topic 2 - Markets and Strategies Flashcards
what is a monopoly
Only one firm can supply the product
- Only one player in the game
- More an optimisation problem than a game
what is perfect competition
There is a large number of firms, all selling an identical product - Firms are price takers (too small to impact the market price)
There are no barriers to entry or exit
- If profit is positive, more firms will enter - If profit is negative, some firms will exit
The free-entry/exit condition implies that each firm makes zero profit →p=c
what is Cournot Competition
Bridges the gap between monopoly and perfect competition - Both models are a special case
what is market power
Market power: Ability for a firm to influence the price at which it sells - The more competitive the market (e.g., the larger the number of firms
in Cournot), the less market power firms have
- Under perfect competition, firms have no market power, they must sell at marginal cost
how do you measure market power
The most common measure of market power is the Lerner Index - Named after Abba Lerner
What is realistic/ unrealistic about the Cournot model of competition
The Cournot model of competition provides realistic predictions - The more firms, the more competitive the market
- Monopoly and perfect competition as special cases - Often used in economic modelling
Yet, the model is often criticised
- Goods are rarely (never?) fully homogeneous
- Firms choosing quantities with the price being set by the market is a little strange
how can a corner solution occure
As quantities cannot be negative, there can be a corner solution
- One firm produces nothing and the other becomes a monopoly - This occurs when the cost difference is large
what happens when Managers want a large firm instead of maximising profit
Managers who want a large firm compete more aggressively - Firms produce more
- Price is lower
- Profit is lower
- Consumer surplus is higher (as quantity higher and price lower)
Bertrand paradox
Two firms are enough to obtain perfect competition - Very different from the Cournot prediction
- Very different from what we observe in real life
what is a key assumption of Bertrand model
Homogeneous product is a strong assumption
- It is key to Bertrand’s result
- With a homogeneous product, quantity competition is less aggressive
- In reality, it is often product heterogeneity that reduces competition
- This might explain why Cournot reaches a more realistic prediction with a less realistic model
what solves the Bertrand paradox
Differentiated products solve the Bertrand paradox
- Firms compete in prices but make profit
- The more different the products, the softer the competition
It is (usually) more realistic than traditional Bertrand and Cournot - It allows competing firms to produce differentiated products
But it is a much more tedious model
- Cournot is still widely used as it provides intuition and realistic
predictions with simple maths
arguments for/against minimum wage
Arguments in favour
- Ensures that all workers can make a decent living - Reduces inequality
Arguments against
- Goes against the freedom to contract - Creates unemployment
We will apply this topic’s tools to the issue of minimum wage
- Show that a minimum wage does not necessarily create unemployment - One possible explanation is market power
what does minimum wage do to employment
The minimum wage has increased employment! - The level of labour goes from 1/2b to 3/4b
The reason is market power
- The firm is able to keep the wage low by keeping the labour level low
- The minimum wage takes this power away by fixing the wage - Similar to regulating the price of a monopoly
Choosing the minimum wage correctly is key
- The previous reasoning holds for any minimum wage between 1/2 and 1
- Below 1/2, the minimum wage is ineffective
- Above 1, the firm goes out of business, creating unemployment
