9. Market structure and imperfect competition

Question 1

An imperfectly competitive firm faces a downward-sloping demand curve. Its output price reflects the quantity of goods it makes and sells.

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Question 2

An oligopoly is an industry with few producers, each recognizing their interdependence.

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Question 3

An industry with monopolistic competition has many sellers of products that are close substitutes for one another. Each firm has only a limited ability to affect its
output price.

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Question 4

A natural monopoly enjoys such scale economies that it has no fear of entry by
others.

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Question 5

Minimum efficient scale is the lowest output at which a firm’s LAC curve stops falling.

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Question 6

The N-firm concentration ratio is the market share of the largest N firms in the industry.

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Question 7

Globalization is the closer integration of markets across countries.
Multinationals are firms operating in many countries simultaneously.

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Question 8

In monopolistic competition, in the long-run tangency equilibrium each firm’s demand curve just touches its AC curve at the output level at which MC equals MR. Each firm maximizes profits but just breaks even. There is no more entry or exit.

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Question 9

Collusion is an explicit or implicit agreement to avoid competition.

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Question 10

A game is a situation in which intelligent decisions are necessarily interdependent.

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Question 11

A strategy is a game plan describing how a player acts, or moves, in each possible situation.

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Question 12

In Nash equilibrium, each player chooses the best strategy, given the strategies being followed by other players.

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Question 13

A dominant strategy is a player’s best strategy whatever the strategies adopted by rivals.

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Question 14

A commitment is an arrangement, entered into voluntarily, that restricts future actions.

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Question 15

A credible threat is one that, after the fact, is still optimal to carry out.

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Question 16

A firm’s reaction function shows how its optimal output varies with each possible action by its rival.
In the Cournot model, each firm treats the output of the other firm as given.
In the Bertrand model of oligopoly, each firm treats the prices of rivals as given.
In The Stackelberg model, firm B can observe the output already fixed by firm A. In choosing output, firm A must thus anticipate the subsequent reaction of firm
B.
A first-mover advantage means that the player moving first achieves higher payoffs than when decisions are simultaneous.

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Question 17

A contestable market has free entry and free exit.

An innocent entry barrier is one not deliberately erected by incumbent firms.

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Question 18

A strategic move is one that influences the other person’s choice, in a manner favorable to oneself, by affecting the other person’s expectations of how one
will behave.
The Strategic entry deterrence is behavior by incumbent firms to make entry less likely.

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Question 19

Imperfect competition exists when individual firms believe they face downward-sloping demand curves. The most important forms are monopolistic competition, oligopoly and pure monopoly.

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Question 20

Pure monopoly status can be conferred by legislation, as when an industry is nationalized or a temporary patent is awarded. When minimum efficient scale is
very large relative to the industry demand curve, this innocent entry barrier may be sufficiently high to produce a natural monopoly in which all threat of entry can be ignored.

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Question 21

At the opposite extreme, entry and exit may be costless. The market is contestable, and incumbent firms must mimic perfectly competitive behavior to avoid being flooded by entrants. With an intermediate size of entry barrier, the industry may be an oligopoly.

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Question 22

Monopolistic competitors face free entry to and exit from the industry but are individually small and make similar though not identical products. Each has limited monopoly power in its special brand. In long-run equilibrium, price equals average cost but exceeds marginal revenue and marginal cost at the tangency equilibrium.

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Question 23

Oligopolists face tension between collusion to maximize joint profits and competition for a larger share of smaller joint profits. Collusion may be formal,
as in a cartel, or informal. Without credible threats of punishment by its partners, each firm faces a temptation to cheat.

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Question 24

Game theory analyses interdependent decisions in which each player chooses a strategy. In the Prisoner’s Dilemma game, each firm has a dominant strategy. With binding commitments, both players could do better by guaranteeing not to cheat on the collusive solution.

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Question 25

A reaction function shows one player’s best response to the actions of other players. In Nash equilibrium reaction functions intersect. No player then wishes to change her decision.

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Question 26

In Cournot behavior each firm treats the output of its rival as given. In Bertrand behavior each firm treats the price of its rival as given. Nash– Bertrand equilibrium entails pricing at marginal cost. Nash–Cournot equilibrium entails lower output, higher prices and profits. However, firms still fail to maximize joint profits because each neglects the fact that its output expansion hurts its rivals.

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Question 27

A firm with a first-mover advantage acts as a Stackelberg leader. By deducing the subsequent reaction of its rival, it produces higher output, knowing the rival will then have to produce lower output. Moving first is a useful commitment.

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Question 28

Innocent entry barriers are made by nature, and arise from scale economies or absolute cost advantages of incumbent firms. Strategic entry barriers are made in boardrooms and arise from credible commitments to resist entry if challenged. Only in certain circumstances is strategic entry deterrence profitable for incumbents.

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