IO Flashcards
What are the assumptions for perfect competition?
- Large numbers of buyers and sellers
- Free entry and exit
- Homogenneous products
- All have perfect information
- No transportation costs
- P=MC
- Firms are price takers
What are the assumptions for the Bertrand model?
- There are two firms
- Entry barriers exist
- Identical products
- Both firms have the same MC
- There are no capacity constraint
What does the Bertrand model mean?
The company with the lowest price gain the entire market
What are the assumptions for monopoly?
- Singler seller in the market to many buyers
- No threat of entrants
- Many entry barriers
- All have perfect information
What is a prisoners dilemma?
When 2 firms both choose the same strategy that does not maximize their options, but is a strategy they have to choose in fear of the other choosing a strategy which will make them worse off.
What is the difference between Bertrand model and Edgeworth model?
Same assumptions, but in Edgeworth there is a capacity constraint.
What does firms in the Edgeworth model have incentive to do?
Raise prices, as they do not need to fear that they are loosing all customers.
How is the equilibrium in the Edgeworth model?
Not stable, as firms change prices either higher or lower than the equilibrium
What are the motives for cartels?
- Profit maximization
- Risk management
- Exchange information
- Unsatisfactory performance
What is barometric price leadership?
The barometric model occurs when a particular firm is more adept than others at identifying shifts in applicable market forces. Market share does not matter, but other firms might follow.
Describe the factors for cartel formation
- Seller concentration and number of firms
(small number of firms or high concentration) - Cost functions
(firms with similar cost structures) - Size and product differentiation
(similar i market share, product range, capability etc) - Vertical integration
(renders effective monitoring)
Why can cartels be unstable?
- Prisoners dilema, as cartel outcome is not a Nash equilibrium
- Free rider problem
- Different goals
- Sanctions
- Buyer concentration
- Seller concentration
- Detecting of cheating
- Entry
- Whistleblower law
What is the free rider problem of cartels?
When non-cartel firms “ridder med på bølgen” - Sell products at cartel price, but still supplies what non-cartel members does (higher than cartel)
What is the n-firm concentration ratio?
Measures the largest number of firms (CR3, CR4 etc) in relation to the total industry in terms of sales, assets, employment
What is the HH index?
Hirschmann-Herfindahl Index:
Measures concentration based on the sum squared market shares of all firms in the industry.
Gives more weight to larger firms
What are the advantages of the n-firm concentration ratio?
Easy to compute as we only need information on the largest firms
What are the disadvantages of the n-firm concentration ratio?
Only takes few points of the concentration curve into account
What is the Hannah-Kay index?
Measures concentration based on weighted sum of squared market shares of all firms in the industry. Is a generalization of the HH index
What are the Hannah-kay criteria?
- Concentration curve ranking
- Sales transfer
(transfer of sales from smaller to larger firms must increase concentration) - Entry
(entry of a new firm must decrease concentration) - Merger
(Should increase concentration)
What are the problems with concentration measures?
- Definition of relevant market
- Multiproduct diversified companies
- Ownership
(some firms have the same owners)
What is numbers equivalent?
1/HH. Represents the number of equal sized firms there are.
What are the determinate for seller concentration?
- Economies of scale
- Barriers to entry
- Regulation
- Industry life cycle stage
- Sunk costs
What is MES?
Minimum efficient scale
What is Gibrat’s law?
Random growth hypothesis:
A company’s growth is independent of its size and past growth
Which entry barriers exist?
- Economies of scale
- Growth
- GDP growth
- R&D
- Exit of firms
- Market concentration
- Risk
Which entry barriers exist?
- Economies of scale
- Growth
- GDP growth
- R&D
- Exit of firms
- Market concentration
- Risk
What pricing strategies are there?
Limit and predatory pricing
What is limit pricing?
Pre-entry, set the price just low enough so that no one will enter the market
What is predatory pricing?
Post entry, setting prices lower than variable costs. Incumbent firm looses profit in short run. Violates §11
What is SCP?
Structure-Conduct-Performance.
Used to study the conduct and performance of firms
What is efficiency hypothesis?
CPS.
Conduct effect performance that effect structure.
More efficient –> higher profitability –> higher concentration
What is collusion hypothesis?
SCP.
Structure effect conduct that effects performance.
More market concentration –> market power —> higher profitability
What is horizontal product differentiation?
Similar quality but different characteristics
What is vertical product differentiation?
Varying quality across products
What are the motives for advertising?
- Launch/promote new products
- Give customers information about the product
- Increase market power
- Create a brand
Which model can be used to find the optimal level of advertising?
Dorfman Steiner
How is the Dorfman Steiner condition version 1 calculated?
A/PQ=AED/PED
A=advertising expenditure
PQ=revenue
AED= elasticity of demand with respect to advertising
PED=price elasticity of demand.
