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Industrial organization
From Wikipedia, the free encyclopedia

Industrial organization is a field of economics that studies Economics

the structure of and boundaries between firms and markets
and the strategic interactions of firms. The study of industrial
organization adds to the perfectly competitive model
real-world frictions such as limited information, transaction
costs, costs of adjusting prices, government actions, and
barriers to entry by new firms into a market that may be Economies by region

associated with imperfect competition. It then considers how

Africa · North America
firms are organized and how they compete.[1] The subject has South America · Asia
been described as concerned with markets that "cannot easily Europe · Oceania
be analyzed using the standard textbook competitive
General categories
model."[2] The development of industrial organization as a
separate field owed much to Edward Chamberlin, Edward S. Microeconomics · Macroeconomics
Mason and Joe S. Bain. History of economic thought
Methodology · Heterodox approaches
There are two major approaches to the study of industrial
organization. The first approach is primarily descriptive and Mathematical & quantitative methods
provides an overview of industrial organization. The second,
price theory, uses microeconomic models to explain firm Mathematical economics
Computational · Econometrics
behavior and market structure.[1] As to strategic firm Experimental · National accounting
interactions, non-cooperative game theory has become the
standard unifying method of analysis.[3] Fields and subfields

Behavioral · Cultural · Evolutionary

Growth · Development · History
Contents International · Economic systems
Monetary and Financial economics
Public and Welfare economics
1 Structure, conduct, performance Health · Education · Welfare
2 Market structures Population · Labour · Managerial
3 Areas of study Business · Information · Game theory
4 History of the field Industrial organization · Law
Agricultural · Natural resource
5 See also Environmental · Ecological
6 Notes Urban · Rural · Regional · Geography
7 References
8 Journals Lists

Journals · Publications
Categories · Topics · Economists
Structure, conduct, performance
Economic ideologies
According to the structure-conduct-performance approach, an
industry's performance (the success of an industry in Anarchism · Capitalism
Communism · Corporatism
producing benefits for the consumer) depends on the conduct Fascism · Feudalism
of its firms, which then depends on the structure (factors that Georgism · Imperialism
determine the competitiveness of the market). The structure Islamic · Laissez-faire
of the industry then depends on basic conditions, such as

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technology and demand for a product.[1] For example: in an Leninism · Maoism

industry with technology that the average cost of production Market socialism · Marxism
Monarchy · Monopolism
falls as output increases, the industry tends to have one firm,
Mercantilism · Neocolonialism
or possibly a small number of firms. Oligarchy · Oligopoly
Plutocracy · Primitivism
Components that make up the structure, conduct, and Protectionism · Socialism
performance model for industrial organization include: Syndicalism · Third Way

Economy: concept and history

basic conditions: consumer demand, production,
elasticity of demand, technology, substitutes, raw Business and Economics Portal
materials, seasonality, unionization, rate of growth,
product durability, location, lumpiness of orders, scale of economies, method of purchase,
scope economies
structure: number of buyers and sellers, barriers to entry of new firms, product differentiation,
vertical integration, diversification
conduct: advertising, research and development, pricing behavior, plant investment, legal
tactics, product choice, collusion, merger and contracts
performance: price, production efficiency, allocative efficiency, equity, product quality,
technical progress, profits
government policy: government regulation, antitrust, barriers to entry, taxes and subsidies,
investment incentives, employment incentives, macroeconomic policies

Industrial organization The subject of industrial organization applies the economics’ model of price
theory to the real world industries. The goal of industrial organization study is to increase the
understanding of how industries operate, improve the industries contribution to the economic
welfare, and to improve government policy toward these industries.

Structure Conduct Performance Paradigm (SCPP) SCPP is an industrial organization’s approach,

used to analyze the relation among market performance, market conduct, and market structure. The
SCPP indicates that market structure determines the market conduct, and thereby sets the level of
market performance. Working backward, we find that market performance is determined by market
conduct, which in return depends on market structure.

Economists are especially interested in studying the SCPP because they tend to believe that seller
concentration affects the industry’s social performance. The economic theorists express that effect in
terms of higher profits earned by the monopoly. On the other hand, Industrial Organization
economists express the effect in terms of locative inefficiency. However, economists who use the
Structure Conduct Performance (SCP) approach disagree on the emphases that they give to each of
the three elements. Some give market structure and market conduct an equal importance in
determining market performance. Others argue that market conduct is largely determined by market
structure, hence, market performance depends heavily on market structure, and that leads them to
pay little attention to market conduct.

