Topic 3 Oligopoly and Game theory Applications

Question 1

Monopoly Key points

Answer 1

1. MC=MR
2. Price or Output can be set, not 3. both
3. Production on elastic portion of demand
4. DWL
5. Supernormal profits possible in SR and LR

Question 2

Nash Equilibrium

Answer 2

Doing the best you can, given what every else is doing

Question 3

What is a pure strategy in a simultaneous game?

Answer 3

a pure strategy in a simultaneous game involves picking one action

Question 4

What is a pure strategy in a sequential game?

Answer 4

involves picking one action each node in the game tree

Question 5

Dominant Strategy

Answer 5

A strategy that is optimal for a player, no matter what strategy is adopted by that player’s competition.

Question 6

Assumptions for Bertrand Model

Answer 6

2 firms
Identical goods
Identical Constant MC
No recurring fixed costs
neither can observe what the other is doing

Question 7

In Bertrand Model what price should firms charge?

Answer 7

If Pi MC neither is best responding: each could cut price and still have Profits >0

Question 8

What are the conclusions from Bertrand Price Competition?

Answer 8

1. Bertrand Price competition eliminates market power even if there are only 2 firms in the market.
2. It results in zero profit for firms and an efficient level of output
   P=MC

Question 9

Critique of Bertrand

Answer 9

It assumes firms can produce any quantity demanded at the announced price
- Unlikely : Firms have to set some capacity and quantity then becomes a strategic variable
- It assumed one shot interaction, either simultaneously or sequentially
- most firms interact repeatedly
- possible for a scenario where P >MC
It assumes identical products
If differentiated products, could see P >MC

Question 10

Cournot Model Assumtions

Answer 10

2 firms; Each chooses capacity ( or Q) and then finds highest price to sell this Q

Question 11

Stackbelberg Model

Answer 11

A model of Quantity Leadership
Followers choose q, as a best response to leader’s q
Leader’s q set based on his forecast of followers likely responses

Question 12

How does a leader in the Stackelberg model choose his quantity?

Answer 12

Likely that followers will maximise their profits, given q choice of leader
Leader considers profit maximising problem of followers before choosing q
this is a sequential game theory problem

Question 13

When might there be no PSNE

Answer 13

rock, paper scissors

Question 14

what is a mixed strategy

Answer 14

A mixed strategy for a player is a probability distribution over the pure strategies.

Question 15

Repeated Games? What Happens in finite number of games

Answer 15

No co-operation in last round implies no co-operation.

Question 16

In infinitely repeated games?

Answer 16

there is no last time
each player has an incentive to co-operate, as non co operation can be punished
Trade offs between short term benefit and long term cost from non co operation
Coperation can emerge as an equilibrium

Question 17

Tit for Tat

Answer 17

Start by co-operating and then copy what the other player did in the previous period
Tit-for-tat punishes non-co-operation but rewards co-operation

Play nice with the other kids… but if someone hits you, you hit them back until they start being nice again