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Teaching notes for chapter 3

As a first-order approximation, one may say that IO focuses primarily on competition between firms, placing relatively little weight on the internal workings of each firm. In particular, from the point of view of strategy, IO suggests how firms may improve their situation as a result of actions with respect to rivals, not so much actions with respect to its internal organization.

The somewhat narrow focus of IO is not a bad thing in and of itself: the effectiveness of every partial science results precisely from the fact that they are partial and are thus able to tackle a particular issue in depth. However, this is a limitation that should be duly acknowledged: there is more to the world of firms and markets than IO addresses.

This chapter highlights three aspects in which the IO view of the firm has to be taken with caution. First, IO assumes that firms behave as profit maximizers. Second, IO takes the limits of the firm--in fact, the very existence of firms--as exogenously given. Third, IO has little to say about why firms are different--other than to assume it. This chapter is therefore included in the introductory part of the book not because its contents are used later on. Rather, the idea is to help the student put the later chapters in their proper context.

The statement at the beginning of the first paragraph is perhaps a little too strong. Many IO economists have recently devoted themselves to studying the theory of the firm, one of the fastest growing areas of microeconomics. In fact, several schools now offer courses on the theory of the firm. When this is the case and students have taken or will take a course on the theory of the firm, the discussion of this chapter may be reduced or omitted.

Moreover, it is increasingly common for IO courses (or microeconomics courses with an emphasis on IO) to delve into issues of the theory of the firm, in particular the vertical boundaries of the firm. In that case, it may be worth to join together the discussion of Section 3.2 (what determines the size of the firm?) and that of Chapter 11 (vertical relations).

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