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ECON2101 > Imperfect Competition > Flashcards

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
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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
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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
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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
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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
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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)
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7
Q

What are the assumptions of Bertrand?

A
  • Two firms
  • Homogenous goods
  • Same Constant MC (Identical Firms)
  • Both choose prices simultaneously (One Period)
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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
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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
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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
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11
Q

What are the two periods in Bertrand with capacity constraints?

A
  • 1st: Firm builds capacity

* 2nd: Choose prices

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12
Q

What are q̅ and p̅?

A
  • q̅: maximum quantity that each can produce

- p̅: if production is at capacity for both firms

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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
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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
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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
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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
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
    1. Select product characteristics
      - Need to be similar/near consumers but have some differentiated features
    1. 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
Q

What will the outcome of a Stackelberg eqm be?

A

Not Equal

26
Q

What is limit pricing?

A
  • Can use prices to send a signal when prices are related across time
  • i.e. lower than profit maximising
27
Q

In what situations is limit pricing applicable?

A
    1. e.g. Large Advertising Campaigns
      - Prices will be set for given period of time when advertised
    1. Leaning Curve
      - If expecting lower future costs due to learning, set a lower current price to deter entry - initial losses but future monopoly rent
    1. 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
    1. Signalling based on Asymmetric Information
      - Incumbent Firm (A) has information about it’s cost structure that B doesn’t
28
Q

What is the outcome of limit pricing?

A
  • 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
Q

What is predatory pricing?

A
  • Illegal

- Price set artificially low i.e. P

30
Q

What is the price leadership model?

A
  • 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
Q

What is the leader’s price decision in the price leadership model?

A
  • 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
Q

Where does the leaders demand curve occur in price leadership model?

A
  • P(D=Sc) down to P(Sc=0)

- (Sc: supply of competitive fringe)

33
Q

What are the steps in a price leadership model?

A
  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
Q

What are the attributes of monopolistic competition?

A
  • Slightly differentiated products
    • Downward sloping demand curve
    • Gives them some control over prices: P > MC
  • Free entry and exit: πLR = 0
35
Q

What are the important outmodes of monopolistic competition?

A
  • Excess capacity: Doesn’t produce at efficient scale

- D & MR that move

36
Q

What is the difference between COurnot BR and Bertrand w/ produce differentiation BR?

A
  • qb vs + Pb

ECON2101 (11 decks)

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