Market Structure Conduct and Performance SCP framework was derived from the neo-classical
analysis of markets. The SCPP was the brainchild of the Harvard school of thought and popularized
during 1940-60 with its empirical work involving the identification of correlations between industry
structure and performance. This SCP hypothesis has led to the implementation of most anti-trust
legislation. The Chicago school of thought followed this from 1960 to 1980. They emphasized on the
rational for firms becoming big, price theory and econometric estimation. During 1980-90 game

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theory took center stage with emphasis on strategic decision-making and Nash equilibrium concept.
After 1990, empirical industrial organization with the use of economic theory and econometrics led
to complex empirical modeling of technological changes, merger analysis, entry-exit and
identification of market power.

Market structure The Market structure consists of the relatively stable features of the market
environment that influence rivalry among the buyers and sellers operating within this market. The
main elements that influence market structure are, seller concentration, product differentiation,
barriers to entry, barriers to exit, buyer concentration, and the growth rate of market demand. Other
elements of market structure exist, but they are usually unstable and therefore ignored either because
they can’t be measured or because they are hard to observe.

Elements of market structure Seller concentration Refers to the number and size distribution of
firms in the market. The most widely used device is determining seller concentration is the
Concentration Ratio. To compute the concentration ratio, the firms are ranked in order of size
“usually measured in terms of sale”, starting from the largest in the industry at the top and going
down to the smallest firm at the bottom. Concentration ratios are usually given for the largest 4,
largest 8, and sometimes the largest 20 firms. Usually industries that are highly concentrated in one
advanced economy tend to be highly concentrated in another.

Product differentiation A differentiation or distinguishing a product from the products of other

competing firms. Differentiation of products along key features and minor details is an important
strategy for firms to defend their price from leveling down to marginal cost.

Horizontal differentiation When products are different according to features that can't be ordered in
an objective way, or in other words, at the same price, some consumers would prefer the product
while others would prefer a different substitute Horizontal differentiation can be differentiation in
colors (different color version for the same good), in styles (e.g. modern/antique), or in tastes. A
typical example is the ice cream offered in different tastes. Chocolate is not better than Mango.

Vertical differentiation Vertical differentiation occurs in a market where the several goods that are
present can be ordered according to their objective quality from the highest to the lowest. It's
possible to say in this case that one good is "better" than another.

Mixed differentiation Certain markets are characterized by both horizontal and vertical
differentiation. For instance, apparel, and shoes have a rich combination of shapes, colors, materials,
and appropriateness to social events. In such markets, the differences in colors or shapes are
horizontal differentiation, while the quality of the materials is usually perceived as vertical

Barriers to entry A set of economic forces that create a disadvantage to new competitors attempting
to enter the market. These forces could be government regulation such as IP rights, or patent, or they
could be large economies of scale in a specific industry, or high sunk costs required to enter the
market. Sometimes firms within a specific industry adopt certain pricing strategies to create barriers
to entry, one of the most widely adopted strategy is “Limit Pricing” by lowering prices to a level that
would force any new entrants to operate at a loss, this strategy is especially effective when the
existing firms have a cost advantage over potential entrants.

Barriers to exit A set of economics forces that influence the firms decision of exiting the market,

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such forces make it cheaper for the existing firm to stay in the market than to exit the market.
Although sunk costs could be barriers to entry, especially when the sunk costs are too large, sunk
costs could be a huge barrier to exit as well, because large investments in fixed plant and equipments
commits the firm to stay in the market. Barriers to exit increase the intensity of competition in an
industry because existing firms have little choice but to stay and fight when market conditions have
deteriorated. The loss of business reputation and consumer goodwill, could be a barrier to exit
especially if the firm is planning on reentering the market later, or when the firm exits a specific
market but still operating in other markets. In such a situation, the decision to leave the market can
seriously hurt the reputation of the firm among current consumers in other markets, and affect the
goodwill among previous customers, not least those who have bought a product which is then
withdrawn and for which replacement parts become difficult or impossible to obtain.

Buyer concentration The number of buyers in a market. Buyer concentration is as equally important
as seller concentration, especially in markets with a few buyers. The term was used by Michael E.
Porter in 1979 in his “Five Forces Analysis”. Porter’s analysis proposes that in markets with high
buyer concentration, the firms earn lower level of profits than in markets with low buyer

The growth rate of market demand The market structure in industries with a relatively static
demand or low growth rate of demand is different from the market structure in industries with an
accelerated demand growth. That’s because when the demand grows fast enough, the firms have their
hands full just expanding their production capacities, in this case, if new entrants are coming in, there
will be little incentive to fight for market share. Also, firms are likely to honor oligopolistic
agreements with each other, and profits tend to be high. All these elements of market structure tend
to be stable over time. However, they are all interrelated. Any change in one tends to bring about
changes in another. By realizing this relation among the different elements of market structure, it
becomes easier to understand why market structures change over time.

