Week 8 (GPT) Flashcards
What distinguishes an oligopoly from a monopoly?
A: An oligopoly has a small number of sellers, while a monopoly has only one seller.
What is an example of an oligopoly in the Australian market?
The airline industry, with Virgin, Jetstar, and Qantas dominating the market.
Why are there high barriers to entry in an oligopoly?
Barriers include
government licensing,
high investment costs,
economies of scale.
What does it mean for firms in an oligopoly to be interdependent?
Each firm’s actions affect the others, requiring strategic decision-making.
What is strategic interaction in an oligopoly?
Firms anticipate and respond to competitors’ actions in order to maximize profit.
What is a payoff matrix used for?
To model strategic interactions between firms in oligopolistic markets.
What is a dominant strategy?
A strategy that provides a better outcome for a firm regardless of the rival’s action.
What is the Nash Equilibrium?
A situation where no player has an incentive to change their strategy unilaterally.
Why might the Nash Equilibrium not be the best mutual outcome?
Because firms may earn less collectively compared to if they cooperated.
What is the prisoner’s dilemma in the context of oligopoly?
A situation where firms acting in their own interest leads to a worse collective outcome.
Why is collusion difficult in oligopoly markets?
It is illegal and firms have an incentive to cheat for individual gain.
What is a cartel?
A formal agreement between firms to coordinate pricing and output, often illegal.
What happens in a coordination game?
Firms or individuals benefit most by coordinating their actions rather than acting independently.
What is an example of a coordination game outside business?
Deciding which side of the road to drive on – all must choose the same for safety.
What does a strategy profile denote in game theory?
The set of strategies chosen by all players in the game.
How do firms decide in a simultaneous game?
They make decisions at the same time without knowing the other’s choice.
Why does advertising in oligopoly often lead to market failure?
Because mutual advertising increases costs with no added market share, reducing profits.
What is a key feature of the Nash equilibrium in the advertising game?
Both firms advertise, leading to reduced collective profit despite the best individual strategy, as both advertising cancels out and they will both have to inatate to advertise inorder to not b under cut by the competitor, as a result they both loss money due to unessaey advertising.
What is the invisible hand principle, and how does oligopoly differ?
Normally, pursuit of self-interest leads to optimal outcomes, but in oligopoly, it may not.
What are the legal implications of cartel behavior?
Cartels are prohibited under competition law, and members cannot legally enforce agreements.
What does a 2x2 payoff matrix in game theory represent?
It shows the outcomes for two players, each choosing between two strategies, with each cell showing their respective payoffs.
In a payoff matrix, what do the rows and columns represent?
The rows represent one firm’s possible strategies, while the columns represent the other firm’s possible strategies.
What does it mean when a strategy is dominant in a payoff matrix?
It yields a higher payoff for a player no matter what the other player chooses.
How can you visually identify a dominant strategy in a matrix?
By comparing payoffs across a row or column and seeing which choice always gives the higher number.
Where is the Nash equilibrium found on a payoff matrix?
It is the cell where both players’ strategies are the best responses to each other, and neither has an incentive to deviate.
Why is the bottom-right cell often the Nash equilibrium in a price war matrix?
Because both firms choose to lower prices due to dominant strategies, even though it leads to reduced profits.
In a graph showing profits on a payoff matrix, what do higher payoffs indicate?
More favorable outcomes for the firm—usually shown by larger numbers in the matrix.
What is the significance of the top-left cell (both firms charge a high price) in a price war matrix?
It represents the highest collective profit, but it’s unstable due to incentives to undercut.
How does a payoff matrix model the prisoner’s dilemma in economics?
It shows how rational self-interest leads both firms to worse collective outcomes (e.g., both undercutting prices).
How does the difference in utility between players affect the likely outcome in a coordination game?
The player with the stronger preference is more likely to influence the joint decision.
What does a coordination game payoff matrix visually highlight about cooperation?
That mutual cooperation yields better outcomes than miscoordination, even if preferences differ.
In game theory, how is graphical representation useful for firms?
It helps visualize strategic decisions and anticipate competitor responses.
What does a Nash equilibrium graphically show about market behavior?
It predicts where firms will settle given rational, self-interested strategies without communication.
What does equilibrium in a market mean?
It’s the point where marginal benefit (demand) equals marginal cost (supply), maximizing total surplus.
What assumption is required for market equilibrium to maximize utility?
That demand reflects true marginal benefit and supply reflects true marginal cost.
What is an externality?
A cost or benefit incurred by a third party who is not directly involved in the transaction.
What is a positive externality?
A benefit enjoyed by someone who is not the consumer or producer of the good.
What is a negative externality?
A cost suffered by someone who is not the consumer or producer of the good.
Give an example of a positive consumption externality.
Vaccination, which benefits others by reducing disease spread.
Give an example of a negative consumption externality.
Smoking, which harms others through second-hand smoke.
Give an example of a positive production externality.
Beehives near orchards providing pollination services to neighboring farms.
Give an example of a negative production externality.
A factory polluting a river, harming people not involved in its production.
What is the Coase Theorem?
If transaction costs are low, private bargaining will lead to an efficient outcome regardless of who has property rights.
What causes a product to be under-supplied in the presence of a positive externality?
The market only considers private benefit, not social benefit.
What causes a product to be over-supplied in the presence of a negative externality?
The market only considers private cost, not social cost.
How can governments correct positive externalities?
By subsidizing consumers or producers to increase production or consumption.
How can governments correct negative externalities?
By taxing goods to internalize the external cost.
What is deadweight loss in the context of externalities?
The loss of social surplus when market output is not socially optimal due to unaccounted external costs or benefits.
In a graph with a positive consumption externality, what happens to the demand curve?
It shifts outward (right/up) to reflect the social benefit.
What does the area between the private and social demand curves represent in a positive externality graph?
The external benefit not captured by the market.
Where is the efficient output in a positive consumption externality graph?
Where the social demand curve intersects the supply curve.
In a negative production externality graph, what happens to the supply curve?
It shifts upward (left) to reflect the true social cost.
What does the vertical distance between the private and social supply curves represent in a negative externality graph?
The external cost per unit.
What is the result of ignoring a negative externality in the supply curve?
The good is overproduced, leading to deadweight loss.
In a graph with deadweight loss due to a negative externality, where is the deadweight loss located?
Between the social marginal cost and the demand curve, beyond the socially optimal quantity.
How does a subsidy for a good with a positive externality affect the graph?
It shifts the demand or supply curve to increase output toward the socially optimal level.
How does a tax for a good with a negative externality affect the supply curve?
It shifts the supply curve upward, decreasing output toward the socially optimal level.
What do parallel supply curves in an externality graph signify?
The difference between private and social costs or benefits remains constant per unit.
Where is the deadweight loss in a graph with under-consumption due to positive externalities?
Between the demand curve and the social demand curve, up to the efficient quantity.
What is the market equilibrium point in a graph with no externalities?
The intersection of the private demand and private supply curves.
What is the socially optimal equilibrium in the presence of an externality?
The intersection of the social cost or social benefit curve with the opposing market curve.
How does government subsidy move equilibrium in a positive externality scenario?
It increases quantity and lowers or maintains price depending on whether it’s given to the buyer or seller.
How does government tax shift equilibrium in a negative externality scenario?
It raises the price and reduces quantity, moving the market toward the social optimum.
