1. Flashcards
What do we assume about knock on effects to other markets?
The can be ignored, partial equilibrium analysis
What does d=0 mean?
The goods are independent
What does d>0 mean?
The goods are substitutes
What does d<0 mean?
The goods are complements
What is a way of thinking about consumer surplus?
The extra income needed to compensate consumers for not being able to buy goods
Assumptions of perfect competition
-homogeneous goods
-attempt to max profits
-firms are price takers
-free entry and exit (at least in the LR)
In perfect competition what is average revenue equal to?
Marginal revenue and price
What does the shape of the LR market supply depend on in perfect competition?
How the expansion/ contraction of the industry affects the firms’ cost curves
What is a constant cost market?
-change in market supply has no effect on costs
-LR market supply curve is horizontal
What is an increasing cost market?
-increase in market supply leads to increase in costs
-LR market supply curve upward sloping
What is a decreasing cost market?
-increase in market supply leads to decrease in costs
-LR market supply curve is downward sloping
Is the LR equilibrium for perfect competition efficient?
-P=MC (allocative efficiency)
-firms produce at min(AC) (productive efficiency)
Assumptions of monopoly
-firm serves whole market
-barriers to entry
-firms make economic profit in LR
How do you mathematically find the profit maximising quantity a monopoly chooses?
Differentiate the profit function wrt q and set equal to zero to get the FOC. Solve to find q*. Check SOC condition is less than zero to prove it is a maximising point
What determines the size of the price- marginal cost mark up in a monopoly?
The elasticity of demand. The less elastic demand is, the higher the mark up
What is the Lerner Index?
The difference between price and marginal cost as a % of the price. It is 1/ elasticity of demand
How would a multi plant monopoly pick a quantity that maximises profit?
Set MR=MC1=MC2
Equalise MC across the plants
Two part tariff
Where there is a purchase of a base product and also complementary services for an extra fee
How should a monopolist set price to maximise profit in a two part tariff?
Set price to maximise SW then set access fee to extract all SW as profit
Why might a two part tariff not be equivalent to perfect discrimination in reality?
In practice, consumers may be heterogeneous and it isn’t possible to charge different prices to different consumers
Oligopoly
Few producers of a good who set their own price
Nash equilibrium
A set of strategies, one for each player, such that each player is maximising its payoff given the other player’s strategies
When should a cournot model be used?
When firms simultaneously choose quantities to set
When will a corner equilibrium occur in a cournot duopoly?
When firm 2’s MC is greater than firm 1’s monopoly price
When is stackelberg used?
When firms compete over quantity but one firm moves first
Subgame perfect nash equilibrium
Requires each player’s strategy maximises their payoff given the strategy of others in every subgame
What does SPNE rule out which NE doesn’t?
Unreasonable equilibria that relies on incredible threats
How does a first mover’s payoff in the stackelberg model compare to when firms move simultaneously
First mover always gets the same or better payoff as it does in a simultaneous game
How does the payoff of being a follower in a stackelberg game compare to a simultaneous game?
May be better or worse depending on structure
What is a natural moving order?
Where one firm prefers moving first snd the other prefers moving second
How do subsidies in international trade benefit the domestic firm?
In essence, the gov’s prior action in setting a subsidy changes the domestic firm’s set of credible actions in the output rivalry
What happens in the Brander and Spencer model if both governments decide to use subsidies?
They settle on the same equilibrium subsidy
How could both countries benefit more in the Brander and Spencer model?
If they agreed to set a negative subsidy (ie an export tax) then domestic welfare would be maximised
When is the Bertrand model used?
When firms choose prices simultaneously
What is the equilibrium outcome in a Bertrand model with constant per unit costs?
All firms produce at P=AC
When is there likely to be many equilibria in a Bertrand model?
When costs per unit are increasing and identical firms charge a common price
What is an important feature of Bertrand models?
They are demand determined, so once a firm commits to a price it must serve as many units as customers demand at that price
What do we assume about consumers in the Bertrand model with uninformed consumers?
Informed consumers know prices on offer and buy from cheapest firm as long as it is less than their reservation price.
Uninformed consumers choose firm as random as long as price is less than their reservation price
Why doesn’t an equilibrium unravel to P=MC=AC in the Bertrand model with uninformed consumers?
Because p=MC=AC is a strictly dominated strategy. You can guarantee a positive profit from charging the reservation price
What is a property of a mixed strategy?
Any price used in equilibrium must yield the same expected payoff otherwise a firm would increase its payoff by using the more profitable prices more frequently
When will the Bertrand paradox not hold?
