Week 6 - Market Structure and Competition

Question 1

Case Study: Airbus V Boeing

Answer 1

• Since the end of the 1990s, Airbus and Boeing possess a duopoly in the large commercial jet market.
• …..
• …..
• There is a high volume of backlog which indicates that market demand cannot be satisfied (this attracts new entrants).

Question 2

What are 2 important oligopoly models?

Answer 2

• Cournot Quantity Competition and

- Bertrand Price Competition

Question 3

What is the Cournot Competition model?

Answer 3

The Cournot competition is an economic model used to describe an industry structure in which companies compete on the amount of output they will produce, which they decide on independently of each other and at the same time.

Here each firm selects a quantity to produce and the resulting total output determines the market price.

Question 4

What is a Cournot equilibrium?

Answer 4

It is a special case of Nash equilibrium, it requires that:

• Firm 1’s optimal level of production is the best response (i.e. maximises its profits) to the level it expects firm 2 to choose.
• Firm 2’s optimal level of production is the best response (i.e. maximises its profits) to the level it expects firm 1 to choose.

The C.E. is a pair of outputs (Q1, Q2) that satisfies the following conditions:

• Q1* maximises firm 1’s profits given firm 2’s choice is Q2*
• Q2* maximises firm 2’s profits given firm 1’s choice is Q1*

The profit maximising outputs Q1* and Q2* are determined by the standard MR = MC condition.

Question 5

What results are expected when there are more sellers in the market?

Answer 5

• Lower market price
• Higher market quantity
• Lower individual firm quantity
• Lower profits

Question 6

What is the Bertrand Competition model?

Answer 6

This is where each firm selects a price to maximise its own profits, given the price that it believes the other firm will select.

• With firms producing identical products, rivalry between two firms results in the perfectly competitive outcome.
• When firms’ products are differentiated, as in monopolistic competition, price competition is less intense.

Question 7

The Cournot and Bertrand models make dramatically different predictions:

Answer 7

The Cournot and Bertrand models make dramatically different predictions about the quantities, prices, and profits that will arise under oligopolistic competition. One way to reconcile the two models is to recognize that Cournot and Bertrand competition may take place over different time frames.

• Cournot competitors can be thought of as choosing capacities and then competing as capacity-constrained price setters. The result of this two-stage competition (first choose capacities and then choose prices) is identical to the Cournot equilibrium in quantities.
• More cutthroat Bertrand competition results if the competitors are no longer constrained by their capacity choices, either because demand declines or a competitor miscalculates and adds too much capacity.
• The Cournot model applies most naturally to markets in which firms must make production decisions in advance, are committed to selling all of their output, and are therefore unlikely to react to fluctuations in the rivals’ output. This might occur if the majority of production costs are sunk, or because it is costly to hold inventories – commodities such as natural gas and copper.

Question 8

Why does the Bertrand model not fully capture the nature of price competition when there are differentiated products?

Answer 8

In many oligopolistic markets, products are close, but not perfect, substitutes. The Bertrand model of price competition does not fully capture the nature of price competition in these settings.
- When products are horizontally differentiated, a firm that lowers its price will only steal some of its rival’s customers.

Question 9

What is a Bertrand equilibrium?

Answer 9

We assume each firm’s objective is to maximize its profits. A Bertrand equilibrium occurs
when neither firm has an incentive to change its price, given the price the other firm sets.
- In other words, a Bertrand equilibrium is a special case of Nash equilibrium applied in this particular setup.

Question 10

What are strategic commitments?

Answer 10

They are decisions that have long-term impacts and are difficult to reverse.
- Investing in a new production facility is a strategic commitment
- Strategic commitments influence the choices made by rival firms
- A decision to expand capacity might deter new firms from entering the market
- Making strategic commitments could make a firm better off
As a result, game theory is used to hep figure out what decision to make.