Conduct Conduct means what firms do to compete with each other. It includes pricing, advertising,
research and development investment, decisions on product dimensions, merger and acquisition, etc.
Conduct also can include collusion both explicit or tacit.

Performance The performance of an industry or firm is measured by profitability. Profit is the

difference between revenue and cost, and revenue is determined by price. Thus performance can be
influenced through changing costs or prices. Profitability can also be affected by a firm’s agility (i.e.
ability to adjust to things like changes in market demand). Research and development, and
availability of capitol and resources are factors that greatly influence whether or not a firm is agile.
The ability to measure performance between industries is important in understanding the SCP
relationships. For example, if an industry is dominated by one firm or cartel does not see higher costs
than a competitive industry yet has monopoly prices, then that non-competitive industry will see
higher profits, whereas if costs increase, then profitability levels will be relatively similar. This
comparison is the driving force behind anti-trust legislation. SCPP predicts that performance
increases with concentration of the industry. This is in contrast with the efficiency hypothesis that
states that a firms performance is based on how well and efficiently it produces its product for the

SCP Interaction Overview There are two competing hypotheses in the SCP paradigm: the
traditional “structure performance hypothesis” and “efficient structure hypothesis”.

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The structure performance hypothesis states that the degree of market concentration is inversely
related to the degree of competition. This is because market concentration encourages firms to
collude. This hypothesis will be supported if positive relationship between market concentration
(measured by concentration ratio) and performance (measured by profits) exist, regardless of
efficiency of the firm (measured by market share). Thus firms in more concentrated industries will
earn higher profits than firms operating in less concentrated industries, irrespective of their

The efficiency structure hypothesis states that performance of the firm is positively related to its
efficiency. This is because market concentration emerges from competition where firms with low
cost structure increase profits by reducing prices and expanding market share. A positive relationship
between firm profits and market structure is attributed to the gains made in market share by more
efficient firms, but not to the collusive activities, as the traditional SCP paradigm would suggest
(Molyneux and Forbes, 1995).

Relationship of structure to performance

Early studies by Bain (1951; 1956) hypothesized a positive relationship between industry
concentration, barriers to entry and profits. Though his studies are flawed in the measurement of
profit rates and choice of industries (Brozen 1971), later papers supported this hypothesis (Mann
1966; Weiss 1974).

However, the differential in the performance measures between concentrated and non-concentrated
industries fell substantially overtime (Brozen 1971; Hubbard and Petersen 1986). Moreover, studies
based on more recent data tend to find only a weak relationship or no relationship between the
structural variables and performance (Salinger 1984; Kwoka and Ravenscraft 1985). As a result,
some econometric studies began to look at other factors impacting industry performance. These
studies commonly found that high rates of return and industry growth are related.

Other researchers studied the structure-performance relationship using alternative measures of

performance, for example, the speed of adjustment of capital. They found that the capital-output ratio
is positively related to concentration. The explanation for this phenomena has not been verified, but
it is possible that in highly concentrated markets, there are more specialized capital which is more
difficult to adjust, thus in these markets high profits take longer to fall back to the industry average.
Similarly, if concentrated industries take longer time to react to demand changes, then, all else equal,
good economic news should raise the value of a company more in a concentrated industry than in an
non-concentrated industry (Lustgarten and Thomadakis 1980).

Relationship between structure and conduct

Conduct is influenced by market structure since firm strategies differ with competition. Inversely,
conduct can influence market structure because firms can make entry cost endogenous by choosing
different levels of quality, advertising and so on, thus affect the potential entrant number.

Relationship between conduct and performance

Conduct is related to performance. For example, advertising expenditure is usually higher in highly
profitable industries, because firms with more profits can afford higher advertising costs, and in order
to keep their profits and prevent new entrants into the profitable market, these firms would use
advertising investments as endogenous sunk costs. Econometric studies linking profit to market

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structure often conclude that measured profitability is correlated with the advertising-to-sales ratio
and with the R&D expenditures-to-sales ratio.


