially the same physical
characteristics and quality as similar products from other suppliers.
2. Perfect information – all consumers and producers have perfect and
instantaneous knowledge of all market prices, their own utility, and own cost
functions (perfect information).
3. Law of supply and demand – the theory that defines what effect the
relationship between the availability of a particular product and the desire (or
demand) for that product has on its price.
4. Comparative statics – comparison of 2 different economic outcomes, before
and after a change in some underlying exogenous parameter.
5. Rent – amount of money earned that exceeds that which is economically or
socially necessary (often arise from market or information inefficiencies; can
appear in labor markets, real estate, and monopolies.
6. Competitive selection – formal or informal process engaged in by a
department or establishment to compare prices, terms, and conditions of
equal or similar services in order to meet the objective of purchasing services
based on price, quality, performance, or any combination thereof.
7. Monopolistic competition – many producers sell products that are
differentiated from one another and hence are not perfect substitutes.
8. Consumer surplus – happens when the price consumers pay for a product or
service is less than the price they're willing to pay (benefit or good feeling of
getting a good deal); it always increases as the price of a good falls and
decreases as the price of a good rises.
9. Producer surplus – total amount that a producer benefits from producing and
selling a quantity of a good at the market price (total benefit to everyone in the
market from participating in production and trade of the good).
MARKET FAILURE, PUBLIC POLICY

MAIN TAKEAWAYS:
1. Market externalities imply market failure.
2. Pigou taxes can help re-establish equilibrium efficiency.
3. Monopoly model provides good approximation to the behavior of dominant
firms.
4. Degree of monopoly power is inversely related to demand elasticity faced by
the seller.
5. Main areas of competition policy are price fixing, merger policy, abuse of
dominant position.
6. High-power regulation mechanism provides strong incentives for cost
reduction but little incentives for quality provision. It implies high risk for
regulated firm and requires strong commitment on the part of regulator.

TERMS:
1. Free riding problem – market failure that occurs when those who benefit from
resources, public goods, or services of a communal nature do not pay for
them or under-pay. Free riders are a problem because while not paying for
the good, they may continue to access or use it.
2. Tragedy of the commons – individual users, acting independently according to
their own self-interest, behave contrary to the common good of all users by
depleting or spoiling the shared resource through their collective action
3. Pigou tax – tax on any market activity that generates negative externalities.
The tax is intended to correct an undesirable or inefficient market outcome.
4. Coase theorem – economic efficiency of an economic allocation or outcome in
the presence of externalities.
5. Property rights – legal ownership of resources and how they can be used
6. Adverse selection – situation where buyers and sellers have different
information.
7. Advantageous selection –
8. Moral hazard – occurs when an individual has an incentive to increase their
exposure to risk because they do not bear the full costs of that risk
9. Network effects – effect described in economics and business that an
additional user of goods or services has on the value of that product to others.
10. Harberger triangle (DWL) – used to calculate the efficiency costs of taxes,
government regulations, monopolistic practices, and various other market
distortions.
11. Excess burden – economic loss that society suffers as the result of taxes or
subsidies.
12. Residual demand – market demand that is not met by other firms in the
industry at a given price.
13. Normative theory – branch of philosophical ethics that investigates the set of
questions that arise when considering how one ought to act.
14. Capture theory – industry can benefit from regulation if it can capture the
regulatory agency involved
15. Competition policy – aimed at ensuring that competition is not restricted or
undermined in ways that are detrimental to the economy and society.
16. Antitrust – healthy competition promotion.
17. Price fixing – rival companies come to an illicit agreement not to sell goods or
services below a certain price.
18. Merger policy – agreement that unites two existing companies into one new
company.
19. Abusive practices – materially interferes with the ability of a consumer to
understand a term or condition of a consumer financial product or service
20. Natural monopoly – high infrastructural costs and other barriers to entry
relative to the size of the market give the largest supplier in an industry, often
the first supplier in a market, an overwhelming advantage over potential
competitors.
21. Regulatory capture – corruption of authority that occurs when a political entity,
policymaker, or regulatory agency is co-opted to serve the commercial,
ideological, or political interests of a minor constituency, such as a particular
geographic area, industry, profession, or ideological group.
22. Rate of return regulation – system for setting the prices charged by
government-regulated monopolies.
23. Regulatory lag – difference between the time when a utility's costs increase
and when the utility is allowed to raise its rates, has long been regarded by
ratemakers as the primary efficiency incentive for public utilities.
24. Low power incentive mechanism – price varies in same measure as cost, this
fact minimizes incentives for cost reduction.
25. High power incentive mechanism – price is set beforehand and doesn’t
change with costs.
26. Price cap regulation – mechanism which provides maximum incentives for
cost reduction ($1 saving in costs yields $1 in profit).
27. Bottleneck – process in a chain of processes, such that its limited capacity
reduces the capacity of the whole chain. The result of having a bottleneck are
stalls in production, supply overstock, pressure from customers and low
employee morale.
28. Essential facility – legal doctrine which describes a particular type of claim of
monopolization made under competition laws. In general, it refers to a type of
anti-competitive behavior in which a firm with market power uses a
"bottleneck" in a market to deny competitors entry into the market.
29. Access price – customer gains access to low, crazy prices according to her
total spending at the retailer and on the number of items with bonus points
that she buys.
30. Efficient component pricing rule – addresses access pricing by emphasizing
the opportunity cost of the integrated access provider.
6. PRICE DISCRIMINATION