If PED>AED then focus on price
If AED>PED then focus on advertising
Assuming monopoly
How is the Dorfman Steiner condition version 2 calculated?
(P-MC)/P * AED
Here we assume there are others players on the market, so we do not receive full mark up from out advertising.
The higher the mark up, the higher reward a company gets when they increase advertising.
How can advertising be used as a entry barrier?
- Raising entrants initial costs
- Building reputation
- Economies of scale in advertising
What merger types exist?
- Horizontal
- Vertical
- Conglomerate
What is horizontal merger?
Companies at the same stage in the supply chain that produces similar products
What are the motives for horizontal merger?
1. Market power • Degree of seller concentration • Productive capacity of rivals • The ease of entry • Market demand • The level of buyer concentration • Acquisition of a failing firm 2. Cost saving • Rationalization • Economies of scale • Research & Development • Purchasing economies • Productive efficiency and organizational slack • Coordiation of joint operations • Sharing of complementary skills • Improved interoperability • Network configurations 3. Managerial discretion 4. Failing firm hypothesis 5. Risk diversification
What is vertical mergers?
Companies at different stages in the supply chain, e.g. a supplier buying a customer
What are the motives for horizontal merger?
- Market power
- Cost saving
- Managerial discretion
- Failing firm hypothesis
- Risk diversification
What are the motives for diversification?
- Economies of scale + scope
- Risk diversification
- Market power
- Managerial motives
- Transaction costs
What is diversification?
Entering a new market with new products – possible through mergers
What is double marganization?
motive for vertical integration
All suppliers in the supply chain needs a markup on the product
What can be done if there is vertical restraints?
Form “links” between the companies instead.
What is RPM
Resale price maintenance
Where an upstream firm retain the right to control the price the downstream firm sells it at. I.e setting min or max prices.
Can be anti-competitive
Service hypothesis
What are the motives for vertical integration?
- Double marginalization
- Price discrimination
Etc.
What types of bundling are there?
- Sales bundling
- Buying bundling
- Direct bundling
- Tying
- Indirect bundling
What is sales bundling?
When the selling company bundle its products
What is buying bundling?
When the buyer only only will purchase a single package
What is direct bundling?
The purchase of a product conditional on the purchase of a second and visa versa - a total package.
What is tying?
The purchase of a product conditional on the purchase of a second but not visa versa - a total package. E.g. when buying a car you must also later buy the replacement parts thwere.
What is a contestable market?
Market with only one (or small number of) incumbents.
Even though they could set high prices they keep them low to keep others from entering the market.
What is hit and run?
In a contestable market:
When a firm enters a monopoly/oligopoly market with prices lower than incumbent, and then sells all that it can before the incumbent repsonds and lower its price.
What are the different costs?
TC=VC+FC AVC=VC/Q AFC=FC/Q SRAC=AFC+AVC SRMC=change in VC/change in Q
Define returns to scale
Increasing returns to scale: economies of scale
Constant returns to scale
Decreasing returns to scale: diseconomies of scale
What is the relationship between LRAC and LRMC
LRMCLRAC: LRAC is increasing - diseconomies of scale
LRMC=LRAC: constant returns
Reasons for economies of scale
Internal:
- Larger scale operations are more cost effective
- Lower risk premiums to raise finance
- Lower transport, purchasing, marketing
External: (all firms in the industry benefits from this)
- Increased specialization of labor
Reasons for diseconomies of scale
Internal:
- Increased complexity within the organization
- Transport diseconomies
External:
- Shortage of inputs –> higher input costs due to larger number of firms in the industry
What is economies of scope?
Cost savings when a firm produces two or more outputs using same set of inputs
§6 is about?
Prohibition against anti-competitive agreements
- Fixing purchasing/selling prices
- Share market
- Binding resale prices
§11 is about?
Abuse of dominant position
- Unfair prices
- Limiting production, technological development
- Dissimilar conditions for trade
§12 is about?
Merger control
1. Prohibit mergers if they impede efficient competition
Weaknesses of neoclassical model
- Companies may pursue other goals than profit maximization
- Leaders may not have all information about MR, MC etc.
- Does not include complexity of companies
- Does not include uncertainty
- Does not explain innovation
Purpose of competition act?
Promote efficient resource allocation (perfect competition)
What are the managerial theories of firms?
- Baumol’s sales revenue maximization model
- Marris’s growth maximization model
- Either capital or demand growth - Wiliamsons’s theory of managerial utility maximization
- Staff (power over others)
- Perks (larger office)
- Discretionary profits
What is the seperation of ownership and control?
Today, the owners of a firm are not the managers. These have different motives and interest, hence managerial theories are relevant.
