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19ECB502 - Fundamental Microeconomics > L18 - Oligopoly Markets > Flashcards

L18 - Oligopoly Markets Flashcards

1
Q

How do markets differ?

A

Market differ according to:

  • the number of firms in the market
  • the ease with which firms may enter and leave the market
  • the ability of firms to differentiate their products from rivals
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2
Q

What is the Oligopoly market structure?

A

is a market structure in which a small group of firms each influence price and enjoy substantial barriers to entry.

  • examples include - video game producers (Nintendo, Microsoft, Sony)
  • Oligopoly is am market structure with a limited number of firms with limited market power
  • Marke power is collectively shared
  • Firms cant ignore their competitors’ behaviour
  • Have strategic interactions - game theory
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3
Q

How can the different market structures be compared?

A
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4
Q

What are the three different models on Oligopolies?

A
  • Cournot: firms decide the quantity, and the price adjusts to consumer demand (automobiles?) – simultaneous decision.
  • Bertrand: firms set prices and sell whatever is demanded at those prices (most services) – simultaneous decision.
  • Stackelberg: first mover advantage – timing matters, sequential decision (airlines)
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5
Q

What are the four main assumptions of a duopoly?

A
  1. There are two firms and no others can enter the market
  2. The firms have identical costs - this is a very strong assumption
  3. The firms sell identical products - homogeneity
  4. The firms set their quantities simultaneously - cannot observe what the other is doing, they must make predictions of what they will set the quantity at

example: Airline Market

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6
Q

What is Game Theory?

A

is a set of tools used by economists and many others to analyze players’ strategic decision making.

A game is an interaction between players (such as individuals or firms) in which players use strategies.

We concentrate on how oligopolistic firms behave within a game.

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7
Q

How are payoffs defined?

A

The payoffs of a game are the players’ valuation of the outcome of the game (e.g. profits for firms, utilities for individuals).

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8
Q

How are the rules of the game defined?

A

The rules of the game determine the timing of players’ moves and the actions players can make at each move.

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9
Q

How is an action defined?

A

An action is a move that a player makes at a specified stage of a game.

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10
Q

How is a strategy defined?

A

A strategy is a battle plan that specifies the action that a player will make based on the information available at each move and for any possible contingency

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11
Q

How is strategic interdependence defined?

A

Strategic interdependence occurs when a player’s optimal strategy depends on the actions of others.

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12
Q

What are the assumptions of Game Theory?

A
  • All players are interested in maximising their payoffs (i.e. profit, utility, etc)
  • All players have common knowledge about the rules of the game (i.e. I know that you know, that I know)
  • Each player’s payoff depends on the actions taken by all players (i.e. duopoly interaction)
  • Complete information (payoff function is common knowledge among all players) is different from perfect information (player knows the full history of the game up to the point he is about to move)
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13
Q

What is a static game?

A
  • In a static game, each player acts simultaneously, only once and has complete information about the payoff functions but imperfect information about rivals’ moves. •
    • Examples: employer negotiations with a potential new employee, teenagers playing “chicken” in cars, street vendors’ choice of locations and prices
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14
Q

What is a normal-form static game?

A

Consider a normal-form static game of complete information which specifies the players, their strategies, and the payoffs for each combination of strategies.

  • • Competition between British Airways and Lufthansa on the London-NYC route.

Summary of the game:

  • 2 players: BA (A) - player 1 and Lufthansa (U) - player 2
  • Strategies: either reaching a low output (48 thousand passengers, or high output (64 thousand passengers)
  • Payoffs: (in millions of Euros 3.8; 4.1; 4.6; 5.1) – it depends on the strategic interaction.
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15
Q

How can you predict a games outcome?

A

Rational players will avoid strategies that are dominated by other strategies.

  • In fact, we can precisely predict the outcome of any game in which every player has a dominant strategy.
  • A strategy that produces a higher payoff than any other strategy for every possible combination of its rivals’ strategies

In the aeroplane example, the dominant strategy is to pick the lower quantity regardless of what their competitor picks

Make sure you state which one you pick by saying they prefer that option over the others and circle it on the payoff matrix

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16
Q

What is a Nash Equilibrium?

A
  • The best response is a strategy that maximizes a player’s payoff given its beliefs about its rivals’ strategies.
  • A Nash equilibrium, named after John Nash, is a set of strategies, one for each player, such that no player has an incentive to unilaterally change her action.
  • Players are in equilibrium if a change in strategies by anyone of them would lead that player to earn less than if she remained with her current strategy

Every game has at least one Nash equilibrium and every dominant strategy equilibrium is a Nash equilibrium, too.

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17
Q

What is the general notation for the linear Cournot Model?

A
18
Q

What is the strategic form of the Cournot duopoly game?

A
19
Q

What is the graph for residual demand in the linear Cournot model?

A
20
Q

How is residual demand for Firm 1 derived given Firm 2’s demand in the Linear Cournot Model?

A
  • Given constant marginal cost for both firms - they produce the exact same product with the exact same quantity
  • produce at the point MR=MC
21
Q

What is the best response by firm 1 given q2 - linear Cournot model?

A
  • If firm 2 produced zero:
    • firm 1 would produce at MR=MC and the will consist of the total market quantity produced
      • firm1 becomes a monopoly
22
Q

What are the formulas for demand and costs in the linear Cournot model?

A
23
Q

What is the Algebraic derivation of the best response functions of the two firms?

