MICRO 8

• Monopolistic competition

  Monopolistic competition desc a mkt structure with a large number of firms, each one selling a product which is an imperfect subt for the product of its rivals (product diff, not identical).
• Firms in a monopolistically competitive industry are not price-takers; If they increase prices they will lose some customers. If they drop their price they will gain some market share but will not capture the whole market.

   

  A monopolist chooses the price based on PED

   

  The number of firms is large, they can ignore any reactions of competitors when they make their output and pricing decisions.

   

  Free entry and exit

   

  Firms have a strong incentive to advertise their products
• Monopoly outcome < comp outcome, can improve with -externality. Unclear whether lower prod will entirely fix the externality. It will reduce output k inc P but if they socially eff = coincidence.

   

  A profit maximising monopoly sets output of 100 per day and a price of £10

  = Firm's MC = MR intersect at output of 100 and pt on its dd curve at this output is at £10 
• SR eqm of monopolistically competitive firm

  1. Supernormal/ abnormal (ep>0)          
  2. Normal profit (ep=0)                     
  3. Losses/ subnormal (ep<0)

  Shut down rule

  TR<SVC or P<SAVC
• Evaluation

  Monopolistically competitive firm achieves productive eff (prod output on AC) but not allocative efficiency. At profit max output lv P>MC
• Oligopoly

  Market structure characterized by there being only a few firms, usually large firms who have competitive advantage because of their fixed costs and economies of scale, hence oligopoly can be sustained.

  Large firms can exploit economies of scale and scope, which creates natural significant entry barriers.

  Products may be homogeneous or differentiated
• Oligopoly characteristics

  Firms interact strategically

  Firms are aware that their decisions depend on what the other firms are doing.

  Firms cannot make independent decisions bc it will affect that of other rival firms which will retaliate leading to counter retaliations and so on.

  Each firm is highly aware of its close competitor and no firms can make major decision regarding the price or sale of the good without considering how other firms will react.
• The basic tension is between wanting to collaborate to achieve a monopoly outcome, and the incentives to cheat on any agreement so as to raise one's own market share and profits.

  Examples of oligopolies in the UK include the supermarket industry (dominated by Tesco, Sainsbury and ASDA)
• Profit in oligopoly

  In some oligopolistic industries, firms manage to approach joint profit maximisation (in this case, the outcome in terms of market price and output is similar to pure monopoly). In others, firms compete very intensely and approach the perfectly competitive output. In the long run, profits will attract entry, unless there are natural entry barriers such as large economies of scale.
• Collusion (collusive oligopoly)

  Rather than competing one another, few large firms in the oligopoly industry can max their total profit by setting their total output as if they were monopolists. They can form cartel if collusion is legal.

  Cartel : formal collusive agreement typically involves a formal written agreement about price and production. Output must be controlled, and the mkt must be shared in order to maintain the agreed price.

  In many countries, cartel is illegal being seen by the gov as means of driving up prices and profits and against the public int
• Game Theory (non collusive oligopoly)

  Game theory is a very useful approach for analysing strategic interaction. In a game, your best move depends on what your opponent does. The players in the game try to max their own payoffs. In oligopoly, firms r players and payoffs r profits in LR

   

  In a game, a player must choose strategy (a game plan explaining how player acts or moves in each possible situation)

   

  An eqm in a game = a situation where each player plays the best strategy given the strategy of others.
• Dominant strategy - a player has a dominant strategy if one strategy is their best response, regardless of what the other player does. The best strategy remains the same no matter how competitor reacts.

        Type of Nash eqm. Any dominant strategy eqm is always a Nash eqm.
• Nash equilibrium - this is a situation where no player has an incentive to change their strategy, since they are doing as well as they can, given the strategies chosen by the other players.

        Not all Nash eqm r dominant strategy. There r games where there no dominant strategies but can attain a Nash eqm

  No Nash equilibrium in pure strategy e.g. prisoner’s dilemma
• Cournot Model

  Firms compete on output/ quantity

   

  Competing firms choose a quantity (output) to produce independently and  simultaneously (at the same time).

   

  The model applies when firms produce identical goods and it is assumed they cannot collude or form a cartel.

   

  Assumes firms have the same view of market demand, and are familiar with competitors' operating costs
• Why Cournot Model exist: In markets with limited competition such as oligopolies, firms can try to steal market share from one another by altering the market quantity. Lower output drives prices higher (law of supply and demand) so firms will consider how much quantity its competitors will produce to see how they can maximise their own profits. (same cost & dd = prod same output = +profit)
•  

  ADVANTAGE

  Yields logical results, with prices and quantities that are between monopolistic (i.e. low output, high price) and competitive (high output, low price) levels. Also yields a stable Nash equilibrium, an outcome from which neither player would like to deviate on its own.
• DISADVANTAGE

  It's unlikely that two players set a quantity strategy independently of each other (they're likely to be highly responsive to one another).

   

  Cournot argues that a duopoly could form a cartel and reap higher profits by colluding. (But game theory shows that a cartel arrangement would not be in equilibrium since each company would tend to deviate from the agreed output
• Bertrand Model

  Firms compete on prices: each firm sets the price for its product with the aim to maximise its own profit (and of course taking into account the prices set by competing firms).

   

  Firms set P= MC, so profit=0. Bc firms hv the same MC, if anyone set P>MC, the other can undercut and obtain all market demand. Therefore, will push both firms to set P=MC. Nash eqm of this model is outcome of the perfect competition.
• The result from Bertrand competition is known as Bertrand paradox. This is bc we obtain the same result as in the case of perfect competition (P=MC) even if only 2 firms in the mkt.

   

  If output easily change, Bertrand model is a good approx. of a duopoly.

  When output needs time to adjust, Cournot model is a better representation of a duopoly

   

  homogenous goods: consumers have no preference for either firm and will buy from the firm offering the goods at a lower price. homogeneous identical

   

  Example: gasoline market.
• Profits

  Theoretically, this competition in prices, provided the goods are perfect substitutes, will end with firms selling their goods at marginal costs and thus making zero profits. (called the Bertrand paradox)

   

  Suppose there are two firms that produce a homogeneous good at constant marginal costs 'C'. They are competing in Bertrand competition, so they assume goods are perfect substitutes.
• Stackelberg Leadership

  Firms choose their output sequentially rather than simultaneously.

   

  There is a market leader who chooses output level and the market follower who fulfils the leftover demand

   

  If firm A moves first, it is a Stackelberg leader

   

  The Stackelberg leader reaps higher payoffs than in Cournot competition, while the follower reaps lower profits than in Cournot competition.
• Sequential games

  1 player makes the decision, the other player knows that decision and then makes its decision. Each player’s payoff r common knowledge.