Review

Author(s): Dennis W. Carlton

Review by: Dennis W. Carlton
Source: Journal of Political Economy, Vol. 98, No. 3 (Jun., 1990), pp. 668-671
Published by: The University of Chicago Press
Stable URL: http://www.jstor.org/stable/2937706
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668

JOURNAL

OF POLITICAL

ECONOMY

Theoryof Industrial Organization. By JEAN TIROLE.

Cambridge, Mass.: MIT Press, 1988. Pp. 479. $35.00.
Jean Tirole has written a masterful book that should be invaluable to those
who want a lucid presentation of the significant recent theoretical developments in industrial organization. The book should be required reading for
graduate students and professors specializing in industrial organization.
There has been a burst of theoretical research in industrial organization,
much of it inspired and conducted by Tirole. Once considered by theorists as
a wasteland, industrial organization has now emerged as a place in which the
most advanced theoretical tools can be applied. This book eloquently describes these major theoretical developments. Tirole is a good writer and is at
his best when he provides simple (or pretty simple) mathematical models to
illustrate new ideas. His ability to capture the essential idea and strip away
needless complexity is remarkable and reflects his sharp analytical thinking.
This review first discusses the book's contents and then the topics not covered. Next, I assess the difficulty of the book and finally suggest the courses
for which it is most appropriate.
I.

Subjects Covered

The book is almost entirely theoretical with a focus on the latest theoretical
advances. An introductory chapter on the theory of the firm provides an
excellent overview of principal-agent theory. The book is then divided into
two parts. The first part (chaps. 1-4) covers single-firm behavior, while the
second part (chaps. 5-11) covers multiple-firm behavior and is the distinguishing feature of the book. Each chapter is wonderfully written.
Chapters 1-4 consider the monopolist's optimal choice of durability, quality, prices, and control of distribution. The heuristic proof of Coase's result
regarding the lack of monopoly power in a durable-good industry is one of
the clearest I have seen. The discussion of quality goes through the Spence
result on optimal product diversity and the signaling literature when consumers must infer quality from a firm's pricing. I have always been skeptical about
the empirical importance of the signaling equilibria in which a firm signals
quality by sinking costs; after reading Tirole's discussion, I remain skeptical.
The discussion regarding asymmetric information and government intervention is all right but sometimes comes close to confusing the theoretical possibility of remedying an externality with the practical ability to do so.
The discussion of price discrimination goes through first-, second-, and
third-degree price discrimination in more detail than is typically done. The
material in the supplementary section on optimal nonlinear tariffs is excellent
but a bit difficult. It is hard to find this material anywhere else in such a
readable form. For example, Tirole concisely discusses the condition on the
distribution function of consumer types that is needed for the optimal nonlinear price to be concave-a difficult but key topic in nonlinear pricing. I
would have spent more time on two-part tariffs and stressed more some of
the relationships between consumer heterogeneity and the optimal two-part
tariff. (For example, the fixed fee tends to rise and marginal charge fall as
consumers become more homogeneous.) Tirole does a good job of proving
I thank Andrew Rosenfieldand George Stigler for helpful comments.

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BOOK REVIEWS

669

the welfare properties of price discrimination. One minor quibble is that the
section entitled "Welfare" (p. 158) talks about output, not welfare.
Vertical relationships is the last topic in part 1. It is not clear that this
chapter belongs in the first part of the book on single-firm behavior since the
point of many vertical restrictions is to improve a firm's ability to compete
with its rivals. Vertical relationships is a topic in which empirical examples
abound and in which a student may need help understanding the empirical
relevance of the models. Tirole does provide some empirical glimpses, but the
professor will need to supplement them. Tirole's discussion of the antitrust
laws on vertical control is so short (one paragraph) that no student will understand it. Tirole discusses many of the most important reasons for vertical
foreclosure and control but omits some. For example, the rationale for exclusive dealing as a way to prevent free-riding among manufacturers is omitted.
Tirole seems overly modest in the discussion on foreclosure and stresses the
premature nature of any conclusions. Still, I am concerned that antitrust
enforcement agencies will read Tirole to say that foreclosure is a potentially
serious worry that has the support of theoretical models. I would have preferred a statement such as "Although some models of vertical foreclosure
have been developed, most rely on strong assumptions of asymmetry between
incumbent and entrant. It appears then that foreclosure is likely to succeed
only when such asymmetry can be preserved over time. Vertical foreclosure is
an area in which more work is needed." Some of Salop's work on foreclosure
and raising a rival's costs could be profitably discussed at greater length.
Part 2 analyzes competition among firms. Chapter 11 (which is an appendix
to the book) should be read before one begins part 2 since it provides the
basics of game theory used in the remainder of the book. It starts out with
simple concepts but quickly gets into sophisticated topics such as Bayesian
perfect equilibrium. It is an excellent primer, but if students have never seen
Bayes's theorem, the end of this chapter will be too hard. The supplementary
section is clearly designed for advanced students interested in existence
proofs that freely utilize notions of compactness, quasi concavity, and Jensen's
inequality. In short, this chapter will be challenging even for top graduate
students.
Part 2 goes on to analyze static models and dynamic models of oligopoly
and monopolistic competition. The analysis of the standard models (Cournot
and Bertrand) is insightful as is the discussion of monopolistic competition.
The discussion of dynamic models treats subjects that are not presented elsewhere in the same detailed but readable way. Tirole is careful to emphasize
that, at the current stage of development, there is an "embarrassment of
riches" in the sense that in many dynamic games almost any type of behavior
can be justified as an equilibrium. He candidly admits that little attention has
yet been paid to empirical implications of these models. The discussion of
how a rival's earlier behavior can affect others' beliefs about the rival and
benefit the rival is clearly expressed and is an important concept that students
will easily grasp. The supplementary sections of several of these chapters
contain material that will appeal exclusively to advanced graduate students.
The last three chapters (chaps. 8-10) really form the heart of the book.
These chapters apply the insights of game theory to strategic competition.
They contain clear and detailed discussions of topics that students might find
inaccessible if they relied on published articles. Tirole characterizes precommitments in two-period games by how they affect a rival's decisions in the
future, and he goes quite a way in making empirically testable theoretical

