IOA2017Q13 Flashcards
What is interdependent decision making?
When your payoff does not only depend on your own decision, but also another player’s decision.
What is a game?
A stylized model that depicts situations of strategic behaviour, where the payoff for one agent depend on its own actions as well as on the actions of other agents.
What does a game consists of?
A set of: players, rules, and payoff
What are the two types of decision-making?
Simultaneous decision making
Sequential decision making
What is a dominant strategy?
A strategy that is strictly better than any other strategy regardless of the other players’ strategy choices.
If a player has a dominant strategy and if the player is rational, we should expect the player to choose the dominant strategy (we do not even need to assume the other players to be rational)
What is the prisoner’s dilemma?
It depicts the conflict between individual incentives and joint incentives.
What is a dominated strategy?
One whose payoff is inferior to that of another strategy regardless of what the other player does.
Intuition: if a given player has a dominated strategy and that player is rational, then we would expect the player not to choose such strategy
What is the difference between dominant and dominated strategies?
A player will always choose a dominant strategy, however, NEVER a dominated strategy. However, when we have a dominated strategy, it doesn’t tell us which strategy the player will then choose.
What is the importance of rationality in a game?
It is not only important whether players are rational. It is also important whether players believe the other players are important.
What is a Nash equilibrium?
A pair of strategies constitutes a Nash equilibrium if no other player can unilaterally change its strategy in a way that improves payoff.
Most games have a NE, but not all.
Equilibria sometimes requires players to randomly choose one of the actions
What are the assumptions for a monopoly?
- Well-defined market
- One single supplier
- Seller chooses a price to maximize profits
What is the profit condition for a monopoly?
MR=MC
How does the price elasticity of demand relate to the price-cost margin?
The more inelastic (steep demand curve) the demand is, the greater is the price-cost margin for the monopoly → inelasticity leads to higher price, i.e. higher markup
What is monopoly power and how is it related to demand elasticity?
- The ability of the firm to sell at a price substantially above costs
- It is inversely related to the demand elasticity
- Inelastic markets (0<ϵ<1) imply high degree of monopoly power (easier for monopoly to set price substantially above costs)
- Elastic markets (1<ϵ) imply low degree of monopoly power (harder for monopoly to set price substantially above costs)
- I.e. monopoly is not as much about market shares, but more about the ability to sell at a price substantially above costs (monopoly power)
What is the allocative efficiency under monopoly?
- Monopoly implies allocative inefficiency
- I.e. price is greater than marginal costs (P>MC)
What is a natural monopoly?
- A situation where only one firm is viable, and thus the optimal solution to only have one firms (e.g. due to large fixed costs / economies of scale)
- Solution: direct regulation of the firm
- For example, set price equal to average costs
- But, can lead to no incentives to reduce costs or improve quality
- For example, set price equal to average costs
What is a monopoly bottleneck?
- When the monopolist’s assets or output is an essential facility
- E.g. an airport, railroads, etc.
What is the Efficient Component Pricing Rule (ECPR)?
- Implies that the maximum price an integrated firm can charge another downstream firm is w2=p1-c1
- Meaning that, the other firm can set the same price, but will only receive a positive margin if its marginal costs are lower: c2 < c1
- Implies productive efficiency (however, can end in monopoly prices)
What are the assumptions for perfect competition?
- Many small independent sellers and many small independent buyers
- Homogenous product
- Perfect information regarding price (Sellers and buyers are price takers)
- Free entry in long run (zero profits (for marginal firm))
Or as quoted by the book:
- Atomicity (many suppliers)
- Product homogeneity
- Perfect information
- Equal access (symmetric cost functions)
- Free entry
What are the characteristics of perfect competition?
- An individual firm cannot affect price or quantity
- Long run equilibrium: No firms want to enter/exit: P=MR=MC and P=AC
- Short run definition: firms cannot change the usage of fixed inputs
- Long run definition: firms can change all factors of production
- Long run equilibrium has both productive and allocative efficiency (it is actually the condition for perfect condition)
- Demand faced by each firm is horizontal
- Perfect competition only leads to maximum efficiency given the existing technology → does not say anything about technological progress
- Positive profits: firms are attracted to industry
- Negative profits: firms make losses and exit
- Because technology is the same (equal access assumption): firms receive zero supranormal profits in long run
- All plants must be of same size in long run
What is the allocative efficiency under perfect competition?
- Equilibrium is efficient:
- Firms set efficient output (P = MC) (max allocative efficiency)
- Active firms are efficient in LR (P = min AC) (productive efficiency)
What is productive efficiency?
Productive efficiency: goods are sold and produced at the lowest possible average cost (P = min AC )
What is allocative efficiency?
Allocative efficiency: that price is equal to marginal cost of production (measured by total surplus) (P = MC)
What is dynamic efficiency?
Dynamic efficiency: rate of introduction of new products and improvements in production techniques