all Flashcards
perfect comp characteristics
atomistic - large number of buyers and seller
homogenous product
perfect knowledge
no collaboration
free to leave and enter a market
oligopoly characteristics
- Large buyers => small producers
- May have perfect information
- Identical or different products
- firms interact and make decisions based on others in order to max profits
- some barriers
oligopoly topology
Cournot Model:
OUTPUT
- Each firm picks a level of output based on assumption other firm output is fixed
e.g. airlines decide number of flights then charge based on WTP
Bertrand Model:
PRICES
- Firms pick price level that maxes profits assuming other firms prices are fixed
Cournot Model Assumptions
- Homogenous product
- Duopoly, only two firms operate
- Identical cost structure
- Each firm sets its own output (Q) to max profit given other output
- Each firm treats others output as fixed when making its own output decision
Zero Conjectural Variation Assumption (ZCVA)
Expected change output in Firm when firm A changes output
QeB/QA = 0, QeA/QB= 0
Isoprofits
- Show all combos of Qa and QB which produce identical profits for a firm
- Concave to axis
- Closer to axis represents higher profits
Reaction functions
Shows level of output that would max profits for firm
- Further to the right of RFa, firm B produces less
-> therefore firm a can obtain more market share
Cournot-Nash Equilibrium
- Assume both firms have identical costs
- Equilibrium because both firms max profits given the output of the other
- Stable, no incentive to move
- Non-Cooperative equilibrium
- Market automatically reaches stable
- Dont try to influence
C-N Monopoly
If one firm does not produce anything => the other is a monopoly
M - evenly shared monopoly output
Output at M < C-N
Profit at M > C-N
Output at PC > C-N
Profit at PC < C-N
Weaknesses of Cournot-Nash
Each firm takes output as given (ZCVA) which is unrealistic:
-> Under ZCVA, firms dont realise their actions have effect on competitor
=> limits firm to only aim for C-N
-> In reality could tacitly collude/cooperate and aim for M where both make higher π
Still allows to identify outcome of no cooperation or after cooperation breaks down
Forms of collusion
Cartels:
- In which members fix quantities or prices subject to explicit rules and monitor compliance with penalties with cheats
Examples of Cartels
Bridgestone Tyres
- Manipulated the prices of antivibration rubber parts (£255M) US DOJ
Libor price thinking
China fined 12 japanese car part manufacturers for price fixing 1.2 bn yuan
- Under China’s anti-trust law, which was enacted in 2008, authorities can fine a company as much as 10% of its annual revenues.
Libor Scandal
In 2012, some banks falsely reported their rates that they periodically report in the interbank market.
rig key rate of London interbank lending rate
- There was liquidity concers from 2007 crisis. Barclays manipulated libor sumbissions to give a healthier picture of banks credit quality and ability to raise funds
Tacit Collusion
Firm influence market outcomes without formal agreements or commitments between firms
Conjecture approach
Based on conjecture that firms make about reaction of other firms
Dropping ZCVA
- Cooperation appears (use output to influence one another)
- Tacit collusion = no agreement
- C-N is no longer a stable equilibrium, more incentivised to move to M (Chamberlain joint profit max)
Size of conjecture => degree of the effectiveness of collusion
Game Theory
Study how independent agents make decisions under uncertainty
Different types:
- Single period vs multi period
- Simultaneous vs sequential
- Constant sum or nonconstant sum
- Zero sum game
Prisoner dilemma
What is the dominant strategy of each firm
-> best strategy no matter what competitor does
-> whichever returns highest profit
C-N = High/High
M = Low/Low
M in prisoner dilemma
By dropping assumptions can reach M
- Allow communication - cooperation is likely
- Allow for repeated games, firm can realise influence, coop likely
=> repeated games with small reaction lags dissuades cheating
Tit For Tat assumptions
- Two players
- Sequential moves to produce lower/higher output
period t:
A Produce low
Period t+1:
B produce low = πCoop
B produce high = πCheat
period t+2:
A retaliate to high = πcheat
leads to πcheat from then on
or leads to πcoop onliy
- no communication
- infitinte repetitions of the game
Coop Condition
PV Coop > PV Cheating
