Scopes of Industrial
Economics and Its History
Lecture 01
Main Book Reference: R. R. Barthwal,
Supplementary References: Jeffry M. Perloff, Oz Shy, J. Tirole
What Industrial Economics is about:
• Distinctive branch of economics which deals with the firms,
industries, markets and their relationships with each other
along with the society.
• It looks at firms of all sizes – from local corner shops to
multinational giants and considers a whole range of industries,
such as electricity generation, car production, and restaurants.
• Usually known in different names like “Economics of
industries”, “Industrial Organization”, “Industry and Trade”,
“Business and Economics”, etc.
• It is assumed that, through the writings of P.W.S Andrews in
the early 50s, the name Industrial Economics became popular
worldwide.
Two broad elements of Industrial Economics:
Descriptive Element
Analytical element
How Decision-making problems Arise in Industries:
• Resources like land, raw materials, labor, capital are scarce.
• Given the scarce resources, the producer has to take decisions about
production and distribution.
― What commodities he should produce
― what should be the level of output of each
― what type of technology he should adopt
― where should he produce the goods
― what should be the size of his factory
― what price he would charge
― how much wages he should pay
― how much he should spend on advertisement, etc.
Microeconomics Industrial Economics
• Formal, deductive • Less formal, realistic, more inductive in nature
• Passive in approach. It mostly assumes that • Active discipline. It searches the goals of the
the main goal of firm is profit maximization. firm from the relevant facts and concentrates
on the barriers that impede the achievement
of the goal and tries to remove them.
• Microeconomics, being abstract, does not go • Goes into the depths of operational details of
into operational details of production, the firms and industries
distribution and other aspects of the firms
and industries.
• The conclusions derived from the • Industrial economics is free from such
microeconomics may not be testable limitation because of its emphasis on
empirically and therefore we may not assess empiricism. In setting public policies, the
their predictive efficiency. observations from Industrial Economics plays
an effective role than that of traditional
Microeconomic Theories for being more
realistic.
Industrial Economics vs. Managerial Economics:
• There are two striking differences:
• Industrial economics has a positive approach while managerial economics
follows normative one.
• Secondly, managerial economics is more interdisciplinary in nature than
industrial economics. Industrial economics does not go too far for its analysis
of the economics in managerial problem.
• The new emerging field of study known as "organizational economics’
is integrating both managerial economics and industrial economics
Macro Dimensions of Industrial Economics:
• To achieve the broader policy objectives, a state will regulate
industries through varieties of ways such as nationalization, anti-trust
policies, control of prices and outputs, credit controls, taxes, etc. A
study of all such instruments of industrial regulation is very much a
part of industrial economics. How they affect the performance of the
firms is a crucial aspect to be examined under industrial economics:
Such information is useful for the regulatory agency of the
government to assess the success of its industrial policy.
Brief History
• Cutoff point in 1776 by Adam Smith in “Wealth of Nations”
• After Adam Smith, the historical development of the economic
analysis of industrial activities subjected to the methodological
division.
• One school of thought led by Jevon followed abstract, deductive reasoning to
derive testable hypotheses in the theory of the firm, while the other, known
as Historical School, followed inductive or empirical approach for study of the
economic behavior of the firm and industry.
• Jevon, almost 100 years after Adam Smith, developed the theory of
demand in terms of the present utility theory. In addition to this, he
was able to refine the concepts of costs and the factors production.
Contd.
• He and his follower Edgeworth were able to establish the conditions
for equating price and average cost of a product and thus, elimination
of the excess profit.
• Clark carried their work further
• Knight refined perfect competitive model
• John Robinson’s theory of imperfect competition stumbling block
• Chamberlin’s analysis of monopolistic competition
• The impact of Chamberlin's work on industrial economics was so profound
that it was regarded as the single most important antecedent of
contemporary industrial economics.
Contd.
• Hotelling developed the stability conditions for competition by taking
differentiated goods and spatial dimensions.
• Lancaster new theory of consumer demand.
• An independent development in the theory of firm was seen during
the decade of the 1940's when Von Neumann and Morgenstem
published their work on the game theory.
• The important authors who made significant contributions in
industrial economics during the early thirties were Allen, Sargent
Florence, Berle and Means and W.G. Hoffman.
Contd.
• Berle and Means made a break-through in the empirical analysis of
the modern corporations by making a separation between ownership
and management.
• Mason was an important author in the late thirties
• P.W.S. Andrews in the forties
• The fifties and sixties developed bulk of the industrial economics that
we read at present. The Journal of Industrial Economics was started in
1952. Then appeared the important contributions by Bain, Marris,
Stigler on one side and Simon, Cyert and March, and Galbraith on the
other.
