Chapter 11 : Imperfect Competition Flashcards
What are the 2 key assumptions of game theory?
- Each player is Rational
- Each player is Intelligent
What are the 3 elements to consider in game theory and how do they apply to markets?
- The N : who (firms)
- The A : what (decisions – how much output)
- The u : consequences of decision (profit)
What is a Nash equilibrium?
A profile /list of strategies is a Nash equilibrium when no player can gain from a unilateral deviation
OR : when each’s player strategy is the best response to other players’ strategies
What does the Hotelling model prove?
That firms, in order to maximize their profits, should be located at equal distance from their consumers. That is why similar markets are always found together.
In the prisoner’s dilemma, which action strictly dominates the other?
Confessing
What is strictly dominance?
a is strictly dominant over b if a yields a higher utility than b no matter what other players do.
Give the profit equations for the profits 2 firms in a duopoly.
Firm 1’s profit = q1 (a - q1 - q2 - c)
Firm 2’s profit = q2 (a - q1 - q2 - c)
When is profit maximized for firm 1 if firm 2 does not produce at all?
When q = (a-c)/2
When does firm 1 make 0 profit, despite firm 2 also not producing? (2)
- when it produces 0 qt
- when it produces (a - c) qt
What is the equilibrium choice for two firms?
1/3 x (a - c)
What is an important type of firms in Canada?
Output is largely produced by firms that are small relative to the size of the industry.
What does the theory of monopolistic competition explain?
It explains why there are many small firms, but each firm has some degree of market power.
What is an oligopoly?
Small number of large firms, each with considerable market power, and that compete actively with each other.
What is a highly concentrated industry?
An industry with a small number of relatively large firms.
What is the concentration ratio?
The fraction of total market sales controlled by a specified number of the industry’s largest firms.
What are the 2 industries with the largest concentration ratios in Canada?
Petroleum and coal, and Beverage and tobacco products.
3 characteristics of imperfectly competitive firms
- Firms differentiate their products.
- Firms set their price
- Firms engage in non-price competition
Do imperfectly competitive firms differentiate their products?
Yes.
Do imperfectly competitive firms set their price?
Yes. They are price setters.
What is a differentiated product?
A group of products that are similar enough to be called the same products, but different enough that all of them do not have to be sold at the same price.
What type of demand curve is faced by imperfectly competitive curves?
A negatively-sloped demand curve. It chooses the price to set.
3 examples of non-price competition
= behaviour absent from monopoly or perfect competition
- Advertising
- Offering competing standards of quality and product guarantees
- Creating entry barriers
Key difference between monopolistic competition and oligopoly
The strategic behaviour displayed by the firms.
Why was monopolistic competition originally developed, and by who?
To deal with production differentiation phenomenon.
1933
Edward Chamberlin
4 characteristics of monopolistic competition
- Many firms
- Freedom of exit and entry
- Product is somewhat differentiated from others
- Firms have some control over product price.
characteristics of the demand curve for monopolistic competition
- Negatively sloped
- Highly elastic
Why do all of the firms in a monopolistic competition have the same cost curves?
Because they all have access to the same technology.
Why do the firms in a monopolistic competition ignore their competitors when making price and output decisions?
Because the industry has so many firms.
Are firms free to enter and exit the industry in monopolistic competitions?
Yes.
In the long run, how do monopolistic competition firms choose their amount of output?
Their output will be when the demand curve is tangent to the LRAC curve.
However, since this happens before the lowest point of the LRAC curve, the firms have 0 profits and an excess capacity
How do monopolistic competition firms decide on their output in the short term?
Like monopolies : when MR = MC. Their profits are illustrated in green.
Describe why the graph changes in the long run for monopolistic competition.
Because the # of firms increasing, which shifts the demand curve to the left until it is tangent to the LRAC.
Each firm is maximizing its profit, but that profit is now = 0.
What does the excess-capacity theory show?
It is a theory of long run equilibrium in monopolistic competition, showing that firms produce on the falling portion of their LRAC.
Why is determining the level of output that maximizes profits in oligopolies complicated?
Because oligopolies must exhibit strategic behavior. That is to consider its rivals’ likely responses to its actions.
What is a cooperative / collusive outcome?
When firms cooperate in an oligopoly in order to maximize their joint profits.
What is the Nash equilibrium in duopolies?
For both firms to compete.
Distinguish between overt/covert and tacit collusion.
When firms agree to cooperate : collusion
Overt/covert collusion = explicit agreement
Tacit collusion = no explicit agreement
Why would firms in an oligopoly choose to actively compete against each other? (3)
- Attract consumers away from their rivals
- Increase their overall share of the market
- Increase their profits.
4 ways for oligopolies to compete against each other.
- Pricing
- Advertising
- Product quality
- Innovation
Do consumers gain or lose from competition between firms in oligopolies?
Gain.
What are 4 strategies of entry barriers that oligopolies might set?
- Brand proliferation (large number of differentiated products leaves a small market share available to a new firm)
- Advertising (a new firm may have to spend heavily on advertising)
- Predatory pricing (keeping costs low until the entrant goes bankrupt)
- Purchasing rival firms (ex. Facebook)
Are oligopolies more or less efficient than perfect competition?
Less efficient, to the extent that price remains above competitive levels and output below
