Lecture unit 4: Markets and competitive analysis (2/2)

Question 1

What are the characteristics of “oligopoly”?

Answer 1

• Market has a small number of sellers.
• Pricing and output decisions by each firm affect the price and output in the industry.

Question 2

What is the idea behind the central models of oligopolistic markets?

Answer 2

Central element: how firms respond to each other´s choice:

Modells:
- Cournot quantity competition
- Bertrand price competition

Question 3

What is the “cournot duopoly”?

Answer 3

• 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

Question 4

Cournot duopoly: What is the prices?

Answer 4

–>Price that emerges clears the markets (demand = supply)
–>This is the price at which consumers are willing to buy the total production (Q1 + Q2)

Question 5

What do the firms expect in the cournot equilibrium??

Answer 5

• 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

Question 6

How is the “cournot equilibrium” in relation to perfect competion and joint profit maximization collusion?

Answer 6

• 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

Question 7

Cournot Equilibrium: What happens if the number of firms increases?

Answer 7

As the number of firms increases,

• the output will drift towards perfect competition and
• prices and profits per firm will decline

Question 8

What does the cournot model allows us in practice?

Answer 8

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

Question 9

What is the bertrand duopoly?

Answer 9

• 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

Question 10

What is the “bertrand equilibrium?
What will the price be, and why?

Answer 10

• 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

Question 11

What is the unique NE for bertrand standard model?

Answer 11

Both firms set price = marginal cost (p1=p2=c)

Question 12

What is the bertrand paradox?

Answer 12

• Only 2 firms but perfectly competitive outcome
• Message: there exist circumstances under which duopoly competitive pressure can be very strong

Question 13

What is the equilibrium in a homogenous product betrand duopoly?
(with identical and constant marginal costs)

Answer 13

the equilibrium is such that:
- firms set price equal to marginal costs

• firms do not enjoy any market power

Question 14

What is the bertrand competiton with uncertain costs?

Answer 14

• each firm has private information about its costs
• trade-off between margins and likelihood of winning the competiton

Question 15

What is the equilibrium with price competiiton model, homogenous products, private information about marginal costs (Bertrand duopoly)?

Answer 15

• 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

Question 16

When is cournot or bertrand the result? (looking at the output)

Answer 16

• 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

Question 17

What is production in bertrand compared?

Answer 17

In Bertrand competition two firms are sufficient to produce the same outcome as an infinite number of firms

Question 18

Bertrand competition with differention:
What happens to demand curves and reaction functions when the products of rival firms are differentiated?

Answer 18

the demand curves are different for each firm and so are the reaction functions

Question 19

What characterizes equilibrium prices in Bertrand competition when products are differentiated?

Answer 19

• The equilibrium prices are different for each firm and
• they exceed the respective marginal costs

Question 20

Why is price cutting not effective in Bertrand competition with product differentiation?

Answer 20

• 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

Question 21

Why is price cutting not effective in Bertrand competition with product differentiation?

Answer 21

• 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

Question 22

What is the minimum efficient scale (MES) of production??

Answer 22

= is the lowest level of production at which a firm can achieve economies of scale .–>produces goods at the Lowest average cost

Question 23

What does theory predict about the relationship between minimum efficient scale (MES) of production and market concentration?

Answer 23

• 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

Question 24

What happens to market concentration if entry is not easy? (oligopoly)

Answer 24

If entry is not easy:

• concentration will be the result

Question 25

What does monopolistic competition mean for entry conditions and market structure concentration?

Answer 25

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

Question 26

How are price-cost margins related to market concentration according to theory?

Answer 26

–>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

Question 27

What are other reasons for variation in price-cost margins?

Answer 27

• 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.

Question 28

How do most studies approach the comparison of markets in relation to price-cost margins and concentration?

Answer 28

Most studies focus on specific industries and compare geographically distinct markets

Question 29

What is a common characteristic of consumer goods markets regarding firm sizes?

Answer 29

Consumer goods markets seem to have few large firms and many small firms

Question 30

Non which costs do the number of large firms and the total number of firms depend upon?

Answer 30

depend more on advertising costs than production costs

Question 31

What are advertising costs classified as in the context of sunk costs?

Answer 31

advertising: are endogenous sunk costs

because they are expenditures that firms decide internally and cannot be recovered if the business exits the market

Question 32

How do small firms compete early in the industry’s life cycle?

Answer 32

• 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.

Question 33

What has been found about prices in several industries with higher concentration?

Answer 33

Prices are found to be higher in markets with higher concentration

Question 34

How does the “**entry threshold”* for locally provided services (doctors, plumbers, etc.) change between 1 and 2 sellers?

Answer 34

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

Question 35

What is the “entry threshold” ?

Answer 35

The entry threshold represents:

• the population size needed to support a certain number of sellers

Question 36

How does the difference between entry thresholds change with increasing number of sellers?

Answer 36

• E3 - E2 > E2 - E1
• E4 - E3 = E3 - E2

Question 37

At what point does the intensity of price competition reach its maximum according to Bresnahan and Reiss? (How many sellers? entry threshold)

Answer 37

The intensity of price competition reaches the maximum with three sellers

Question 38

What is meant with high market concentration and low market concentration? (Impact on price, margins and competition intensity)

Answer 38

• 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