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This book is accompanied by an Online
Resource Centre, which includes:
For students: essay questions. links to
useful websites, historical timelines
For registered adopters of the text:
Scientific Workplace slides, instructor
manual
OXFORD ISBN 978-0- 19-929 119-9
UNIVER ITY PRESS
9 780199 291199
WW\-.Y.oup.com
IN CONTEXT
STEPHEN MARTIN
OF ECONOMICS PURDUE UNIVERSITY
DEPART~1ENT
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OXFORD
UNI\1ERSITY PRESS
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OXFORD
UN IVERS I TY PRESS
Great Clarendon Street, Oxford ox2
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It furthers the University's objective of excellence in research, scholarship,
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Oxford is a registered trade mark of Oxford University Press
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in the UK and in certain other countries
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Published in the United States
\ by Oxford University Press Inc., New York
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I ©Stephen Martin 2010
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The moral rights of the authors have been asserted
Database right Oxford University Press (maker)
First published 2010
All rights reserved. No part of this publication may be reproduced,
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stored in a retrieval system, or transn1itted, in any form or by any means,
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Oxford University Press, at the address above
You must not circulate this book in any other binding or cover
and you must impose the same condition on any acquirer
British Library Cataloguing in Publication Data
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Library of Congress Cataloging in Publication Data
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Typeset by MPS Limited, A Macmillan Co1npany
Printed in Great Britain
on acid-free paper by
Ashford Colour Press Ltd, Gosport, Hampshire
••
ISBN 978-0-19-929119-9
1 3 5 7 9 10 8 6 4 2
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PREFACE
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©
Stephen Martin 2008
Throughout Pareto's presentation of a paper at a seminar in Geneva, the
institutional economist Gustav Schmoller muttered from the audience
"There are no economic laws." Pareto and Schmoll er were not otherwise
acquainted, and Pareto was a shabby dresser. Seeing Schmoller on the
'
street the next day, Pareto pretended to be a beggar and went up to him,
asking "Please, sir, can you tell me where in Geneva I can find a good
restaurant where I can eat for free?" Schmoller replied "My good man,
there are no such restaurants, in Geneva or elsewhere, but I can show you
where you can have an inexpensive meal." At this, Pareto threw off his
cloak and said triumphantly, as he walked away, "So there are economic
laws!n
Source: Based on Livingston (1935, p. xviii).
1 Principles of the Book
There are a few general principles that guide the organization of m aterial in this
book.
0 11e is that tl1ere are economic laws.
Another is that we don't really understand where we are unless we understand
how \.Ye got here. Tl1ere is thus ratl1er more economic history and, in som e places,
histor}' of eco1101nic thougl1t, in tl1is book than migl1t be expected.
A tl1ird is that n1arkets work, a11d imperfect markets work imperfectly. Policies
tl1at \Vill bring desirable results if applied to perfectly co1npetitive 1narkets m ay
bring quite undesirable results if applied to imperfectly com petitive m arkets.
A fourth is tl1at it is equilibriun1 conduct, wl1ich depends on m arket structure,
that deterrn ines r11arket perfor1nance and, by feedback relationships, equilibrium
m arket structure. Go\ ernme11ts cannot, by legislation, induce firms to depart
1
fro1n value-111axin1izing bel1avior. Govern1nents can, by institutional design,
alter i11centives so t11at firms' eqt1ilibriun1 condt1ct ch anges. Such ch an ges 1nay
in1prove or worse11 111arket perfor1nance.
A fi fth is tl1at institutions 1natter; t11is is one of the lessons of experi1nental
economics. Bt1t institt1tions are not all tl1at 1natters. It is not the case that books
are differe11t fron1 all otl1er industries because tl1ey are vehicles of culture, that
soft'\-vare is different from all other i11dt1stries because it is high tech , that aircraft
111anufacture is differe11t fron1 all other industries becat1se it involves n ation al
security, and so 011, partridge, pear, tree. Not o nly are tl1ere are economic laws,
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vi
PREFACE
but there arc ge11eral ccor10111ic la\\'S, C\'Cn tl1ougt1 a ger1eral economic la\v n1ay
1
not cover tl1~ \Vhole tl1ec>ry f>f a J>artict1lar casl,.
2 Thanks
I tl1ank several col1orts of stu,lents at tl1c Copcnl1agen llusir1es~ Sct1o<»I, the Uni
versity of Amstcrdan1 a11d Purdt1c University, who \Vere tl1c tcsti11g grour1d for
early \ ersions of n1ucl1 of tl1e n1aterial tl1at a1>pears l1crc. I thar1k tl1e librari~s at
1
Purdtte University and partict1larly its Ir1tcrlibrary Loa11 division. I thank Cl1arles
J.