πCoop +πCoop/r > πCheat + πC-N/r
PV Coop(Low)
πCoop + πCoop/r
PV Cheat(High)
πCheat + πC-N/r
Isolating R
r - discount rate
- Lower the interest rate more likely coop is
r < (πCoop-πC-N)/(πCheat-πCoop)
πCoop-πC-N - reward for cooperation, the greater this is the more likely to coop
πCheat-πCoop - reward for cheating. the smaller the more likely coop is
Folk Theorem
Provided discount rate payoffs is sufficiently small for each play, collusion will occur in infinite repeated game
Finite Horizon
Game 3:
- Two players
- Sequential Moves
- No communication
- Finite time horizon
-> is important for coop: shorter = less like for collab
Cournot Model Math
- Duopoly
- Firm 1: q1
- Firm 2: q2
Supply: Q = q1+q2
- Homogenous good
- Face known demand
- Demand: Q = A - P
- Inverse: P = A - Q - Identical Cost
- Cf1: c1(q1) = kq1
- Cf2: c2(q2) = kq2 - MC = AC and consent
mc1 = dc1/dq1 = k
AC1 = kq1/q1 = k
- ZCVA
- dq2e/dq1 = 0
- dq1e/dq2 = 0
Calculating Reaction function
RF1 denotes q1 max profits firm 1 for given fixed output firm 2 (q2=q2_)
maxπ1 = pq1 -kq1
subject to q2 = q2_
P is a function of quantities p = a - q
- need to find price by substitution
-> Q = q1+q2 into P = A - Q (P = A-q1-q2) - Sub into profit function
-> π1 = Pq1-Kq1
=> π1 = (A-q1-q2)q1-Kq1 s.t. q2=q2_ - sub in restricts
-> (A-q1-q2_)q1-kq1 - Derive for max
-> Aq1-q1^2-q2q1-kq1
∂π => A-2q1-q2-k - Isolate q1
2q1 =A-q2-k
q1= (A-q2-k)/2 - q2 axis
-> q2 = A-K
MC = K determines RF intercept
-> greater k => closer to axis
Assuming identical cost functions:
Rf2 = 1/2(A-q1-K)
Cournot Nash equilibrium Calculation
Intersect of RF1 and 2:
- Rewrite RF2 in terms of q1
q2 = 1/2(A-q1-k)
-> q2 - a/2 + k/2 = -q1/2
-> q1 = A - 2q2 - K - Equalise RF1 and q1
-> A - 2q2 - k = 1/2(A - Q2 - k) - Isolate for Q2
-> Q2* = A-K/3
Export subsidies
Car Trade in EU
- Cournot can be used between domestic and foreign firms
Tescos - Seoul retail
- Protect family shops from exports
-> supermarkets cant open within 1Km of small stores
-> political challenge
British Steel
- 800 mil tonnes come from China
- China has pricing power
- Chinese steel subsidised heavily by goverment (Low AC)
-> . not allowed in the UK
- Grab foreign cash
-> sell below cost price
2014 more than Canada and Mexico combined
Economies of scale and foreign subsidies
Government may try to improve the export performance by granting subs
K drops so MC and AC drop
C(q) = (K-s)q2
- increase sales foreign abroad
reduction in dom sales
- introduction of subsidy by country 2 might lead to c1 gov adopting same abroad: dueling subsidies
=> martin argues that dueling subs leads to subsidy wars which increase profits abroad at the expense of public resources
==> essentially prisoner dilemma between govs
RF shifts out right
Bertrand argues that in an oligopoly
Under constant MC, Subsidys to export only provides gains in foreign market
- However if EoS exist (Falling ac-mc) subsidy to export will be wider
Cournot applicable when
firms’ decision variable is PRICE not quantity, that is,firms choose price that maximizes profits considering the price of competitors
Bertrand applicable when
i. It is costly to change or adjust quantity, that is, with diminishing returns to scale or operating above capacity.
i.Firms make production decision in advanced and need to sell all output.e.g. Airlines announces number of flights and need to sell all seats
Bertrand, Identical products Assumptions:
i. Firm can adjust quantity without cost, constant returns or increasing returns, i.e.there is spare capacity.ii.Capacity sufficiently flexible to meet market demand.e.g. Retailers, adjust output to customers demands
Bertrand, Differentiated products Assumptions:
- Market with only two firms => duopoly. (Firm A and Firm B) 2. A single homogeneous product. No search cost, i.e. costless switch 3. Both firms have identical cost structure: 4. Each firm choses P that maximise profit, considering the other firm’s price, but taking it as fixed. 5. Each firm treats the other firm’s price as fixed when making its own price decision - “Zero conjectural variation assumption” (ZCVA)
The main problem of Bertrand’s model,
- Only two firms => duopoly
- Product slightly differentiated, eg. by location: eg. Two retailers sell same product but are located at opposed ends of city
- Average & Marginal cost: Identical & Constant 4. Firm set its own price (P) to maximise profit given the other firm’s price 5. “Zero conjectural variation assumption” (ZCVA).
