Lecture unit 4: Markets and competitive analysis (2/2) Flashcards
What are the characteristics of “oligopoly”?
- Market has a small number of sellers.
- Pricing and output decisions by each firm affect the price and output in the industry.
What is the idea behind the central models of oligopolistic markets?
Central element: how firms respond to each other´s choice:
Modells:
- Cournot quantity competition
- Bertrand price competition
What is the “cournot duopoly”?
- Each of the two firms picks the quantities q1 and q2
- Each firms takes the other firms output as given, and chooses the output that maximize its profits
Cournot duopoly: What is the prices?
–>Price that emerges clears the markets (demand = supply)
–>This is the price at which consumers are willing to buy the total production (Q1 + Q2)
What do the firms expect in the cournot equilibrium??
- Each firms expects its rival to choose the cournot equilibrium output
- if one of the firms is off the equilbr., both firms will have to adjust their outputs
Equilibrium is the point where adjustments will not be needed
How is the “cournot equilibrium” in relation to perfect competion and joint profit maximization collusion?
- Output in Cournot equilibrium will be less than the output under perfect comp
- Output in cournot equil will be greater than under joint profit maximazion collusion
Cournot Equilibrium: What happens if the number of firms increases?
As the number of firms increases,
- the output will drift towards perfect competition and
- prices and profits per firm will decline
What does the cournot model allows us in practice?
Allows to:
- compute how a merger will affect the Herfindahl index
- predict the change in price
- forecast how changes in demand and cost will affect profitability
What is the bertrand duopoly?
- Each firm selects its price and sells whatever quantity is demanded at this price
- each firm takes the price set by the other as given
–>In Equilibrium: each firm correctly predicts its rival price decision
What is the “bertrand equilibrium?
What will the price be, and why?
- If the two firms are identical to begin with, they will be setting the same price
- The price will equal marginal cost (same as perfect competition)
- since otherwise each firm will have the incentive to undercut the other
What is the unique NE for bertrand standard model?
Both firms set price = marginal cost (p1=p2=c)
What is the bertrand paradox?
- Only 2 firms but perfectly competitive outcome
- Message: there exist circumstances under which duopoly competitive pressure can be very strong
What is the equilibrium in a homogenous product betrand 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
What is the bertrand competiton with uncertain costs?
- each firm has private information about its costs
- trade-off between margins and likelihood of winning the competiton
What is the equilibrium with price competiiton model, homogenous products, private information about marginal costs (Bertrand duopoly)?
- firms set price above marginal costs;
- firms make strictly positive expected profits;
- more firms –> price-cost margins (down), output(Up) , profits (down);
- Infinite number of firms –>competitive limit
When is cournot or bertrand the result? (looking at the output)
- If firms can adjust output quickly –>Bertrand type competiton
- if the output cannot be increased quickly (capacity decision is made ahead of actual production), Cournot competition is the result
What is production in bertrand compared?
In Bertrand competition two firms are sufficient to produce the same outcome as an infinite number of firms
Bertrand competition with differention:
What happens to demand curves and reaction functions when the products of rival firms are differentiated?
the demand curves are different for each firm and so are the reaction functions
What characterizes equilibrium prices in Bertrand competition when products are differentiated?
- The equilibrium prices are different for each firm and
- they exceed the respective marginal costs
Why is price cutting not effective in Bertrand competition with product differentiation?
- Price cutting in differentiated markets does not effectively steal business from competitors
- since the increased volume does not offset the loss in contrib. margin
- This is because the unique features of each product limit customers’ willingness to switch based on price alone
- reduction in price does not compensate for the lost revenue per unit
Why is price cutting not effective in Bertrand competition with product differentiation?
- with differentiated products, price cutting is not an effective way to steal business because
- at some point, the reduced contribution margin, will not be offset by increased volume by customers switching
What is the minimum efficient scale (MES) of production??
= is the lowest level of production at which a firm can achieve economies of scale .–>produces goods at the Lowest average cost
What does theory predict about the relationship between minimum efficient scale (MES) of production and market concentration?
- predicts that the larger the minimum efficient scale (MES) of production,
- the greater the market concentration
–>high MES means significant investment in capacity is required before achieving low-cost production
–>thus only a few firms can operate at this scale –>higher/greater concentration
What happens to market concentration if entry is not easy? (oligopoly)
If entry is not easy:
- concentration will be the result
What does monopolistic competition mean for entry conditions and market structure concentration?
Monopolistic competition:
- would mean easier entry and
- larger number for firms
–>Conversely, high entry barriers lead to higher concentration as fewer firms can enter and compete effectively
How are price-cost margins related to market concentration according to theory?
–>Theory predicts that price-cost margins will be higher in industries with greater concentration.
This is because fewer firms control more of the market, enabling them to set prices above marginal costs more effectively
What are other reasons for variation in price-cost margins?
- regulatory frameworks
- accounting practices,
- and the concentration of buyers
–>It is important to control for these extraneous factors to accurately study the relationship between concentration and price-cost margins.
How do most studies approach the comparison of markets in relation to price-cost margins and concentration?
Most studies focus on specific industries and compare geographically distinct markets
What is a common characteristic of consumer goods markets regarding firm sizes?
Consumer goods markets seem to have few large firms and many small firms
Non which costs do the number of large firms and the total number of firms depend upon?
depend more on advertising costs than production costs
What are advertising costs classified as in the context of sunk costs?
advertising: are endogenous sunk costs
because they are expenditures that firms decide internally and cannot be recovered if the business exits the market
How do small firms compete early in the industry’s life cycle?
- Early in the industry’s life cycle, many small firms compete
- The winners invest in their brand name capital and grow large
- Smaller firms can try to match the investment and build their own brands or differentiate their products and seek niches.
What has been found about prices in several industries with higher concentration?
Prices are found to be higher in markets with higher concentration
How does the “**entry threshold”* for locally provided services (doctors, plumbers, etc.) change between 1 and 2 sellers?
The “entry threshold” – population needed to support a given number of sellers
–> increases fourfold between 1 and 2 sellers:
- En = entry threshold for n sellers.
- For locally provided services E2 is about four times E1
What is the “entry threshold” ?
The entry threshold represents:
- the population size needed to support a certain number of sellers
How does the difference between entry thresholds change with increasing number of sellers?
- E3 - E2 > E2 - E1
- E4 - E3 = E3 - E2
At what point does the intensity of price competition reach its maximum according to Bresnahan and Reiss? (How many sellers? entry threshold)
The intensity of price competition reaches the maximum with three sellers
What is meant with high market concentration and low market concentration? (Impact on price, margins and competition intensity)
- Low concentration: competitive market, with many small firms leading to lower prices
- High concentration: indicates only a few firms have a large share of the market, reduce competition and higher prices and margins