Parker for clarification of tl1e 1netl1odology of Gallo et c1/. (20(){)), arid ·ra11r1ic;ta
l Banerjee, Rostisla\' Bogoslovskiy, an(l Do-Ye11n Park for researcl1 assistance. I an1
I
grateful for con1111cnts received fro111 Bruce 1·. Allen, Ta1111ista Bar1crjee, Jan1es
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Brock, Stephen Oa\1ics, Bruce Lyo11s, Hans-'fl1eo Norrnan11, at BiGSEM (Ur1iver
sit}1 of Bielefeld, Gern1any), at tl1e U11iversita (legli Stt1di di Leccc, Italy, from
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anonymot1s revie'rvers, a11d particularly grateft 1l to Jol111 Scott for careful corn
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ments on Cl1apters 14, 15, and 25. I tl1a11k ·rorste11 Scl11nidt for providing n1e
I J.
ith n1aterial related to 1\t1spitz and Lieben (1889). I thank Victor 'frernblay and
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Carol Horton Tremblay for providing data frorn and Trernblay (2005),
I l~re1nblay
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and ~ifary Raetz for providing sttpplernental data associated witl1 the 2008 Global
I an1 t1ncornmonly grateful to the Department of Managerial
i\farket Data Book.
Econon1ics, Stratehry and Innovation at tl1e Katholieke Universiteit Leuven for
hosting a visit during the first six n1ontl1s of 2009 that allowed me to complete
the book.
This book is dedicated to Linda.
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As ~1111 ( l 86ql \vrot~ of l "llornton ( 1870) In u·spon'l' to 1 hornt1>1i\ r l;llru to 11,1 dhp••" cd t ltr
La\\' ot l)l·111J nd .ind Supply.
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CONTENTS
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1 Introduction
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t 5,3 N ·ons 11
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P. . \RT I Basic A\odels
2 Basic ,\\arket
.\~odels 17
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CONTENTS
32
2.3.3 Measuring Market Performance
34
2.3.4 Lerner Index of Market Power
35
2.3.5 Single Supplier with Possible Entry
37
2.3.6 Rent Seeking and Other Costs of Market Power
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I 2.4 Evidence From Laboratory Markets
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2.4.1 Background
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2.4.2 Experimental Market Demand and Supply
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2.4.3 Double Auction Competitive Markets
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2.4.4 Posted-offer Competitive Markets
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2.4.5 Double Auction Monopoly Markets
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2.4.6 Posted-offer Monopoly Markets
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2.5 Evidence from Naturally Occurring Markets
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2.5.1 Deadweight Loss and Rent Seeking
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2.5.2 Rent Sharing
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2.5.3 Inefficiency
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2.5.4 Distributional Effects
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Summary
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Study Points
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Further Reading
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Problems
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3 Oligopoly I: Basic Models
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3.1 Introduction
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3.2 Cournot Oligopoly
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3.2.1 The Basic Model
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3.2.2 Best-response Functions
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3.2.3 Cournot Equilibrium
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3.2.4 Cost Differences
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3.2.5 Conjectural Variations
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3.2.6 Many Firms
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3.3 Bertrand Duopoly
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3.3.1 Standardized Product
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3.3.2 Contestable Markets
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3.3.3 Differentiated Products
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3.4 Cournot and Bertrand Compared
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3.5 Markets with Consumer Search
85
3.5.1 Setup
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3.5.2 Equilibrium
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3.5.3 Extensions
86
3.5.4 The Incidence of Search in Markets for Perishable Goods
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3.6 Switching Costs
90
3.7 Network Externalities
90
3.7 .1 Direct, Indirect
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3.7 .2 Strategic Possibilities
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3.8 Platform Markets
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3.8.1 A Stylized Model of the Market for Credit Cards
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Summary
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Study Points
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CONTENTS IX
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Further Reading
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Problems
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4 Oligopoly II: Address Models
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4.1 Introduction 99
4.2 Spatial Oligopoly 99
4.2.1 The Emperors of Ice Cream 100
4.2.2 Main Street 103
4.2.3 Ringworld 108
4.3 Vertical Product Differentiation 114
4.3.1 Setup 114
4.3.2 Demand 116
4.3.3 Equilibrium 117
4.3.4 Quality Downshifting 117
4.4 Horizontal and Vertical Product Differentiation
Compared 118
Summary 118
Study Points 119
Further Reading 119
Problems 119
5 Oligopoly Ill: Evidence 121
5.1 Introduction 121
5.2 Evidence from Laboratory Markets 122
5.2.1 Cournot Markets 122
5.2.2 Bertrand Markets 122
5.2.3 Contestable Markets 123
5.2.4 Search Markets 125
5.3 Evidence from Naturally Occurring Markets 126
5.3.1 Barriers to Entry 126
5.3.2 Determinants of Entry Conditions 130
5.3.3 Industry Studies (Mostly) 153
5.3.4 Firm-level Evidence 164
5.3.5 Price 171
5.3.6 Persistence of Profit 174
Summary 176
Study Points 177
Further Reading 177
PART 11 Conduct
6 Collusion: Economics 179
6.1 Introduction 179
6.2 Tacit Collusion 179
6.2.1 Trigger Strategy 180
6.2.2 Uncertainty 183
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CONTENTS
6.3 Collusion 1E6
186
6.3.1 Collusion Cost
.. 3 .,
(), ..... llle~al Collusion 1~6
6.4 FJctors Affecting Cartel Stability 18S
6.-l.1 Factors
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6.5 Cartels in Practice \03
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6.5., 15th-century European Alum 10~
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6.5.3 19th-century British Pin lndustr)' Price Associations \C5
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6.5.4 Pre--Shennan Act U.S. Railroad Cartels
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6.6 The of Collusion
Eff~cts
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6.6.2 On Structure 2t 2
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