Socio-economic effects of cartels
- Higher price –> increase in producer surplus and decrease in consumer surplus and increase in deadweight loss
- Higher profits
- Increase in inefficient use of resources
- Innovation decreases
- Decrease in productivity
- Lower innovation and productivity might increase costs - “business as usual”
What are the four concepts of Oligopoly?
- Conjectual variation: each firm makes assumptions on the actions rival firms take in response to the firm’s own actions
- Interdependence: each firm’s action depends on what it thinks about what actions the other firms will take
- Collusion: can arise when two or more rival firms recognize the interdependence of their actions ) might lead to formulation of joint action
- Independent action: firm acknowledges that actions are
interdependent but reaches conclusion that taking a unilateral decision is better for her (not contacting rivals)
what is a cartel?
Written/oral agreement between independent companies to make joint decisions on the value of parameters (price or quantities), or divide market between them
What are the forms of cartels?
Tacit: no formal agreement or communication
Explicit: verbal and written agreement
What collusive institutions are there?
- Cartels (restrain competition and exploit market power)
- Tarde associations (provide members with information)
- Joint ventures (combine, to reach goals, e.g. overcome entry barriers, increase efficiency)
- State sponsored collusion (government imposes cartel conditions on firms)
§8 is?
Exemptions due to production efficiency:
i) contribute to improving the efficiency of the production or distribution of goods or services, or to promoting technical or economic progress;
ii) provide consumers with a fair share of the resulting benefits;
iii) do not impose on the undertakings restrictions that are not necessary to attain these objectives; and
iv) do not afford such undertakings the possibility of eliminating competition in respect of a substantial part of the products or services in question.
§7 is?
Exemptions for smaller companies
What is PT?
Producer transparency
- Prerequisite for cartel formation
- New entrants
What is CT?
Consumer transparency
- Faster response to change in price/quality.
- Level of information available for consumers
- High CT=high demand elasticity
- High CT=higher incentive to break cartels
Restrictions of Trade association
As TA increase PT they also provide opportunity for collusions. The competition act prohibits:
- Recommendation for prices
- Recommendation for quantities
- Future price information
What does low concentration mean?
Many small firms Higher competition Closer to perfect competition Normal profits (if any) Likely to be low entry barriers
What does high concentration mean?
Few large firms
Lower competition
Degree of market power
Abnormal profits
Likely to be high entry barriers due to efficiency
High concentrated industries might be attractive due to abnormal profits, however only if new entrant can produce as efficiently as incumbent firms.
What is entry ratio?
Share of new entrants as a percentage of number of firms in the industry. The lower the ratio, the fewer new firms there is. This means there is high concentration.
What is market share mobility?
Absolute changes in a firms market share over two periods.
0=no change in firms market shares
100=all firms with market share in period 1 have exited the market.
Mention the other concentration measurements
- Productivity dispersion (productivity compared to average productivity in the economy)
- Wage premium (difference in wages not explained by age, skills, experience)
- ROI (industry profit after tax relative to the fixed assets)
- Price level (if price level is higher than EU9)
- Public regulation (competition is lower in regulated industries)
What is Learner index?
P-MC/P –> shows the market power.
What is MES?
The point where economies of scale are exhausted - firm cannot make any more cost savings through expansion
What are the classic entry barriers?
Economies of scale
Absolute cost advantage
Product differentiation
Why do incumbent firms have absolute cost advantages?
- Experience in the market
- Non replicable ressources
- Access to key inputs
- Patents on processes
- Vertical production linkage
- Better financial conditions (lower risk premiums)
What are the strategic entry barriers?
- Switching costs
- Network externalities
- Brand proliferation
- Signalling commitment
What are the pricing strategies used as entry barriers?
Limit pricing:
- Pre entry strategy
- Incumbent firm has perfect information and cost advantage
- Sets price just below other firms’ LRAC
- Earns profits without attracting entrants as P < others LRAC but above their own
Predatory pricing:
- Post entry strategy
- Sets price lower than AVC
- Only work if credible (otherwise it will attract new entrants)
- Not allow §11 as it is abuse of dominant position
What are other factors that affects market entry?
- Geography
- Monopolies
- Patents
What does Tobins’s Q tell?
Q=Share capital at market value/assets at replacement costs
Q>1: market value exceeds book value
Q<1: market value below book value
Price cost margin
Used to measure firms performance
PCM = (P-AC)/P
If AC=MC then same as Lerner index
This tells how large the mark-up is, hence how much profits is being earned pr. unit.
When can vertical integration remove double marginalization?
Only when both up- and downstream company have market power
What is the service hypothesis?
RPM:
additional services due to higher prices (RPM) increases demand (demand curve shifts outwards). This makes consumers equally better of (CS), and increases PS.
If retailers cannot live up to the service hypothesis, CS decreases.
Too much / little product differentiation
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