In essence, with the SCPP we seek to find the answer to how firms interact and compete with each
other in different situations, and the results of these interactions, and are these results consistent with
an ideal competition or not. That way, an argument can be supported on whether or not action should
be taken to alter the market structure or regulate market conduct. It is interesting there is such a
debate on the emphasis on market structure vs. market conduct on the influence of performance since
it is clear that structure and conduct are themselves influenced by each other. Joseph Bain was one of
the first to realize this and his work led to the re-evaluation of public policy that had been fostered by
the SCP framework. In industrial organization, real world, imperfect competition is studied, and
there are so many different examples that the way markets are evaluated is continually evolving and
changing. Thus every school of thought must be constantly re-evaluated as more data is generated.


Carlton and Perloff (2005), Modern Industrial Organization, 4th Edition, Pearson, Addison Wesley.

Charles C. Fisher. “What can economics learn from marketing’s market structure analysis?”.
Contribution of Marketing MSA to Economics MSA. http://www.westga.edu/~bquest

Caves, E Richard (January 1992). “American Industry: Structure, Conduct, Performance”. Prentice
Hall, 7th E. pp 3-36

Edwards, Allen and Shaik (2006), "Market Structure Conduct Performance (SCP) Hypothesis
Revisited using Stochastic Frontier Efficiency Analysis," presentation at the American Agricultural
Economics Association Annual Meeting, Long Beach, California.

Marion, Bruce. "Structure, Conduct, Performance Paradigm to Subsector Ananlysis." (1976): Print.

Michael E. Porter, Interbrand Choice, strategy, and bilateral market power (Cambridge, MA: Harvard
University Press, 1976).

Pepall, Lynne, Dan Richards, and George Norman. Industrial Organization Contemporary Theory
and Empirical Applications. 4th ed. Malden, MA: Blackwll Publishing, 2008. Print.

Valantino Piana. “Product differentiation.” http://economicswebinstitute.org/glossary/product.htm

Weiss, Leonard W. “The Structure-Conduct-Performance Paradigm and Antitrust.” Apr., 1979 pp.
1104-1140. The University of Pennsylvania Law Review. http://www.jstor.org/stable/3311794

Market structures
The common market structures studied in this field are the following:

Perfect competition
Monopolistic competition

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Areas of study
Industrial organization investigates the outcomes of these market structures in environments with

Price discrimination
Product differentiation
Durable goods
Experience goods
Secondary markets or second-hand markets, which can affect the behaviour of firms in
primary markets.
Signalling, such as warranties and advertising.
Mergers and acquisitions
Entry and Exit

A competitive market structure has the performance outcome of lower costs and lower prices,
(Shepherd, W: 1997:4).

The subject has a theoretical side and a practical side. According to one text book: "On one plane the
field is abstract, a set of analytical concepts about competition and monopoly. On a second plane the
topic is about real markets, teeming with the excitement and drama of struggles among real firms"
(Shepherd, W.; 1985; 1).

The extensive use of game theory in industrial economics has led to the export of this tool to other
branches of microeconomics, such as behavioral economics and corporate finance. Industrial
organization has also had significant practical impacts on antitrust law and competition policy.

History of the field

A 2009 book Pioneers of Industrial Organization traces the development of the field from Adam
Smith to recent times and includes dozens of short biographies of major figures in Europe and North
America who contributed to the growth and development of the discipline.[4] Chapter 9 of Tsoulfidis
summarizes neatly the evolution of thinking on competition and monopoly during last century.[5]

See also
Main article: Outline of industrial organization

Bertrand competition
Competition law
Competition policy
Cournot competition
Input-output model
Theory of the firm

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Relevant market
Important publications in industrial organization
Model of Industrial Organization

1. ^ a b c Dennis W. Carlton and Jeffery M. Perloff (2004). Modern Industrial Organization, 4th edition, pp.
2-3. Description. (http://www.lavoisier.fr/notice/frSWORK23A3RW32O.html)
2. ^ Richard Schmalensee (1987). "Industrial Organization," The New Palgrave: A Dictionary of
Economics, v. 2, p. 803.
3. ^ Jean Tirole (1988). The Theory of Industrial Organization, p. 3 (http://books.google.com
/books?id=HIjsF0XONF8C&printsec=find&pg=PA3=gbs_atb#v=onepage&q&f=false) and Part II.
4. ^ Jong, Henry W. de, and William G. Shepherd, Pioneers of Industrial Organization. Cheltenham, UK:
Elgar (2007). Description (http://www.e-elgar.com/Bookentry_DESCRIPTION.lasso?id=3125) and scroll
to chapter-preview links. (http://books.google.com/books?id=TpfrPPOFWUIC&printsec=frontcover&
5. ^ Lefteris Tsoulfidis (2009), "Competing Schools of Economic Thought”, Springer

