1: INTRODUCTION

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Define what Industrial Economics is about;

Delimit the scope of Industrial Economics;

Describe some basic concepts used in industrial economics;

Understand the similarities & differences between industrial economics

and microeconomics;
Mention & discuss the approaches to Industrial Economics;

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 Industrial economics is a distinctive branch of economics, which deals with the economic
problems of firms & industries, & their relationship with society.
 In economic literature it is known by several names such as, Economics of Industries,
Industry & Trade, Industrial Organization, and etc.
 The question “How decision‐making problems arise in industries?” traces back to the
foundation of industrial economics.
 Economics is the science that studies the scarcity & the alternative uses of the scarce
resources to narrow down the gap. For example, a consumer has to adopt some criterion
to achieve maximum gain from his limited income. Similarly, a producer given scarcity of
resources he has to take decisions about production & distribution.
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 There are several basic issues on which the producer will be taking decisions
such as:
 What commodities he should produce,
 What should be the level of output,
 What type of technology he should adopt,
 Where should be the location of the firm, & what should be the size of the factory,
 What price should be charged, and how much wages should the firm pay,
 How much the firm should spend on advertisement, should he borrow from banks or
elsewhere, etc.
 All such decisions explain the producer's behavior in the different market
situations, which we endeavor to study in industrial economics.

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 In microeconomics we also study producer’s behavior in relation to scarcity of resources.
 Because of this fact, some economists would regard IE as being primarily an elaboration of, & dev’t from,
the traditional theory of the firm taught under microeconomics.
 But, IE is best defined as the application of micro economic theory to the analysis of firms, markets &
industries.
 Stigler (1968) argues that IE does not really exist as a separate discipline, i.e., it’s simply differentiated Mi
 The distinction arises from the overriding emphasis, in IE, on empirical work & on implications for
policy.
 Both microeconomics & IE are concerned with the economic aspects of firms & industries seeking to
analyze their behavior & draw implications.

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 MICROECONOMICS
 Aformal(well-knowntheory),
deductive and abstract discipline
 It is passive(inactive to remove
constraints) in approach & assumes
profit maximization as the goal of the
firm
 Being abstract, does not go into
operational details of production,
distribution & other aspects of the firms
& industries.
 It may shun public policy if necessary
 Provides the main theoretical basis for
the study of IE
INDUSTRIAL ECONOMICS
 Less formal & more inductive in nature.
 It is an active discipline & does not believe in
single goal of profit maximization
 It does go into the depth of such details.
 It takes care of Public (gov’t) policy
implications
 Several important influences from outside
have given a totally d/t character.
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 As was mentioned earlier, Industrial Organization (IO) is viewed as synonymous with IE.
 Carlsson (1989) made clear the distinction between them. He reasons that the main concern of
industrial organization has become the structure of industries at a particular point of time. By contrast, IE
encompasses both IO & Industrial dynamics (ID).
 ID is primarily concerned with the evolution of industry as a process in time both at the macro level, the
sector or industry level, & the firm level.
 It differs from IO in that its main focus of attention can vary from the firm, to r/ships b/n firms, to the
links b/n microeconomics & the macro economy.
 For instance, where IO would be concerned with the extent to which the presence of monopoly in the
economy reduces society’s welfare, ID addresses itself to the reasons why monopoly has developed, &
the question of for how long it might persist.

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 There are two broad elements of industrial economics:
 Descriptive & Analytical elements: They are interdependent
 Descriptive element is concerned with the information content of the subject.
 It deals with the information about the competitors, natural resources & factors of production & gov’t
rules & regulations related to the concerned industry.
 Analytical element is concerned with analyzing the business policy & decision-making.
 It deals with topics such as market analysis, pricing, choice of techniques, location of plant, investment
planning, hiring & firing of labour, financial decisions, product diversification & so on.
 It is a vital part of the IE & much of the received theory of IE is concerned with this. However, this does
not mean that first element, i.e. descriptive IE, is less important.

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 The Firm: A firm is an organization owned by one or jointly by a few or man
individuals which is engaged in productive activity of any kind for the sake
profit or some other well-defined aim.
 The Industry: “a group of firms producing closely substitute goods for a common grou
of buyers”. In the terminology of the monopolistic competition we ar
essentially talking about the “product group" as a substitute for the industr
Note: it’s not necessary that the substitute goods always come from the sam

industry.
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 The Market: Connotes the composition of the buyers & their geographical location along with the
industry w/c produces hetero-/homogeneous goods. In practice it may be difficult to define the
precise boundary for a market.
 Market power: refers to the influence that any particular buyer or seller can exercise over the
price of a product. It indicates the degree to which a business firm is able to earn larger than
normal profits.
 Contestable Market: It is a market in which competitive outcomes can be observed. Its
fundamental feature is low barriers to entry & exit; a perfectly contestable market would have no
barriers to entry or exit.