When consumers are uninformed
When there is product differentiation
When per unit cost rises with quantity
How do prices compare when modelling efficiency, collusion, quantity competition and price competition in a model with product differentiation?
Order of price lowest to highest
1. Efficiency
2. Price competition
3. Quantity competition
4. Collusion
What are strategic substitutes?
Where the reaction functions of two products slope downwards
What are strategic compliments?
Where the reaction functions of two products are upwards sloping
What does the price-MC mark up depend on in the model of price competition with product differentiation
The degree of product differentiation and the type of competition
What is Bellefamme and Peitz’s general lesson about quantity leadership of substituable goods?
At the SPNE the leader enjoys a first mover advantage. The leader is better off and the follower is worse off than at the NE of the cournot game
What is Bellefamme and Peitz’s general lesson about price leadership of substitutable goods?
At the SPNE at least one firm has a second mover advantage
What happens when firm 1 can set a subsidy but firm 2 can’t and they compete in prices?
The gov will place an export tax on firm 1 since the gain in tax revenue will outweigh the loss in profit for firm 1
What happens when both governments can use subsidies and firms can compete on prices?
Both governments use an export tax
What happens to equilibrium quantities and prices at the LR equilibrium compared to the SR?
They are the same but evaluated at n=n^LR
Is a traditional cournot LR equilibrium with constant average costs efficient?
Yes
When there is a fixed cost in the cournot model what is the efficient outcome?
In the efficient outcome only one firm operates. However in reality this firm will operate as a monopolist
Describe the LR equilibrium for a cournot model with fixed costs
The equilibrium isn’t efficient
-allocative inefficiency: P>c
-productive inefficiency: same output could be made more cheaply by one firm
When does restricting the number of firms that are allowed to enter in the LR version of the cournot model give a more efficient outcome?
When there are fixed costs
Characteristics of monopolistic competition
-many firms producing differentiated products
-firm faces downward sloping demand
-firm ignores strategic interdependence (is a price taker)
-free entry/exit
What was chamberlain’s theory on the monopolistic LR equilibrium?
The market is allocatively inefficient because p>MC and productively inefficient because firms operate on downward sloping part of the AC curve. Too many firms producing too little each
What do Spence,Dixie, and Stiglitz (SDS 1977) do to challenge chamberlains view?
They explicitly incorporate a preference for variety into the model of monopolistic competition
What are the assumptions of SDS model?
-Firms produce with fixed costs and constant marginal costs
-A representative consumer whose demand for products reflects the outcome of utility maximisation
-A consumer who is indifferent between two products prefers a mix
What affects how the monopolistic market solution compares to the optimal solution?
It depends on elasticities of substitution between commodities within the group and with other commodities outside the group
In a monopolistic model if the “row” is larger what does that mean?
It means the varieties are closer substitutes
In a monopolistic model what causes more firms to enter in the long run?
When the consumer allocated more income to differentiated goods, when varieties are substitutes, and when fixed costs are low
In the SDS model what do we find out about the number of firms in the market in the long run?
The equilibrium number of firms in absence of lump sum tax is less than the optimal number
What are endogenous sunk costs?
This is where firms incur fixed costs and sunk costs when they enter a market with a view to improving their competitive positions in the market
What are examples of endogenous sunk costs?
R&D designed to reduce costs or improve product quality, advertising to increase demand for the product
What does vertical product differentiation mean?
Where some goods are of highly quality than other
What are the 3 stages of the quality augmented cournot model?
- Firms choose whether to enter. If a firm enters, it costs e
- Knowing n, firms simultaneously choose qualities
- Knowing n and s1, …, sn firms simultaneously choose quantities
How might a market develop the property of being a natural oligopoly?
For positive profit to occur there may be an upper bound on the number of firms who can be within the market, so only a small number of firms can be sustained independent of market size
Why do firms invest more in quality as the market becomes bigger?
The market becomes more valuable so firms invest more in quality giving each firm a better position at the quantity competition stage
Examples of strategic commitment
-investing in cost reducing technology
-investing in capacity
-spending on advertising
-public announcement
In a strategic commitment, what must be true about firm 1’s choice?
It must be irreversible and observable
What are direct and strategic effects on profit?
-direct: eg cost of R&D, lower production costs
-strategic: through the impact on rivals decision
What are strategic substitutes and complements?
-subs: the rivals BR is decreasing in the firms action (rival does the opposite)
-complements: the rivals BR is increasing in the firms action (rival does the same)
What are tough and soft commitments?