Handbook of Industrial Organization, Elsevier:

Richard Schmalensee and Robert Willig, ed. (1989). v. 1. Links to description & contents
/description#description) & (partial) chapter outlines. (http://www.sciencedirect.com
Richard Schmalensee , ed. (1989). v. 2. Links to description & contents
/description#description) and chapter outlines. (http://www.sciencedirect.com
Mark Armstrong and Robert Porter, ed. (2007). v. 3. Links to description
(http://books.google.com/books?id=bvrn72h8dDwC) , chapter descriptions,
/description#description) chapter outlines (http://www.sciencedirect.com
_userid=10&md5=a5b1e4caee2574c6b4cc7ba37c5de3f7) , and preview.

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Cabral, Luís M. B. (2000). Introduction to Industrial Organization. MIT Press. Links to

Description (http://mitpress.mit.edu/catalog/item/default.asp?ttype=2&tid=3333) and ch. 1
(http://mitpress.mit.edu/books/chapters/0262032864chap1.pdf) , and chapter-previews.
Posner, Richard A. (2001) Antitrust Law, 2nd ed., ISBN 9780226675763 Preview.
Rubinfeld, D. L. (2001). "Antitrust Policy," International Encyclopedia of the Social &
Behavioral Sciences, pp. 553–560. Abstract. (http://www.sciencedirect.com
Scherer, Frederic M. and David Ross (1990). Industrial Market Structure and Economic
Performance, Houghton-Mifflin, 3rd ed. Description. (http://papers.ssrn.com
Schmalensee, Richard (1987). "Industrial Organization," The New Palgrave: A Dictionary of
Economics, v. 2, pp. 803–08.
Shepherd, William (1985). The Economics of Industrial Organization, Prentice-Hall. ISBN
Shy, Oz (1995) Industrial Organization: Theory and Applications. Description
(http://mitpress.mit.edu/catalog/item/default.asp?ttype=2&tid=4262) and chapter-preview
links. (http://books.google.com/books?id=tr4CjJ5LlRcC&printsec=find&
pg=PR7=gbs_atb#v=onepage&q&f=false) MIT Press.
Stigler, George J. (1983). The Organization of Industry, Description
(http://www.press.uchicago.edu/presssite/metadata.epl?isbn=9780226774329) and preview.
Tirole, Jean (1988). The Theory of Industrial Organization. MIT Press. Description
(http://mitpress.mit.edu/catalog/item/default.asp?ttype=2&tid=8224) and chapter-preview
links. (http://books.google.com/books?id=HIjsF0XONF8C&pg=PP11&lpg=PP11&
Williamson, Oliver E., ed. (1990). Industrial Organization. Edward Elgar. Description
(http://www.e-elgar.co.uk/Bookentry_DESCRIPTION.lasso?id=593) and article list.
Vives, Xavier (2001) Oligopoly Pricing: Old Ideas and New Tools. MIT Press. Description
(http://mitpress.mit.edu/catalog/item/default.asp?ttype=2&tid=8556) and scroll to chapter-
preview links. (http://books.google.com/books/mitpress?id=le-OE5HMLY8C&
Dennis Carlton, Jeffrey Perloff (2004), "Modern Industrial Organization”, 4th Edition
Jeffrey Church & Roger Ware (2005), “Industrial Organization: A Strategic Approach (aka
IOSA (http://homepages.ucalgary.ca/~jrchurch/page4/page4.html) )”, Free Textbook
Nicolas Boccard (2010), "Industrial Organization, a Contract Based approach (aka IOCB
(http://iocb.info) )”, Open Source Textbook


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Industrial organization - Wikipedia, the free encyclopedia http://en.wikipedia.org/wiki/Industrial_organization#Structur...

International Journal of Industrial Organization (http://www.elsevier.com/wps/find

/journaldescription.cws_home/505551/description#description) and issue-preview links
Journal of Industrial Economics (http://www.wiley.com/bw/journal.asp?ref=0022-1821) and
issue-preview links. (http://onlinelibrary.wiley.com/journal/10.1111/(ISSN)1467-6451/issues)
Journal of Law, Economics, and Organization (http://jleo.oxfordjournals.org/) and issue-
preview links. (http://jleo.oxfordjournals.org/content/by/year)
Review of Industrial Organization (http://www.springer.com/economics
/industrial+organization/journal/11151) and issue-preview links. (http://www.springerlink.com
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