Firms & Markets Flashcard Deck

Question 1

Herfindahl Index

Answer 1

Herfindahl Index = S1^2+S2^2+S3^2+…

S1 = first player market share in percent, calculated by sales/market sales

(measure of size of firms in relation to the industry)

Question 2

Bertrand model

Answer 2

• Firms commit to price –> they can meet the demand
• Output is easy to expand always
• Prices compete down towards MC

Question 3

Cournot model

Answer 3

‘C’ournot = ‘C’apacity ‘C’onstraints

• Output is difficult to expand once capacity is fixed
• Firms set output simultaneously
• Price is determined by demand to clear market

Question 4

Bertrand paradox

Answer 4

Duopoly in Bertrand model - lowest prized firm sells to entire market –> Nash Equilibrium is Price = MC
Same outcome as under perfect competitions (= paradox)
Firms make no profits

Question 5

‘Trigger strategy’

Answer 5

Start by cooperating (Cournot model, implicit collusion), if anyone cheats set punishment quantity

Question 6

Auction value types (3)

Answer 6

Private value auctions
Common value auctions
Correlated value auctions

Question 7

Main auction types

Answer 7

English Auction
Dutch Auction
Sealed Bid Auction
(Vickrey Auction)

Question 8

English Auction

Answer 8

Price increases until there is only one bidder left (price raised by auctioner or bidder themselves) - most popular, esp. online)

Question 9

Dutch Auction

Answer 9

Price decreases until one bidder accepts it

Question 10

Sealed bid auction

Answer 10

Highest bid wins

Question 11

Vickrey auction

Answer 11

Sealed bid - highest bid wins but only pays the second highest bid

Question 12

Price discrimination definition and requirements

Answer 12

Price discrimination = charging different prices for essentially the same good –> e.g. by location, quantity, variations that don’t materially affect costs

Requirements:

1. Resale / Arbitrage prevented
2. Industry cannot be fully competitive

first / second / third degree price discrimination

Question 13

First degree price discrimination

Answer 13

Individual price targeting

Question 14

Second degree price discrimination

Answer 14

Offering choice of different packages to persuade high value customers (market segments are not fully known or cannot be perfectly segmented)

Question 15

Third degree price discrimination

Answer 15

Price targeting by identifiable market segment (e.g. discounts for students and seniors)

Question 16

Price elasticity of demand

Answer 16

e = - %change in demand / % change in price

Question 17

Perfect competition model assumptions (4)

Answer 17

1 Infinitely many small, equally efficient firms
2 Homogenous products, customers only care about price
3 Customers are rational (&perfect information)
4 Unrestricted entry & exit of firms

Question 18

Monopoly MR / price calculation

Answer 18

MR = price * (1 - 1/e)

Question 19

Barriers to entry purpose and examples of barriers

Answer 19

Barriers to entry allow incumbents to earn excess profits without attracting new entry

Common barriers to entry include special tax benefits to existing firms, patents, strong brand identity or customer loyalty, and high customer switching costs.

Question 20

sunk cost

Answer 20

cost that has been incurred and cannot be recovered

Question 21

short-run equilibrium (before new entry, perfect competition)

Answer 21

• AC is not equal MC

- Price equilibrium before new entrant comes in, as soon as new entrant comes in price gets moved to new optimum price

Question 22

long-term Equilibrium (perfect competition)

Answer 22

Price = AC = MC, new optimum price gets reached

Question 23

Conditions needed for price discrimination

Answer 23

no arbitrage

industry not fully competitive

Question 24

Monopoly Formula price MC elasticity ratio (usually given)

Answer 24

(price-MC)/price = 1/e

Question 25

network externalities

Answer 25

exist when the value to one customer rises if the total number of customers purchasing it rises (e.g. a telephone)

Question 26

Cross elasticity of demand

Answer 26

Cross elasticity of demand is an economic concept that measures the responsiveness in the quantity demand of one good when a change in price takes place in another good.

Question 27

Tacit collusion

Answer 27

Collusion occurs in oligopolistic markets when firms co-operate in order to attain profit levels that exceed the short run Nash equilibrium levels. Tacit collusion differs from explicit collusion in that this is achieved without direct communication between firms. Can be achieved when firms interact repeatedly, by using the threat of withdrawing future co-operation if any firm deviates from the agreed price or output levels.

Easier to achieve in a growing market as short-term goals of cheating today are small compared to growing future benefits of collusion, harder to achieve in declining market.

Question 28

Revenue equivalence theorem

Answer 28

The revenue equivalence theorem states that the expected value from a first and second price auction are the same if all bidders are rational and risk neutral. Bidders in first price auctions will bid less aggressively than in second price auctions. On average the top bid in a first price auction will be shaded to the valuation of the bidder with the second-highest value, and so in terms of revenues the two auctions will be equivalent.

Question 29

How does the result in the revenue equivalence theorem change if bidders are known to be risk averse or risk loving?

Answer 29

Risk attitudes do not affect bidding in second price auctions (bidding your true valuation is always a dominant strategy, regardless of what others do or how many other bidders there are).
Risk attitudes do affect bidding in first price auctinosL Risk-averse bidders will bid more aggressively, while risk-loving bidders will bid less aggressively.
Therefore the expected revenues are higher in first price auctions than second price auctions if bidders are risk-averse; and when risk-loving the revenues will be lower in first price auctions.

Question 30

Winner’s curse

Answer 30

The winner’s curse is a phenomenon that may occur in common value auctions with incomplete information. The winner’s curse says that in such an auction, the winner will tend to overpay. The winner may overpay or be “cursed” in one of two ways: 1) the winning bid exceeds the value of the auctioned asset such that the winner is worse off in absolute terms; or 2) the value of the asset is less than the bidder anticipated, so the bidder may still have a net gain but will be worse off than anticipated.

Question 31

Suppose that the marginal cost of a phone call (monopoly) is zero. If the operator could charge a fixed fee, what would it be?

Answer 31

Fixed fee = total surplus –> extracting all consumer surplus for the producer

Question 32

What are structural barriers to entry preventing other competitors from getting a slice of the ebay market?

Answer 32

substantial brand recognition
network externalities are vast as it has very many buyers and sellers that already use the system (of other type than amazon, i.e. not all of those could be converted if amazon entered the same market)

Question 33

What makes it difficult applying auction theory insights to online auctions in practise.

Answer 33

Auction theory can be successfully applied to online auctions, however as with many small auction situations, seemingly small details can create a large outcome. As online auctions typically involve relatively low-value items, a disproportionate amount of a bidder’s satisfaction may come from being the winner, making modelling of these situations much more complex.

Question 34

“The only thing that matters when designing an auction is to ensure that the bidder with the highest valuation wins it”. Do you agree with this statement? Explain.

Answer 34

It is a requirement for efficiency that the bidder with the highest valuation wins. However, the way in which surplus between buyer and seller are divided may be important, and this is not addressed by the statement.

E.g. if the seller was a government, it may be desirable that the auction is revenue-maximising –> design of the auction is important to ensure collusion is minimised and participation maximised to encourage bidders to submit their true valuations.

Question 35

Market entry - nash equilibrium 4 firms out of 10 are optimum

Answer 35

‘it can be any of the 4, so there are multiple equilibria’

Question 36

Why use auctions

Answer 36

1 price discovery
2 revenue maximisation
3 logistically efficient