Imperfect Competition Flashcards
1
Q
What are the conditions of Cournot?
A
- Firms compete by setting output (quantity)
- No production costs
- Firms simultaneously choose qa and qb
- Q = qa + qb
2
Q
How is the Nash Eqm of a Cournot model found?
A
- Given that qa affects πb, when choosing q, they will take into account their beliefs about how their actions will affect the others π
3
Q
What is Firm A’s reaction function in Cournot and how is it derived?
A
- qa that maximises A’s πs for every possible choice that B makes for qb
- MRa = MCa
- MC = MR
- TRa = p.qa = (x - qa - qb)qa = xqa - qa2 - qaqb
- MRa = x - 2qa - qb = 0
- BRa: qa = (x - qb)/2
4
Q
Theoretically what is the Cournot eqm?
A
- If we are anywhere other than equilibrium, the firms will have an incentive to change it’s production decision in response, ultimately culminating at x=y where there is no incentive to change
5
Q
Mathematically how is the Cournot eqm obtained?
A
- Need to sub BRb into BRa
- qa = (x - qb)/2
- 2qa = x - qb
- 2qa = x - (x - qa)/2)
- 4qa = 2x - x + qa
- 3qa = x
- qa* = 1/3x
- qb* = (x - 1/3x)/2 = 1/3x
6
Q
What is true of monopoly compared to cournot?
A
- If two firms combined and create a monopoly, quantity (market) output would have been 60 i.e. less efficient
- Determine monopoly TR, MR and set to 0 (MC)
7
Q
What are the assumptions of Bertrand?
A
- Two firms
- Homogenous goods
- Same Constant MC (Identical Firms)
- Both choose prices simultaneously (One Period)
8
Q
What is the result of Bertrand?
A
- Because the product is identical, the firm with the lowest price will capture the entire market
- Prices will always be identical
- They split the market evenly between them
- The only Nash Equilibrium is for both firms to set Pa = Pb = MC
- π= 0
9
Q
What is the Bertrand paradox?
A
- No matter how many firms, when they compete on price, it will be 0DWL, maximising total surplus at the perfectly competitive market equilibrium
- Holds for any cost or demand curve
10
Q
What do capacity constraints result in?
A
- If we have capacity constraints, then undercutting firm can’t satisfy entire market D, leaving residual D for competitor
- Reduces the incentive to undercut
11
Q
What are the two periods in Bertrand with capacity constraints?
A
- 1st: Firm builds capacity
* 2nd: Choose prices
12
Q
What are q̅ and p̅?
A
- q̅: maximum quantity that each can produce
- p̅: if production is at capacity for both firms
13
Q
What arises in Bertrand with capacity constraints?
A
- Two instances arise because of the fact we’re setting price not quantity
- If pa = pb ≤ p̅ then not in Nash Eqm
- If pa = pb > p̅ then not in Nash Eqm
14
Q
What occurs when pa = pb ≤ p̅?
A
- Firms choose q̅a and q̅b so market supply is fixed s̅
- Total quantity(D) > Total capacity
- Increase price and sell less
- We’re not setting quantity at all in this model, so increase price and take the hit in lost quantity (DEMANDED NOT SOLD) because there is untapped demand
15
Q
What occurs when pa = pb > p̅?
A
- Firms choose q̅a and q̅b so market supply is fixed s̅
- Total quantity(D) ≤ Total capacity
- So A could cut price, increase quantity demand and sales up to q̅a (full capacity because will take entire market) and increase π
16
Q
What happens in the 2nd period of Bertrand with capacity constraints?
A
- Only equilibrium with capacity constraints is pa = pb = p̅
- Comes down to capacity, first stage game just like Cournot
17
Q
What happens in Bertrand with product differentiation?
A
- Law of one price will not hold
- Firms don’t face the same demand curve but they all include the competitors price
- qa = x - Pa + Pb
- Q is - related to P, and + related to competitors
- qa = x - Pa + Pb
18
Q
How do we obtain a reaction function for Bertrand with product differentiation?
A
- Determine TR, TC and therefore π
- ∂π/∂P = 0
- Solve for Pa and Pb
19
Q
What is the working for the best response function in Bertrand with product differentiation?
A
- TRa = Pa.qa = Pa(x - Pa + Pb)
- TC given: determine π
- ∂πa/∂Pa = x-2Pa + Pb
- Pa = (Pb + x)/2
20
Q
What is true of the reaction functions in Bertrand with product differentiation?
A
Positive relationship between Pa and Pb therefore both upward sloping
21
Q
How is eqm in Bertrand with product differentiation achieved?
A
- Substituting B’s reaction function in A’s
22
Q
What are the two stages (and condition thereof) in competing on product characteristics?
A
- Select product characteristics
- Need to be similar/near consumers but have some differentiated features
- Select product characteristics
- Select price
23
Q
What occurs in a Stackelberg model?
A
- Firm A moves first and makes a decision which B observes before making their own
24
Q
What are the steps to determining a Stackelberg eqm?
A
- Plug b best reaction function into A’s INVERSE DEMAND CURVE FROM MARKET DEMAND, rearrange for price
- TRa
- MRa = MCa = 0
- Solve for qa*
- Plug into B’s reaction function
25
What will the outcome of a Stackelberg eqm be?
Not Equal
26
What is limit pricing?
- Can use prices to send a signal when prices are related across time
- i.e. lower than profit maximising
27
In what situations is limit pricing applicable?
- 1. e.g. Large Advertising Campaigns
- Prices will be set for given period of time when advertised
- 2. Leaning Curve
- If expecting lower future costs due to learning, set a lower current price to deter entry - initial losses but future monopoly rent
- 3. Consumer Switching Costs
- Setting a lower initial price allows the firm to gain a large share of the consumer base
- Hard for captive consumers to switch
- 4. Signalling based on Asymmetric Information
- Incumbent Firm (A) has information about it’s cost structure that B doesn’t
28
What is the outcome of limit pricing?
- Firm A could send a signal that it expects low costs in order to keep B out
- Problem is it’s always in A’s best entrance to keep B out of the market & therefore send signal that costs will be low
- An incumbent firm will always send a signal via low prices if the losses that they suffer from this price are less than the gain that they make through monopoly rents
29
What is predatory pricing?
- Illegal
| - Price set artificially low i.e. P
30
What is the price leadership model?
- e.g. steel companies
- 1 Firm (L) is typically seems as the leader over the “Competitive Fringe” (C) in terms of setting price
- Supply Curve of Competitive Fringe vs D/MR
31
What is the leader's price decision in the price leadership model?
- Leader won’t set price > P(D=S): CF can supply at all P > P(D=S))
- Any P ≤ P(D=Sc)
- At any price below P(D=S) the leader gets whatever D from the market that CF is not willing to supply
32
Where does the leaders demand curve occur in price leadership model?
- P(D=Sc) down to P(Sc=0)
| - (Sc: supply of competitive fringe)
33
What are the steps in a price leadership model?
1. Leader’s demand curve
2. Leaders MR curve
3. Leaders MC Curve
4. Ql, PL
5. Sc@PL = Qc
6. D @ PL = Qt
34
What are the attributes of monopolistic competition?
- Slightly differentiated products
- Downward sloping demand curve
- Gives them some control over prices: P > MC
- Free entry and exit: πLR = 0
35
What are the important outmodes of monopolistic competition?
- Excess capacity: Doesn’t produce at efficient scale
| - D & MR that move
36
What is the difference between COurnot BR and Bertrand w/ produce differentiation BR?
- qb vs + Pb