MAIN TAKEAWAYS:
1. Price discrimination allows the seller to create additional consumer surplus
and to capture existing consumer surplus. Its success requires that resale be
expensive or impossible.
2. Sellers can price discriminate either based on observable buyer
characteristics or by inducing buyers to self-select among different product
offerings.
3. Under discrimination by market segmentation, a seller should charge a lower
price in those market segments with greater price elasticity.
4. When selling a durable good, sellers may prefer to commit not to price
discriminate over time. In fact, due to "strategic" purchase delays, profits may
be lower under price discrimination.
5. If the seller can set a two-part tariff and all consumers have identical
demands, then the (variable) price that maximizes total profits is the same
that maximizes total surplus, that is, a price equal to marginal cost.
6. A monopolist's optimal two-part tariff consists of a positive fixed fee and a
variable fee that is lower than monopoly price. Total surplus is therefore
greater
than under uniform pricing.

TERMS:
1. Price discrimination – pricing strategy where identical or largely similar goods
or services are transacted at different prices by the same provider in different
markets.
2. Perfect price discrimination – business is able to charge the maximum price
that consumers are willing to pay for each of its products leaving no consumer
surplus.
3. Law of one price – in the absence of trade frictions, and under conditions of
free competition and price flexibility, identical goods sold in different locations
 must sell for the same price when prices are expressed in a common
currency.
4. Selection by indicators – macroeconomic measurement used by analysts to
understand current and future economic activity and opportunity.
5. Market segmentation – process of dividing a market of potential customers
into groups, or segments, based on different characteristics.
6. Home bias – tendency for investors to invest the majority of their portfolio in
domestic equities, ignoring the benefits of diversifying into foreign equities.
OLIGOPOLY | GAMES AND STRATEGIES

MAIN TAKEAWAYS:
1. Dominant strategy yields a player the highest payoff regardless of the other
players' choices.
2. A dominated strategy yields a player a payoff which is lower than that of a
different strategy, regardless of what the other players do.
3. It is not only important whether players are rational: it is also important
whether players believe the other play- ers are rational.
4. A pair of strategies constitutes a Nash equilibrium if no player can unilaterally
change its strategy in a way that improves its payoff.
5. A credible commitment may have significant strategic value.
6. Because players can react to other players' past actions, repeated games
allow for equilibrium outcomes that would not be an equilibrium in the
corresponding one-shot game.
OLIGOPOLY

MAIN TAKEAWAYS:
1. Under price competition with homogeneous product and constant, symmetric
marginal cost (Bertrand competition), firms price at the level of marginal cost.
2. If total industry capacity is low in relation to market demand, then equilibrium
prices are greater than marginal cost.
3. Under output competition (Cournot), equilibrium output is greater than
monopoly output and lower than perfect competition output. Likewise, the
duopoly price is lower than the monopoly price and greater than the price
under perfect competition.
4. If capacity and output can be adjusted easily, then the Bertrand model
describes duopoly conipetition better. If output and capacity are difficult to
adjust, then the Cournot model describes duopoly competition better

TERMS:
1. Oligopoly – small number of firms, none of which can keep the others from
having significant influence
2. Bertrand trap – even with 2 firms, price is driven down to the competitive price
(marginal cost). Economic profits are 0; accounting profits could be negative if
there are sunk costs.
3. Raising rivals’ costs – firm with monopoly power can decide to impose
additional costs on others in an industry for exclusionary purposes.
COLLUSION | PRICE WARS

MAIN TAKEAWAYS:
1. Collusion in normally easier to maintain when firms interact frequently and
when the probability of industry continuation and growth is high.
2. If price cuts are difficult to observe, then occasional price wars may be
necessary to discipline collusive agreements.
3. Collusion is normally easier to maintain among few and similar firms.
4. Collusion is normally easier to maintain when firms compete in more than one
market.

COURNOT VS BERTRAND

The two models of duopoly competition presented in the previous sections, though
similar in assumptions, are in stark contrast when it comes to predicted behavior.
The Couinot model predicts that price under duopoly is lower than monopoly price
but greater than under perfect competition. The Bertrand model, by contrast, predicts
that duopoly competition is sufficient to drive prices down to marginal cost level, that
is, two firms are sufficient to bring price down to the price level under perfect
competition.