Industrial Economics1

Question 1

Why is oligopolistic competition viewed as a game?

Answer 1

When the number of competitors is relatively small, each firm realizes that any significant move on its part is likely to result in countering moves by its competitors.

Question 2

What is a dominant strategy?

Answer 2

A strategy that outperforms any other strategy no matter what strategy an opponent selects.

Question 3

What is Nash equilibrium?

Answer 3

Where both players are doing the best they can when given the choice of their opponent.

Question 4

What is a Minimax strategy?

Answer 4

A strategy that minimizes the maximum possible outcome for your opponent. (in a zero sum game)

Question 5

What is a mixed strategy?

Answer 5

In an optimal mixed strategy, each player randomly selects its actions with given probabilities that maximize its expected payoff given the randomly selected strategy being played by its opponent.

Question 6

How are sequential games represented?

Answer 6

Sequential games are known as dynamic games and are represented by game trees. Not a matrix.

Question 7

What is a dominant firm?

Answer 7

Few industries are truly monopolies. In practice, it is much more common to find industries in which there is a dominant firm as well as some number of smaller fringe firms.

Question 8

What role does the dominant firm play in pricing?

Answer 8

The dominant firm will set the industry price and the fringe firms will take that price as given. In other words, the fringe firms behave exactly like perfectly competitive firms in the sense that they are price takers and maximize their profits by equating price to marginal cost.

Question 9

Why?

Answer 9

The dominant firm’s cost advantage allows it to be the price leader but is typically not great enough to allow it to act as a monopolist.

Question 10

What happens over time?

Answer 10

If the competitive fringe earns positive economic profits at the price set by the dominant firm, there is a tendency for the fringe to expand and the dominant firm’s market share to decline over time. Empirical evidence from several industries supports the theoretical prediction about the decline in a dominant firm’s market share over time.

Question 11

What is the contestable markets theory?

Answer 11

This hypothesis contends that potential competition may be more important than actual competition and that even a completely monopolized market may perform as if it were perfectly competitive.

Question 12

What assumptions is the theory of contestable markets built on?

Answer 12

(1) entry is free; (2) entry is absolute; and (3) no sunk costs are associated with entry.

Question 13

What are the four characteristics of network industries?

Answer 13

(1) complementarity, compatibility, and standards; (2) consumption externalities; (3) switching costs and lock-in; and (4) significant economies of scale in production.

Question 14

Why do network industries work against competitive markets?

Answer 14

The special characteristics of network industries work against the development of a competitive market. This is especially true if a firm can use network effects to enhance its monopoly power and to extend that power to another product.

Question 15

What is Horizontal product differentiation?

Answer 15

Refers to differences between brands based on different product characteristics but not on different overall quality. BigMAC/QuarterPounder

Question 16

What is vertical product differentiation

Answer 16

Vertical differentiation refers to differences in the actual quality of two brands.

Question 17

Should firms focus on short or long-term profits?

Answer 17

Long-term

Question 18

What is the theory of limit pricing?

Answer 18

Firms may charge lower short-run prices to restrict future entry.

Question 19

When is predatory pricing irrational

Answer 19

In a game with perfect, certain, complete, and symmetric information

Question 20

When is it a rational strategy for preventing entry?

Answer 20

In a game with imperfect, certain, incomplete, and asymmetric information

Question 21

Why might non-pricing strategies to prevent entry be preferred?

Answer 21

Nonpricing strategies may be preferable to pricing strategies from a legal and economic standpoint. From a legal viewpoint, nonpricing strategies are less likely to raise antitrust concerns, and from an economic standpoint, they are less likely to be misinterpreted by competitors as aggressive acts.

Question 22

How does excess capacity serve as entry deterrence?

Answer 22

Models of entry deterrence based on the building of excess capacity are models in which the monopolist moves first and selects a level of capacity, then the potential entrant decides whether to enter, then the monopolist selects a capacity level and an output. The potential entrant produces a quantity of zero if it stays out.

Question 23

Why does excess capacity work?

Answer 23

The monopolist invests in excess capacity in period 1 in order to lower its costs in period 2; more importantly, this investment lowers the monopolist’s costs in relation to a potential entrant’s costs in period 2. As a result, the monopolist deters entry and earns larger profits over the two periods.

Question 24

How does Research and Development serve as a barrier to entry?

Answer 24

Faced with a threat of entry, however, if the monopolist chooses not to invest in research and development in period 1, it earns a large profit in period 1; but, entry occurs and its profits in period 2 will be significantly reduced. Alternatively, faced with a threat of entry, the monopolist can invest in research and development in period 1 and earn a smaller profit in period 1; however, if the monopolist’s lower costs in period 2 deter entry, the monopolist’s profits will be significantly increased in period 2.

Question 25

How does a learning curve work?

Answer 25

An illustration of a simple learning curve is: AC q q ()= + 10 100 2λ, [15.7] where AC(q) represents the average unit cost of production for a cumulative output of q and λ is a constant measuring the rate at which unit costs decline with volume, or the speed of learning.

Question 26

How does Learning by Doing operating as a deterrent to entry?

Answer 26

By producing large outputs, the first firm or firms into the market are protected from some, if not all, future potential entrants and will maintain higher long-run average market shares. Models based on the existence of learning by doing have suggested that in markets with a moderate rate of learning, entry ceases with only a few firms (usually three or four). Like investments in excess capacity and research and development, learning by doing can be viewed as an investment in cost reduction. The early entrant is willing to invest in large current outputs to reduce its future costs, even if this investment significantly reduces current profits.

Question 27

What is product proliferation as an entry deterrence?

Answer 27

Product proliferation refers to the strategic decision to preempt potential entrants by creating brands to fill every available product niche.

Question 28

What are six strategies to deter entry?

Answer 28

1. Limit pricing.
2. Establishing a “tough” reputation (the threat of predatory pricing).
3. Creating excess capacity.
4. Raising rivals’ costs (e.g., advertising costs).
5. Utilizing learning by doing.
6. Product proliferation (filling product niches).

Question 29

How does CRITICAL MASS operate as a network externality?

Answer 29

However, after a specific percentage of consumers, called the critical mass, has subscribed to the service or bought the product, its value increases to become greater than or equal to the price. After this point, all potential consumers subscribe to the service or buy the good.