Topic 4: Market Power Flashcards
What is market power?
A firm’s ability to restrict competition to sustain prices above marginal cost
Under what conditions can market power exist with multiple rival firms?
Differentiated products and/or markets are segmented (firms have loyal customers)
How do managers gain market power?
Attempting to sustain any factors which limit competition
What are 4 market strategies to restrict competition?
- Guard trade secrets
- Control of an essential resource
- Exclusive contracts and customer lock-in
- Collusion (form a cartel and act as a monopoly)
What are 4 non-market strategies?
- Patent or copyright protection
- Trade regulations
- Government licensing
- Government or NGO certification (Certifies products used responsibly»_space;> businesses can increase prices)
What is a company’s optimal sales target to maximize profit?
Marginal Revenue = Marginal Cost
What is a company’s optimal price given the optimal sales target?
Price is a markup over the cost, where markup factor depends on demand for the product (inelastic = higher markup, elastic = little markup above MC)
How will a firm with market power set prices and output?
Lower than efficient levels
What is perfect price discrimination?
Each consumer is charged a price equal to her willingness to pay
How much social inefficiency occurs in perfect price discrimination?
Trick question! None. However, all market surplus goes to producer, so CS = 0
What is imperfect price discrimination?
Groups of consumers are charged different prices
What are some examples of imperfect price discrimination?
- Children/senior discounts
- Airline tickets
- Theater tickets
What is a firm’s goal in Game Theory?
To maximize profit/ payoff- NOT hurt the rival
What is a dominant strategy?
Strategy that results in highest payoff for a player regardless of what strategy their rival plays
What is a secure strategy?
In absence of a dominant strategy, play the strategy that guarantees the highest payoff given the worst payoff (Allows firm to avoid lowest payoff)
If a firm doesn’t have a dominant strategy, what should it do?
Think like its rivals to figure out what rival will do
What is Nash Equilibrium?
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)
What is a Normal Form Game?
Simultaneous-move, one-shot games
What is the mixed (or randomized) strategy?
Firm randomizes over a strategy set to not allow rivals to predict action
What is a multistage sequential move game?
Summarizes the players, available info, available strategies, resulting payoffs, and sequence of moves (options tree)
What is subgame perfect equilibrium?
A set of strategies that allows no player to improve his own payoff at any stage of the game by changing strategies
What is the role of government?
To promote competition (US has enacted antitrust policies that make it illegal to attempt to monopolize a market)
What did the Sherman Act make illegal?
Monopolizing a market, cartels, and other collusive arrangements
What did the Clayton Act make illegal?
Price discrimination, also targets M&A activity that significantly lessens competition
How does the Department of Justice evaluate the level of competition?
Industry sales concentrations
What is the 4-Firm Concentration Ratio (C4)?
- The fraction of industry sales that goes to the four largest firms in the industry
- C4 closer to 1 signals uncompetitive industry
What is the Herfindahl-Hirshman Index (HHI)?
- 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)