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670

JOURNAL

OF POLITICAL

ECONOMY

predictions. He stresses the importance of strategic complements (e.g., in a

Bertrand game, if one rival cuts price, the other does too) and strategic
substitutes (e.g., in a Cournot game, if one rival raises quantity, the other
lowers quantity) and explains how the object of a strategic game is to soften
competition. He then provides a survey of excellent theoretical examples of
how rivals can affect their reaction curves. These examples include tie-in
sales, use of retroactive price clauses, complementarity of products with a
rival, and choice of location. The last chapter covers patent races and time of
technology introduction. The chapter also discusses the adoption of standards and licensing. Overall, it highlights some recent and valuable new developments.
II.

Subjects Not Covered

Tirole is completely forthright in explaining that his text covers selected

theoretical topics and is not intended as a general overview of industrial
organization. There are two major (and intended) omissions as compared
with a standard textbook. First, the text makes no systematic attempt to survey the empirical literature that bears on the theoretical topics. Tirole candidly admits in several places that the empirical implications of several of the
advances in game theory have yet to be developed and tested. The omission
of empirical discussions could leave readers in doubt about the relevance of
the models and virtually guarantee that skeptics of the game theory approach
will remain skeptical. For these reasons, this book is most appropriate for
advanced students who have already been exposed to some of the evidence.
Tirole recommends reliance on other texts for empirical evidence, but that
approach may be a bit difficult since other texts may not be organized in the
same way as Tirole's and may not discuss the same models.
The second major omission is the lack of any systematic treatment of regulation and antitrust. It is in keeping with the theoretical focus of the book to
omit antitrust developments, but it would have been consistent to have a
chapter on the recent theoretical advances in the theory of regulation. Indeed, the recent developments regarding regulation with asymmetric information would fit in nicely with the excellent introductory chapter on the
theory of the firm. The theory of natural monopoly and sustainability would
also fit in nicely with the rest of the book. The profession would benefit if
Tirole had written such a chapter given his remarkable ability to explain
complicated ideas in a simple fashion.
III.

The Level of Difficulty and Pedagogical Features

The level of difficulty of the book raises some questions about whether undergraduates could handle the material. Tirole excels at simplifying and presenting simple mathematical models. Overall, he does a terrific job of minimizing
reliance on complicated mathematical techniques. Even so, undergraduates
could find the mathematics tough or intimidating. Line integrals are discussed in the preface, control theory is needed for a problem in chapter 1,
and game theory is used extensively (after being presented in a clear but
difficult appendix) later in the book. None of these techniques is so complicated that a mathematically sophisticated undergraduate should be put off,
but I suspect that most undergraduates will be at least a little nervous.
The chapters of the book vary in their level of difficulty. The book does not

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671

BOOK REVIEWS

progress from simple to difficult. The first chapters on principal-agent theory

and the Coase problem of durable goods seem more difficult than those at the
end of the book. In particular, the chapters on strategic competition are not,
for the most part, mathematically demanding.
Each chapter contains a supplementary section for advanced students, lots
of well-thought-out exercises within the chapter and at the back of the book,
and worked-out solutions. The text is a delight to teach from because the
exercises provide a great way to illustrate ideas that Tirole mentions but does
not have time to treat. The instructor will never have to worry about questions
for problem sets or final exams. The difficulty of the exercises is indicated
(three levels), a helpful pedagogical idea. The only pedagogical improvement
I could suggest is the addition of an author index. It is hard to guess in which
chapter an article falls, and an index of this type would help.
IV.

What Courses Can Use This Book?

I would use this book as a sole text only in a specialized, advanced graduate
course in industrial organization because of its idiosyncratic coverage of topics, but I would use parts of the book to complement other readings in a more
general graduate course. I have taught graduate industrial organization with
Robert Gertner at the University of Chicago for several years and have used
the Carlton-Perloff (1990) textbook (which is slightly less advanced than
Tirole's, especially on dynamic games under uncertainty, but deals with empirical and theoretical topics) and selected chapters of Tirole plus journal
articles. In particular, Gertner and I use several of Tirole's chapters to discuss
strategic behavior (chaps. 8-10) and to introduce game theory (chap. 11). I
would feel comfortable using parts of selected chapters in an advanced
undergraduate course. Again, parts of chapters 8-10, the heart of the book,
would be the most appropriate, not too hard, and most valuable.
In summary, this book takes as its objective the presentation of several of
the latest theoretical advances in industrial organization. It succeeds admirably in achieving its objective. Tirole is a gifted writer who excels at explaining
the essence of complicated models.
DENNIS W. CARLTON

Universityof Chicago
Reference
Carlton, Dennis W., and Perloff, Jeffrey M. Modern Industrial Organization.
Glenview, Ill.: Scott, Foresman, 1990.

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