Midterm Exam 2 Flashcards
(Chapter 7) Explain what game theory is and why it is often used to model oligopolistic behavior.
Explain how in perfect competition changes in one firm’s production do not have an external effect on other firms, but in an oligopoly they do.
Game theory: Analysis of the action-response relationship among two or more firms in a market. One player/firm’s moves influences the actions of another.
In a perfectly competitive market, actions don’t affect each other because every firm has such a tiny market share. On the other hand, in an oligopoly market, few firms have such a large share of the market, so it makes sense that we use game theory to study how firms produce and price based on the behaviors of each other.
(Chapter 7) Analyze what nature means in the context of game theory, explaining why economists would want to include it in economic games.
Nature is the pseudo-player, which economists require to account for the probability of random actions. Nature is able to determine the patterns of the monopolist who may be high- or low-cost, which affects how and if potential competition enters the market. It’s easier for PE to enter with high-cost monopolists and harder with low-cost monopolists.
(Chapter 8) Explain what it means for there to be a Cournot-Nash equilibrium in oligopoly behavior.
Cournot-Nash Equilibrium occurs when 2 competing firms have identical residual demand curves and produce the same output where the reaction functions intersect. The intersection is the optimal performance of both firms given their behavior, usually under the assumption that one firm’s output remains constant.
(Chapter 8) Four studies are summarized in the last four paragraphs of section 8.1.4 before the application sections.
Briefly describe how one of the studies used the predictions from Cournot-Nash behavior to test if firms appeared to be acting as a cartel or not.
UK and Dutch concentrated frozen potatoes market
In the 1980s, UK’s frozen potatoes market sold product below CN-equilibrium and closer to competitive pricing. Between 1991-1992, Dutch’s influence on UK market caused prices to become close to CN pricing following Dutch imports entering their market and company mergers. Dutch market pricing surpassed CN pricing.
(Chapter 9) Provide an intuitive explanation for why the following condition increases the probability that firms will maintain collusion:
The lower the firm’s discount rate i.
Lower discount rates means payoff is worth more in the future, so it makes more sense to maintain collusion. Each firm is more sensitive to each dollar today in this case. On the other hand, future payoff is worth less with higher discount rates; there’s more incentive to defect because future payoffs is not worth much to the firms.
(Chapter 9) Provide an intuitive explanation for why the following condition increases the probability that firms will maintain collusion:
The higher the probability that the firms play the game in the next period p.
If the players know they’re going to play each other again in another game, it makes more sense to collude to avoid severe punishment from cheating. The lower the probability of playing in the next game is, the more incentive there is to cheat in the existing game because the firms won’t deal with each other again.
(Chapter 9) Provide an intuitive explanation for why the following condition increases the probability that firms will maintain collusion:
The higher are firms’ profits if they collude.
Firms are profit-maximizing so if profits from colluding are higher, it rational to collude. If collusion profits are lower, it makes more sense to defect since firms can make more money from defecting.
(Chapter 9) Provide an intuitive explanation for why the following condition increases the probability that firms will maintain collusion:
The lower are firms’ profits if they defect.
If defect profits are lower, it makes more sense to collude since that will make them the most money; firms are profit-maximizing. There’s an incentive to defect only if they make more money from doing so.
(Chapter 9) Provide an intuitive explanation for why the following condition increases the probability that firms will maintain collusion:
The lower are firms’ profits if they both sell the Cournot-Nash quantity.
Cheating results in severe punishment for both the punishing firm and cheating firm by making everyone worse off. The firm producing at the Cournot-Nash quantity floods the market by bringing the prices down, so both firms make less profits. Since firms want to maximize profits, they want to avoid producing at the Cournot-Nash quantity by maintaining collusion.
(Chapter 9) Explain how the elasticity of demand can affect the ability of firms to collude.
It’s harder to cheat without getting caught with inelastic demand because the quantity effect is larger. It’s easier to cheat without getting caught with elastic demand because the quantity effect is much smaller. In a market with inelastic demand then, it makes more sense to collude to avoid severe punishment (whereas there’s incentive to cheat in a market with elastic demand).
(Chapter 9) Explain why the bigger the increase is in demand (the more demand shifts out or to the right), the harder it can be for firms to maintain collusion.
Increases in demand makes it harder for cartels to maintain collusion because there’s more opportunity for potential entrants to participate the market. That results in more competition and less incentive for firms to stick with market share and price agreements. Effective collusion occurs at a steady, stable rate of demand growth because there are less issues with cartel agreements.
(Chapter 10) In both cases discussed in the chapter in which a large firm acted as the industry’s dominant-firm price leader and benefactor, the leader’s market dominance eventually declined. Describe a theoretical reason as to why this happened in each of these cases.
Competitors take the parametric price (as set by the dominant-firm price leader) and maximize profits by producing the competitive output. There’s no incentive for the competitor to restrict its output below the competitive output, resulting in the competitor gaining market share at the price leader’s expense.
(Chapter 10) Distinguish the difference between collusive and barometric price leadership.
Collusive price leadership:
- Dominant-price leader is a large firm
- Few large firms in a concentrated market agree on price-fixing under the expectation that others will follow and price changes will occur
- Model used to move prices to the joint-profit maximizing levels
Barometric price leadership:
- Price leader is a small and non-dominant firm
- Price changes are lead through example since leader doesn’t have control or discipline over their rivals; first move is made by price leader based on economic conditions
(Chapter 10) Using evidence presented in this chapter (10), identify two factors about an industry’s pricing behavior might lead youth suspect that the firms were fixing prices and explain how/why these facts would be associated with price-fixing.
- Price uniformity due to actions like price publishing to communicate with collusive partners
- Increased prices at different rates, showing that there’s a correlation between the price changes occurring between the different firms
(Chapter 10) Explain how a statistical analysis of pricing behavior in the canned pineapple market led to the conclusion that Dole was the market’s price leader.
Regression analysis was used to come to this conclusion. Graphically, the price sequences between the two firms moved together, where Dole was price dominant with an average of 10% higher prices than Del Monte.
Del Monte was impacted significantly by any sort of price changes from Dole, but Dole was never significantly impacted by price changes from Del Monte. Furthermore, Del Monte was never impacted much by its own lagged price (although impacted heavily by Dole’s lagged price), and Dole was impacted by its own lagged price.
