Technology and Market Structure: Theory and History.

• Author: Vahaly, John
• Position: Review

By John Sutton.

Cambridge, MA: MIT Press, 1998. Pp. xv, 676. $55.00.

John Sutton's study of technological change is an ambitious, rich, and important work. Changing focus from his 1991 book on advertising and market structure, Sutton's attention here is on technological change as a determinant of market structure. The book's contribution is a fresh application of game theory to the interactions of technological change, economic history, and market outcomes. The undertaking even requires 140 pages of mathematical and descriptive appendices!

The book is organized into three parts. Part One presents Sutton's study of market entry utilizing a stage-game theory. Entry is analyzed utilizing an escalation parameter alpha ([alpha]). Alpha is a ratio of the profitability for a new entrant relative to current expenditures on research and development (R&D) by existing firms or "a measure of the extent to which a firm that outspends its rivals on R&D can thereby raise [demand]" (p. 63).

Sutton uses a simple lottery analogy to show how [alpha] can lead to structural insights. The profit earned by a high R&D spending firm may "be diluted indefinitely by the presence of a sufficiently large number of low-spending rivals" (p. 71). As with a lottery ticket, the expected payoff in such instances can be too small to warrant action. In low [alpha] industries, "a high entrant cannot achieve a profit exceeding some fixed proportion of current industry sales independently of the number of low-spending rivals" (p. 71). The opposite is the case in high-[alpha] industries, which is illustrated by Sutton's history of the color film industry.

The effectiveness of R&D escalation, and therefore the value of alpha, depends on two factors: (i) the effectiveness of R&D spending on increasing demand (willingness to pay). If R&D spending is ineffective in raising demand, R&D intensity is necessarily low, and (ii) the strength of linkages between different R&D "trajectories" and their associated submarkets. For industries with high R&D/sales ratio, R&D effectiveness should be high. Whether this leads to a relatively high level of concentration depends on the strength of the linkages between submarkets.

Key also is Sutton's bounds approach to analyzing the link between technology and market structure. Economics is...