A
  • Under the assumption of symmetric firms:
    • MC (c) = c1 = c2
  • We can find the best response by substituting the one equation into the other

Once you find the best response q1* and q2​*:

  • Find the total market quantity Q
  • then find the market demand curve –> p = a-bQ
24
Q

What is the Cournot Equilibrium?

A
  • qm is what is produced at the monopoly level when the other firm doesnt produce
  • if q2 is large, the quantity produced by firm 1 is equivalent to what it would produce under perfect competition

The equilibrium is a nash equilibrium, and occurs when the two best response function intersect - it is derived from the monopoly point - each firm undercuts each other till the point of perfect competition - when the two responses meet

HOW DO YOU WRITE THE NASH EQUILIBRIUM PROPERLY - check the reading

25
Q

What is a Bertrand equilibrium?

A

A Bertrand equilibrium (or Nash-Bertrand equilibrium) is a set of price such that no firm can obtain a higher profit by choosing a different price if the other firms continue to charge these prices.

• The Bertrand equilibrium is different than a quantity setting equilibrium in the Cournot models.

26
Q

What are the assumptions of the standard Bertrand Model?

A

– 2 firms

  • Homogeneous products
  • dentical constant marginal cost: c
  • Set price simultaneously to maximize profits
  • individual production can be freely adjusted changes in quantity are not costly, no capacity constraints.
27
Q

What is the main strategy incentive of the standard bertrand model?

A
28
Q

What is the Summary of the quantity set by firm 1 based on the firm 2’s price in Bertrand’s Standard model?

A
29
Q

What is the residual demand curve of a firm in the Standard Bertrand Model?

A
  • it is assumed that firms have the incentive to undercut each other to gain more market share and thus more profit
30
Q

What are the best responses under the Standard Bertrand Model?

A
31
Q

Where is the Nash Equilibrium under the Standard Bertrand Model?

A
32
Q

What is the Bertrand Paradox?

A
  • Only 2 firms but perfectly competitive outcome - they have no market power
    • Oligopolies such normally function as a monopoly and just share the market power
  • Message: there exist circumstances under which duopoly competitive pressure can be very strong

In a homogeneous product Bertrand duopoly with identical and constant marginal costs, the equilibrium is such that:

  • firms set price equal to marginal costs;
  • firms do not enjoy any market power.

The moment we change one of the Bertrand Standard model assumptions - the paradox will not exist

Cost asymmetries: n firms, ci < ci+1

  • Equilibrium: any price pi=pj= p ε[c1,c2]
33
Q

How does Bertrand’s Model compare to Cournot’s Model?

A
34
Q

How is Stackelberg’s model different from the other two?

A
  • Sequential choice: Stackelberg –
    • Here: sequential decisions •
    • Possibility for some firm(s) to act before competitors, who can thus observe past choices. – E.g.: pharma. the firm with patent acts before generic producers

Better to be leader or follower?

Depends on the nature of strategic variables & on the number of firms moving at different stages.

• The first mover must have some form of commitment

  • When and how is such commitment available?
  • First mover takes on more risk as they are first in the market
35
Q

What is the Dynamic Aspect of imperfect competition Stackelberg?

A

One leader / One follower

  • – First-mover advantage?
    • Firm gets higher payoff in game in which it is a leader than in symmetric game in which it is a follower.
    • Otherwise, second-mover advantage.
  • Quantity competition: Stackelberg model
    • Similar to Cournot duopoly
    • But, one firm chooses its quantity before the other.
    • Look for subgame-perfect equilibrium
  • Setting
  • – P(q1,q2) = a − q1− q2 ; c1 = c2 = 0
  • – Firm 1 = leader; firm 2 = follower
36
Q

What is a Subgame-perfect equilibrium?

A
  • A subgame perfect Nash equilibrium is an equilibrium such that players’ strategies constitute a Nash equilibrium in every subgame of the original game.
  • It may be found by backward induction, an iterative process for solving finite extensive form or sequential games.
    • First, one determines the optimal strategy of the player who makes the last move of the game.
    • Then, the optimal action of the next-to-last moving player is determined taking the last player’s action as given.
    • The process continues in this way backwards in time until all players’ actions have been determined.
  • Subgame perfect equilibria eliminate noncredible threats.
37
Q

When the Output of the commitment is small what is the subgame-perfect nash equilibrium?

A
  • Start with the small firm:
    • Would commit in both cases
  • Based of the small firms decision:
    • 90 > 80 so Wal-Mart would commit

therefore the unique Nash- equilibrium would be:

NE{Commit,Commit}

38
Q

When the Output of the commitment is large what is the subgame-perfect nash equilibrium?

A
  • Start with the small firm:
    • Would do you opposite to what Wal-Mart does
  • Based on the small firm’s decision:
    • Wal-Mart would commit

therefore the unique Nash- equilibrium would be:

  • NE{Commit,Do Not Commit}
39
Q

What is Stackelberg’s Oligopoly Model?

A
  • General linear inverse demand function: p = a – bQ
  • Two firms have identical marginal costs, m
    • Firm 1 (American Airlines) is the Stackelberg leader and chooses output first
    • Firm 2 (United Airlines) is the follower and chooses output using best-response function
  • The Stackelberg leader knows the follower will use its best-response function and so the leader views the residual demand in the market as its demand.

We solve by using backward induction:

  1. Solve the max problem of the follower -firm 2
  2. Solve the max problem of the leader - firm 1
40
Q

REVIEW - what is the maths of Stackelberg Oligopoly?

A
41
Q

What does the firm’s residual demand and best response curve look like in the Stackelberg Oligopoly model?

A

19ECB502 - Fundamental Microeconomics (20 decks)

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