Chapter 5 Flashcards
What idea does competitor identification start with
What are competitors?
Competitors are the firms whose strategic choices directly affect one another
What does SSNIP stand for
A small but significant nontransitory increase in price
Where is SSNIP used for
The SSNIP is used as a conceptual guideline for market definition. This is used for mergers and follows the following criteria:
Small is useally defined as 5 procent and non transistory is usually defined to be at least one year
What is SSNIP based on?
The economic concept of substitutes
What are substitutes
In general, two products X and Y are substitutes if, when the price of X increases and the price of Y stays the same, purchases of X go down and purchases of Y go up. When asked to identify competitors, most managers would probably name substitutes
Which three conditions do close substitutes hold
- They have the same or similar product performance characteristics
- They have the same or similar occasions for use
- They are sold in the same geographic market
What does market structure refer to
The number and distribution of firms in a market
What is the N-firm ratio
This give the combined market structure of the N largest firms in the market. ( F1+F2+F3+etc)
What is the problem with the N-firm ratio
it is invariant to changes in the sizes of the largest firms
What is the Herfindahl index
The Herfindahl index equals the sum of the squared market shares of all firms in the market.
Why is the Herfindahl index better than the N-firm ratio
It conveys more information. If one believes that the relative size of the largest firms is an important determinant of conduct and performance.
What are the types of market structure
Perfect competition
Monopolistic competition
Oligopoly
Monopoly
Perfect competition herfindahl index:
Usually below .2, Fierce competition
Monopolistic competition herfindahl index:
Usually below .2, May be fierce or light competition, depending on product differentiation
Oligopoly herfindahl index:
.2 to .6, may be fierce or light competition, depending on interfirm rivalry
Monopoly herfindahl index:
.6 and above, usually light, unless threatened by entry
In a perfect competition market conditions will tend to drive down prices toward marginal costs when at least two of the following conditions are met:
- There are many sellers
- Consumers percieve the product to be homogenous
- There is excess capacity
Regarding many sellers what are reasons they drive down prices
- A diversity of pricing preferences, even if the industry is profitable, a seller may prefer a lower price
- When sellers maintain high prices, consumers make fewer purchases, this will cause the cutting of production and prices will fall
- Related to the second point, some seller will cheat when the production is lowered by lowering price and increasing production
Regarding homogenous products what are the reasons they drive down prices
When a firm lowers it price; it expects to increase it sales; they may come from the following sources
1. Increased sales to the firm’s existing customers
2. Sales to customers of a competing firm
3. Sales to individuals who were not planning purchase from any firm at the prevailing price
Regarding excess capacity what are the reasons they drive down prices
For production processes that entail high fixed costs, marginal costs can be well below average cost over a wide range of output. Only when production nears capacity - the point at which average cost begins to rise sharply - does marginal cost begin to exceed average cost.
How is monopoly power described?
the ability to act in an unconstrained way
What are the two main features that characterize monopolistic competition
- There are many sellers
- Each seller offers a differentiated product
What is vertical differentiation
A product is vertically differentiated when it is unambiguously better or worse than competing products. Example: a clothing manufacturer engages in vertical differentiation when it uses stronger stitching to enhance durability.
What is horizontal differentiation
A product is horizontally differentiated when only some consumers prefer it to competing products (holding price equal) Example: the popularity of many different brands of blue jeans, at different price points, is a testament to widely diverging consumer tastes for fashion.
What does the degree of horizontal differentiation depend on
The magnitude of consumer search costs
What are search costs
That is, how easy or hard it is for consumers to learn about alternatives.
What is idiosyncratic preferences
That is, if tastes differ markedly from one person to the next
What are incumbents
Firms that are already in the market
What is an oligopoly
A market in which the actions of individual firms materially affect the overall market is called an oligopoly
What is the definition of Cournot’s model
In Cournot’s model, the sole strategic choice of each firm is the amount it chooses to produce Q1 and Q2. Once the firm are committed to production, they set whatever price is necessary to “clear the market.” This is the price at which consumers are willing to buy the total production, Q1+Q2
What is the best response in Cournot
Each firm’s optimal level of production is the best response to the level it expects its rival to choose
What is a Cournot equilibrium
A Cournot equilibrium is a pair of outputs Q1* and Q2* and a market price P* that satisfy three conditions
What are the three conditions that are needed for a Cournot equillibrium
- P* is the price that clears the market given the firms’ production levels; that is, P= 100 - Q1 - Q2*
- Q1* is firm 1 profit-maximizing output given that it guesses firm 2 will choose Q2*
- Q2* is firm 2 profit-maximizign output given that it guesses firm 1 will choose Q1*
What is the Revenue Destruction Effect
When a firm expands its output, it reduces the market price. This reduces revenues from all customers who would have purchased goods at the higher price. This is known as the revenue destruction effect
Why do small firms disrupt pricing stability
Because of the revenue destruction effect, they suffer a smaller revenue destruction effect then the other bigger firm
How do herfindahl and cournot relate to eachother in regards to antitrust
Antitrust enforcers often use the Herfindahl index to predict the effects of a merger on pricing. Cournot’s model provides a justification for this approach; in markets where firms behave as Cournot describes, one can compute how a merger will affect the Herfindahl index and use the results of the Cournot model to predict the change in price.
What other use does Cournot have aswell
It is very easy ro alter the parameters of the model, this makes it possible to forecast how changes in demand and costs will affect profitability in markets in which firms behave according to the cournot equillibrium assumption. This makes the Cournot model a valuable tool for planning.
What is the definition of Bertrands model
In Bertrands model, each firm selects a price to maximise its own profits, given the price that it believes the other firm will select. Each firm also believes that its pricing practices will not affect the pricing of its rival; each firm views its rival’s price as fixed
What is the difference between Bertrand and Cournot
In Cournots model, each firm selects a quantity to produce, and the resulting total output determines the market price. Alternatively, Bertrand model selects a price and stands ready to meet all the demand for its product at that price
What is the difference in time frame between Bertrand and Cournot
Cournot may take place over different time frames. Cournot competitors can be thought of as choosing capacities and then competing as capacity-constrained price setters.
Bertrand competition results if the competitors are no longer constrained by their capacity choices, either because demand declines or a competitor miscalculates and adds too much capacity
