Topic 4: Market Power

Question 1

What is market power?

Answer 1

A firm’s ability to restrict competition to sustain prices above marginal cost

Question 2

Under what conditions can market power exist with multiple rival firms?

Answer 2

Differentiated products and/or markets are segmented (firms have loyal customers)

Question 3

How do managers gain market power?

Answer 3

Attempting to sustain any factors which limit competition

Question 4

What are 4 market strategies to restrict competition?

Answer 4

• Guard trade secrets
• Control of an essential resource
• Exclusive contracts and customer lock-in
• Collusion (form a cartel and act as a monopoly)

Question 5

What are 4 non-market strategies?

Answer 5

• Patent or copyright protection
• Trade regulations
• Government licensing
• Government or NGO certification (Certifies products used responsibly&raquo_space;> businesses can increase prices)

Question 6

What is a company’s optimal sales target to maximize profit?

Answer 6

Marginal Revenue = Marginal Cost

Question 7

What is a company’s optimal price given the optimal sales target?

Answer 7

Price is a markup over the cost, where markup factor depends on demand for the product (inelastic = higher markup, elastic = little markup above MC)

Question 8

How will a firm with market power set prices and output?

Answer 8

Lower than efficient levels

Question 9

What is perfect price discrimination?

Answer 9

Each consumer is charged a price equal to her willingness to pay

Question 10

How much social inefficiency occurs in perfect price discrimination?

Answer 10

Trick question! None. However, all market surplus goes to producer, so CS = 0

Question 11

What is imperfect price discrimination?

Answer 11

Groups of consumers are charged different prices

Question 12

What are some examples of imperfect price discrimination?

Answer 12

• Children/senior discounts
• Airline tickets
• Theater tickets

Question 13

What is a firm’s goal in Game Theory?

Answer 13

To maximize profit/ payoff- NOT hurt the rival

Question 14

What is a dominant strategy?

Answer 14

Strategy that results in highest payoff for a player regardless of what strategy their rival plays

Question 15

What is a secure strategy?

Answer 15

In absence of a dominant strategy, play the strategy that guarantees the highest payoff given the worst payoff (Allows firm to avoid lowest payoff)

Question 16

If a firm doesn’t have a dominant strategy, what should it do?

Answer 16

Think like its rivals to figure out what rival will do

Question 17

What is Nash Equilibrium?

Answer 17

A set of strategies in which no player can improve her payoff by unilaterally changing her strategy, given her rival’s strategy (No player will move in a different way- can be 0, 1, or many Nash Equilibriums)

Question 18

What is a Normal Form Game?

Answer 18

Simultaneous-move, one-shot games

Question 19

What is the mixed (or randomized) strategy?

Answer 19

Firm randomizes over a strategy set to not allow rivals to predict action

Question 20

What is a multistage sequential move game?

Answer 20

Summarizes the players, available info, available strategies, resulting payoffs, and sequence of moves (options tree)

Question 21

What is subgame perfect equilibrium?

Answer 21

A set of strategies that allows no player to improve his own payoff at any stage of the game by changing strategies

Question 22

What is the role of government?

Answer 22

To promote competition (US has enacted antitrust policies that make it illegal to attempt to monopolize a market)

Question 23

What did the Sherman Act make illegal?

Answer 23

Monopolizing a market, cartels, and other collusive arrangements

Question 24

What did the Clayton Act make illegal?

Answer 24

Price discrimination, also targets M&A activity that significantly lessens competition

Question 25

How does the Department of Justice evaluate the level of competition?

Answer 25

Industry sales concentrations

Question 26

What is the 4-Firm Concentration Ratio (C4)?

Answer 26

• The fraction of industry sales that goes to the four largest firms in the industry
• C4 closer to 1 signals uncompetitive industry

Question 27

What is the Herfindahl-Hirshman Index (HHI)?

Answer 27

• The sum of squared market shares of firms in industry multiplied by 10,000
• An HHI above 2,500 signals an un-competitive industry (closer to 10,000 = less competition in industry)