Contd.
• Bain provided structure-conduct-performance' nexus as a framework
for industrial analysis.
• Robin Marris analyzed the role of managerial behavior in the context
of modern corporations.
• His work extended further by Galbraith.
• Cyert and March developed a behavioral theory of the firm which
opened a new frontier in the study of industrial economics.
• Simon studied the process of decision-making in the context of
organization as an administrative unit. Stigler focused on the analysis
of the industrial oligopoly structures apart from other things.
Contd.
• Schumpeter and Marshall used both deductive and inductive
methods.
• Schumpeter was mainly a development economist, but his work on
entrepreneurship, innovation and analysis of competition had a
profound impact on contemporary industrial economics.
• Marshall’s "Industry and Trade' which was an early textbook of
industrial economics.
• Following the line of Marshall, we have seen the highly useful work of
E.A.G. Robinson in the field of industrial economics. (“The Structure
of Competitive Industry”)
Two Waves
• There are at least two major approaches to the study of
industrial organization.
• The first approach, structure-conduct-performance, is primarily
descriptive and provides an overview of industrial organization.
• The second, price theory, uses microeconomic models to explain
firm behavior and market structure.
First wave
• First wave associated with Joe Bain and Edward Mason
• Known as Harvard tradition
• Empirical in nature
• Rested on loose theories and emphasized empirical studies of
industries
• Developed the famous “structure-conduct-performance” paradigm
acc. to which market structure determines conduct and conduct
yields market performance
Contd.
• Market structure are the factors that determine the competitiveness of the
market which includes
• no. of sellers in the market,
• the degree of product differentiation,
• cost structures,
• the degree of vertical integration with suppliers and so on.
• Structure means how sellers interact with other sellers, with buyers, and
with potential entrants.
• Market structure also defines the product in terms of the potential number
of variants in which the product can be produced.
• The structure of an industry depends on basic conditions, such as
technology and demand for a product.
Contd.
• Conduct consists of
• price,
• research and development,
• investment,
• advertising and so forth.
• Market conduct refers to the behavior of the firms in a given market
structure, that is, how firms determine their price policy, sales, and
promotion.
Contd.
• Market performance means
• efficiency,
• price ratio to marginal cost,
• product variety,
• innovation rate,
• profits and distribution.
• Performance refers to the welfare aspect of the market interaction.
That is, to determine performance we measure whether the
interaction in the market leads to a desired outcome, or whether a
failure occurs that requires the intervention of the regulator.
Second Wave
• Second wave associated with Aaron Director and George Stigler
• Started in 1970s
• Known as Chicago tradition
• Emphasized the need for rigorous theoretical analysis and empirical
identification of competing theories
• Famous for its permissive view of market behavior
• Had relative distrust on govt intervention in comparison with Harvard
tradition
• Price theory models analyze the economic incentives facing
individuals and firms to explain market phenomena.
The Study of Industrial Organization
• Our approach to analyzing industry behavior is based on four stylized facts:
• Concentration: For example, some are comprised of a few large firms; some have
one large firm and many smaller ones.
• Product characteristics: Firms in some industries produce homogeneous or almost
identical products, whereas firms in others distinguish themselves from the
competing firms by selling differentiated brands.
• Costly activities: Firms in an industry are engaged in repeated costly activities
targeted for the purpose of enhancing the sales of their brands. In some industries,
these activities constitute the major cost of the firm and may exceed the cost of
producing the product itself. These costly activities may include advertising, quality
control, product differentiation costs, marketing and dealership costs.
• Research and development: Firms allocate resources for inventing cost reducing
production technologies as well as new products. These resource allocations also
include large investments in imitations of technologies invented by rival firms
(reverse engineering).
Concluding remarks:
• Industrial Economics has a strong theoretical base of
microeconomics. It provides useful applications for industrial
management and public policies and has acquired the status of a
specialist subject.
• It is the study of imperfect competition. Industrial economists are
interested in markets that we actually encounter in the real world.
• Firms in imperfectly competitive industries need to make strategic
decisions—that is, decisions that will have an identifiable impact on
other participants in the market, be they rival firms, suppliers, or
distributors.
Contd.
• Our interest is more than just determining the profit-maximizing
strategies that firms in a particular market context should adopt. As
economists we are interested in the market outcomes that result
when firms adopt such strategies, and whether those outcomes are
close to those of the competitive ideal. If not, we then need to ask
whether and how public policy can improve market allocations.