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 1. The Structure-Conduct–Performance (SCP) Paradigm (Harvard tradition)
2. Chicago school approach
1. The Structure-Conduct–Performance (SCP) Paradigm (Harvard tradition)
 The central questions addressed by IE includes:
Is there market power and if so, how do you measure it?
How do firms acquire and maintain market power?
What are the implications of market power?
What is the role of public policy in relation to market power?
 To do a complete analysis of an industry, market, or economy, Joe Bain & Edward Mason
(both from Harvard) & sometimes called the “Harvard tradition” developed the concept of
“Structure-Conduct-Performance” Paradigm.
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 According to this paradigm, there is a priori(uni-directional) r/ship b/n the three concepts of market: S-C-P.
 The link b/n these three concepts is that the market structure of an industry determines or strongly influences the
crucial aspects of its market conduct, w/c in turn directly or indirectly determines certain important dimensions of its
performance.
 This link gives us the basic framework for the study of the economic behavior of the firms & industry in the market.
 The market structure of an industry is concerned with the number & size distribution of buyers & sellers, the nature of
the product & conditions of entry.
 The market conduct is the pricing behavior, the product strategy & policy, & the promotional activities (advertising,
Research & Development) operating within the market.
 The market performance deals with the productive & allocative efficiency (price, cost, profit levels & trends) & the
industry progressivity (technological change) of the market.

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A. Market Structure: The concept of market structure refers to three main organizational characteristics of
buyers & sellers in a particular market:
 It’s a multidimensional concept, hence it’s difficult to measure it with a single variable
a. The degree of seller & buyer concentration in the market, as well as their size distribution
b. The degree of actual & imagined differentiation between the products of competitor producers
c. The conditions surrounding entry into the market
B. Market Conduct: it includes the pattern of behavior followed by firms in the industry when
adapting/adjusting to a particular market situation. It includes:
 Pricing behaviors of the firm or group of firms: its profit maximizing level of price/price discrimination followed
 Product policy of the firm or group of firms: product design, quality, variety…consistent/variable??

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 Sales promotion & advertising policy of the firm or group of firms

 Research, development, & innovation strategies employed in the firm or group to adopt new technology
 Legal tactics used by the firm or group: it is used to get patent & trade mark rights. Eg, take the situation
of two- firm industry (i.e. Duopoly). They may act independently, interdependently, honorable & dirty games
C. Market Performance: It is the end result of the activities under taken by the firms in pursuit of their
goals. Generally, good market performance includes the ff elements:
 Resources should be allocated in an efficient manner across industries & products, Technical or
operational efficiency of cost, Exchange/pricing Efficiency affects allocative efficiency, Normal
Profit Rates, Producers should be technologically progressive, Product Suitability for the consumer
preference & an equitable distribution of income among resources with stable price.

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 Harvard traditional SCP approach argues that performance is determined by conduct of firms,
w/c in turn is determined by the structural characteristics of the market (Fig. 1.1)

 The traditional approach asserts that market structural condition yields sufficient information to
deduce how firms should behave & performance can be directly predicted from conduct.
 However, the traditional premise that unidirectional running from structure-conduct-performance
is unsound. In some cases, analysis of conduct is superfluous.


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 It can be summarized that, while IE has traditionally emphasized the causal flows running from
exogenous market structure &/or the exogenous basic conditions to conduct & performance.
 There are important feedback effects from performance to structure (e.g., high profits from
efficiency increase market share & affect structure), from performance to conduct (reinvested
monopoly profits can finance greater R&D, advertising, or predation & low profits encourage collusion),
& from conduct to structure (R&D, mergers, predation, strong product differentiation, advertising, &
patents affect structure i.e., from PCMs to oligopoly/monopoly/MCms).
 Market structure, conduct, & ultimately performances are also influenced by certain fundamental market
& environmental conditions. These may be divided into factors primarily influencing the supply or input
side of the production equation & those whose primarily influence is on the demand side.

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 The major concern of studies in the field of market structure, conduct, & performance is to
develop the capability to predict market performance indirectly, market structure & conduct
directly.
 The task of industrial economics is to find how strong these linkages are.
 Once this is known, the next step would be to use them independently or jointly in a model
form for policy purposes.
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 Say, suppose the goal is profit maximization, then we have to take the appropriate linkages b/n the
blocks as constraints or strategies for this and solve the model. This is what we have to do in
industrial economics.
The Chicago school approach. (Demsez & Stigler)
 The SCP economists conclude that the +ve association b/n concentration & profits provides
empirical support for the concentration → collusion → profits relation (collusion hypothesis).
 But Chicago School economists question the direction of causality & the persistence of the
relation throughout time.
 First, economies of scale & innovation result in both high concentration & high technical
efficiency, which in turn lead to a +ve correlation b/n concentration & profits. Therefore, high
profits capture high technical efficiency, not collusion.
 Second, the +ve association may imply that markets are in disequilibrium, which is temporary,
not persistent throughout time. Therefore, the +ve r/ship does not capture market power.

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 In any market, the firm with high efficiency possesses lowest cost, which will again increase the firm size
& market share overtime.
 There will be a tendency for market power to increase but, at the same time, there will be pressure on all
firms to be efficient, i.e. large profits in the concentrated industries are due to their superiority in
production & better utilization of resources.
 Consequently, the market structure will develop into the one that enables productions & distribution to be
undertaken at least cost. This implies competition policy as proponed by SCP paradigm is largely
unnecessary b/c efficiency prevails regardless of the market structure. These rules out the need
for gov’t intervention.
 If some firms have a cost advantage over rivals, then market concentration will increase, since the
competitive advantage this confers results the efficient firms growing over time at the expense of
others.

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 The causation runs from lower costs to higher profits & greater market power (i.e. from
performance to structure). See summarized Figure 1.4 below:

 The difference in approach between the Traditional SCP & the Chicago School is that importance
is given to market power in the former & to efficiency in the later.

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…………………………………………………………………..

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