Long Run Perfect Competition
The main problem of Bertrand’s model, is that each firm treats the other firm’s price as fixed when making its own price decision: ZCVA. * Unrealistic because, under ZVCA, firms do not realise that Firm A price cuts lead the further price cuts by Firm B, and prevents them from achieving 𝑷𝑴. (As in C-N). 1.In reality, firms could cooperate and aim for 𝑷𝑴, both higher profits. Conditions and tools for cooperation As in C-N: o Conditions: Communication, repeated games, short reaction lags o Tools: Prisoners dilemma, infinite tit-for-tat and the Folk Theorem 2.In reality, there could be a leader, that realises that its actions influence competitors or first mover Stackelberg solution in prices.
Minimum efficient scale (MES)
Level of output that delivers lowest AC
Edward Chamberlain Monopolistic competition
Similar to PC but product differentiation is a factor
product differentiation
anything that makes buyers prefer one seller to another
long run monopolistic competition
entry and exit drive economic profit to zero
Free entry pushes price down to MES
Chamberlain product differentiation
Differentiation is always better for society
Profits in long run not affected
more differentiation always maximises social welfare
Dixit and Stiglitz product differentiation
Total society surplus = CS + Abnormal profit (PS)
- therefore there is an optimal level
- Diminishing returns to increase in firms/differentiation
- More variety not always good
If number of firms > n* more products reduce welfare
N* does not need to match mc
Bain barrier to entry
Any obstacle to entry of new firms allowing existing firms to maintain price that yield LR abnormal profits
Types of barriers
- Product differentiation
-> highly differentiated and established product/brand image - Scale economies
-> L shaped AC
-> pecuniary economies of scale
- Generated by scale of purchases of inputs - Absolute cost advantage
-> lower ac curve - Initial capital requirement
- Limit Price
Bain limit price
Establishment of a price which stalls entry as the highest common price which established sellers believe can charge without inducing the entry of at least one firm
Limit price
Pl = Pc (1+m)
Pc - competitive price
M - Mark up
Modiglianis assumptions
- One incumbent one entrant
- Perfect information about industry costs and demand structure
- single homogenous product
- Economies of scale for incumbent and potential entrant (L shaped LRAC)
- Stylos postulate holds
-> entrant takes existing output as given
Criticisms of modigliani
- ignores product differentiation
- Stylos is unrealistic
- Perfect information not necessarily
- Little evidence of firms implementing price limits and little evidence of effectiveness
Dixit Model
Investment as deterrent
- Investment by incumbent could be seen as sign of willing to fight for market share
outcome of dixit
Passive:
Entrant - stay out [πm | 0]
Entrant - enter:
-> Share [πD | πD]
-> Fight [πW | πW]
Commitment (Cost = c):
Entrant - stay out [πm-c | 0]
Entrant - enter:
-> Share [πD-c | πD]
-> Fight [πW | πW]
Defer entry level
πD-c < πW
Role of information and reputation
If firm has tough reputation (willing to fight) may be easier to prevent entrants
- Dixit argues if threat is persistent, may be in best interest to build reputation
Imperfect information
- entrant may not enter if unsure of the incumbents commitment or the price of entering the market
Monopoly assumptions
- Large number of buyers but only one seller
- may have perfect knowledge or perfect information
- product differentiation
- only aim is profit max
- no free entry
Vertical integration
Firm that participates in more than one successive stage of production/distribution
Upstream (backward)
- investing into a supplier
Downstream (upward)
- Firm control over activity that utilises its outputs
Motives for vertical integration
Cost savings:
-Based on Ronald Coase and Williamsons transaction costs
- Firms integrate when its cheaper to coordinate operations in house
Enhance market share: (Forward)
- allows a monopolist input supplier to extend market power to next stage
Avoid arbitrage when price discriminating:
- Supplier sells inputs to different buyers at different prices
-> cheaper buyers can sell the cheaper inputs to others
Avoid double markup
- Both producer and distributor are monopolies
-> sales and profits would be higher if firms integrated
Double Mark up assumptions
- Single homogenous product
- Single manufacturer
- Single distributor
- Both monopolies
- Both max profits (MR=MC)
- Constant AC = MC => Horizontal cost curves
- Only cost of distributor is purchasing good from manufacturer
Alternatives to integrating
Might still like to move to output Q2
- Producer impose max retail price p = p2
- Impose sales quota or quantity
-> distributor has to bring down prices to sell whole quota - Franchise agreement
-> producer charges retailer MC to ensure that is profitable at Q2
Long Run Perfect Competition
Price falls until normal profit
point where P = Lowest AC