Tough commitments hurt the rival
Soft commitments help the rival
How does strategic investment compare to the non strategic investment benchmark where firm 1’s decision isn’t observed by firm 2?
In the strategic case, firm 1 over invests to become “top dog”. In general, firms should over invest in tough commitments when actions are strategic substitutes
What is the strategic incentive to invest if actions are strategic complements and tough commitments?
The incentive is to under invest since this will induce tough responses which isn’t good for firm 1
What will be the SPNE of a finitely related game?
The unique NE of the stage game is if it has one
What are the two general results for payoffs in an infinitely repeated game?
- The infinitely repeated game has a SPNE where the NE of the stage game is repeated in every stage
- There are many other SPNE. In particular if delta is sufficiently close to 1 the joint payoff maximising outcomes can be attained in a SPNE (Folk theorem)
How does the benefit of collusion and deviating compare in repeated games for price and quantity competition?
Compared to quantity competition, under price competition the benefit of collusion is larger, but so is the temptation to deviate
When n=2 and using grim trigger strategies, is it easier to sustain collusion in price or quantity competition?
In price competition
Stick and carrot strategies
This allows players to go back to cooperation after a deviation from cooperation but only after some punishment
In stick and carrot strategies what do we need to check to see if we have an equilibrium?
Punishment is credible
Collusion is optimal
What is a cartel?
A group of agents who act together, often to fix price, restrict output, or engage in other policies to coordinate decisions and limit competition
What are the two stages in the two stage model of cartels?
Each firm decides simultaneously whether to join the cartel.
Firms compete. Firms in the cartel max cartel profits and independent firms max their own profits
What must there be for an equilibrium to hold in a cartel?
Internal stability- a cartel must make at least as much profit as it would have had it stayed independent
External stability- an independent firm must make as least as much profit as it would have had it joined the cartel
What are the results of a cournot model for running a cartel?
A cartel is stable for just two firms in the industry but unstable if there are any more than two firms in the industry
What might make cartels easier to sustain?
-firms compete in prices
-firms produce differentiated goods
-firms make bilateral market sharing agreement
What is an empty market?
Where firms in a market have no market sharing agreements
What must be true for a stable market sharing network to hold?
No pair of firms have an incentive to form a new link. No firm has an incentive to unilaterally destroy an existing link
When are partially collusive networks stable?
Never. It can be shown that if a firm has any links, it must be a monopolist in its local market for the network to be stable. Thus if there are any links in the network it must be a complete set of links to be stable
Are cartels always bad for consumers?
No. When goods are complements, forming a cartel to max joint profits may produce a lower price than had the firms competed normally
Are mergers always good for the merging firms and bad for rival firms?
No. Mergers are only profitable between multiple firms for cournot competitors if a highly concentrated market results
Why are mergers profitable under price competition but not quantity competition?
- under price comp quantities are strategic substitutes, while under price comp prices are strategic complements
How might a merger actually increase social welfare overall?
If the merger causes increased efficiency so that cost saving means the increase in producer surplus is greater than the loss in consumer surplus
Vertical mergers
Mergers between firms operating at different levels of a vertical supply chain
What is an alternative solution to the double mark up problem If vertical integration isn’t possible?
Producer offers retailer a contract specifying a price per unit and fixed fee.
How is output, price, profits and consumer surplus affected by a vertical oligopoly merger?
Output is higher after merger, retail price is lower, consumers are better off and profits increase for merging firms
Input foreclosure
Where vertically integrated form has substantial market power in the upstream market, it may be able to restrict supply to downstream suppliers
Customer foreclosure
Where a vertically integrated firm with substantial downstream market power may restrict ability of rivals to supply downstream market.
In monopolistic competition how does average cost vary with the number of firms in the market?
If number of firms increases then so does average cost
In monopolistic competition how does price vary with the number of firms in the market?
As number of firms increases, the price decreases
How does an increase in the market size affect monopolistic firms in the short run?
Number of firms is fixed
Price is fixed
Each firms enjoys increased sales
Produces at lower AC
Profits per unit increases
Profit increases
How does an increase in the market size affect monopolistic firms in the long run?
New firms enter
Price falls
Higher AC
Until there is zero profit
There will be higher output per firm
How does the number of firms in an integrated market compare to before integration?
Number of firms in integrated market is less than number of firms previously in both markets combined
How does the individual output of a firm compare in an integrated market compared to before?
Each firm in the integrated market sells more than in either separate market
What are the benefits of an integrated market for consumers?
Firms operate at lower AC so prices are lower and consumers have more variety of products
