Industrial Organization and Competitive Strategy Essentials

Posted on Jun 24, 2026 in Economy

Topic 0: Economic Primer

Cost Definitions: TC = FC + VC. Fixed costs remain constant in the short run; variable costs fluctuate with output. Sunk costs are unrecoverable and should be ignored in decision-making.
Key Metrics: AC = TC/Q; MC = dTC/dQ (slope of TC).
Time Horizons: Short run (fixed capacity); Long run (variable capacity, entry/exit possible).
Elasticity: %ΔQ/%ΔP. High elasticity indicates price sensitivity; low elasticity indicates price insensitivity.
Monopoly: TR = P·Q; Profit maximization occurs where MR = MC.

Economies of Scale: As Q increases, AC decreases. The Minimum Efficient Scale (MES) is the output level where AC is minimized.
Diseconomies of Scale: AC increases after passing the MES.
Economies of Scope: C(A+B) < C(A) + C(B).
Learning Curve: Cumulative output increases lead to lower AC due to experience.

Make vs. Buy: Buy when suppliers offer scale, learning, or specialization. Make to avoid coordination problems, information leakage, hold-up risks, or double marginalization.
Hold-up Problem: Occurs when relationship-specific assets are involved, leading to renegotiation risks.
Double Marginalization: Occurs when both upstream and downstream firms apply markups, leading to inefficiently high final prices. Vertical integration resolves this.

Concentration Metrics: CR_N (share of N largest firms) and HHI (sum of squared market shares).
HHI Thresholds: < 0.2 (Perfect/Monopolistic Competition); 0.2–0.6 (Oligopoly); > 0.6 (Monopoly).
Pricing Power: PCM/Lerner Index = (P−MC)/P = 1/|Elasticity|.
Models: Bertrand (price competition, P=MC for homogeneous goods); Cournot (quantity competition).
Cournot Formulas: Demand P = A − bQ. Reaction: qi(qj) = (A−c)/(2b) − qj/2.

Hotelling Model: Differentiation softens price competition. Equilibrium: pA*=pB*=c+t.
Salop Model: p*=c+t/n; πi*=t/n²; free entry n*=√(t/F).
Price Discrimination: Requires distinct groups, varying elasticities, and no arbitrage. Third-degree discrimination targets less elastic groups with higher prices.

Cooperation: Sustainable if future punishment outweighs short-run gains.
Condition: r ≤ 1/(n−1).
Facilitating Factors: Few firms, identical products, transparent pricing, and frequent small orders.

Entry Strategy: Enter if expected post-entry profits exceed sunk costs.
Strategic Commitment: Visible, credible actions that alter future incentives.
Asymmetric Cournot: Entry is deterred if qE* ≤ 0, where qE* = (A+cI−2cE)/(3b).

Porter’s Five Forces: Internal rivalry, threat of entry, substitutes, supplier power, and buyer power.
Two-Sided Platforms: Optimal pricing considers participation elasticity and cross-side network effects.

Value Creation: Value = B − C. Price divides value but does not create it.
Strategies: Cost advantage (lower C) vs. Benefit advantage (higher B).
Isolating Mechanisms: Patents, scale, history dependence, and causal ambiguity protect competitive advantages.