Traditional market structure analysis (described in the previous three chapters) appears deceptively simple. Begin by ascertaining the structure of the industry in which a firm operates. (Is it competitive, monopolistic, monopolistically competitive, or oligopolistic?) This market structure almost is assumed to rigidly determine each firm's conduct (output decisions and pricing behavior), which yields an industry's overall performance (e.g., its efficiency and profitability). This approach called the structure-conduct-performance paradigm (S-C-P theory), is outlined in Figure 1.
Traditional S-C-P theory dictates three steps in analyzing an industry. First, it emphasizes properly categorizing an industry's market structure according to (a) the number of active competitors, (b) barriers to entry and exit, and (c) the extent of product standardization. Second, conventional models conclude that certain pricing and output decisions (conduct) predictably arise from market power or its absence. (Sparse competition, barriers to entry, or product heterogeneity create market power.) Finally, this theory suggests that the equilibrium price of any imperfectly competitive firm invariably exceeds marginal social cost; too little of the good is produced, creating allocative and productive inefficiencies.
Movement along the continuum of market structures from monopoly toward pure competition appears to yield more efficient resource allocations. Consequently, the structure-conduct-performance approach suggests that government policy to cure problems of industrial organization is straightforward---outlaw monopolies or near monopolies where possible, while tightly regulating market power that arises from economies of scale.
Thus, the S-C-P approach indicates that competition is the most efficient structure for an industry, and unregulated monopoly, the least. According to the theory of contestable markets, however, business tactics are not determined by structure alone. But antitrust policy is intended to diffuse market power, as is much of the economic regulation of business. Before we consider antitrust and regulatory policies in depth, we will examine the current structure of U.S. industry and discuss some implications for the economic performance of the hundreds of thousands of firms in our economy.