ECP 3403 Final Exam (Combined Quizlet)
What is a "grim trigger" strategy in an infinitely repeated game?
"I will cooperate until I see P2 defect, after which I will defect forever" Basically, player cooperates in the 1st round and in the following rounds as long as the opponent does not defect, if the other player defects they will now defect forever
How might a retail price maintenance with a price floor help a manufacturer solve the problem of underprovision of service identified above? How about exclusive territories?
- An RPM agreement might fix this issue bc although the retailers still might provide less services than the manufacturer would like, their aims are no longer reduced as a result of offering services, so they have less to lose by offering services. - The producer can limit their downstream competition by granting exclusive territory, meaning the whole issue of under provision described above never even happens
How do we resolve the merger paradox? What does this tell us about why firms choose to merge?
- We can resolve it by saving on fixed costs, decreasing marginal cost, and using production more efficiently
Factors that limit price discrimination
- iminited information on consumer preferences - possibility of resale - consumer outrage over "unfair prices"
How might a retail price ceiling help a manufacturer to solve the doublemarginalization problem?
-A retail price ceiling is a mechanism that aids manufacturers in mitigating the double marginalization problem. -A retail price ceiling can alleviate the double marginalization problem by capping the maximum price that retailers can charge for a product. This prevents excessive markups at each level of the supply chain, fostering a more efficient pricing structure. Additionally, the price ceiling curbs free-riding by ensuring that retailers cannot exploit the manufacturer's brand and marketing efforts without contributing proportionately. By promoting collaboration and fair pricing, this approach benefits both the manufacturer and consumers, enhancing overall market performance.
How might downstream competition among retailers help a manufacturer tosolve the double marginalization problem?
-Downstream competition among retailers can help a manufacturer solve the double marginalization problem by encouraging retailers to lower their markups, leading to more competitive prices for consumers. -In simple terms, let's say a manufacturer produces a product and sells it to multiple retailers. If these retailers are competing with each other to attract customers, they are motivated to offer lower prices. To stay competitive, each retailer will try to minimize their markup on the manufacturer's product. -This downstream competition effectively addresses the double marginalization problem because retailers are less likely to impose high markups. Instead, they aim for a balance between offering an attractive price to consumers and maximizing their own profit. As a result, the final price that consumers pay for the product is likely to be lower compared to a situation where retailers have more pricing power.
Briefly describe the Joint Executive Committee railway cartel. How does this cartel illustrate the principles of collusive behavior we discussed in lecture? Pay special attention to the role of foreseen versus unforeseen demand shocks in triggering price wars.
-Each member allocated a target market share— when new firms enter JEC redivides shares -JEC office took accounts to determine total quantity transported -Total demand was quite variable: Actual market shares could be pretty unpredictable in the short run -Uncertainty in demand occasionally generated price wars since some firms suspected rivals of cheating JEC's main competitor was steamers on the Great Lakes: Lakes were only open in the summer.... This is a predictable change in demand and shouldn't produce price wars 12.Why might collusive firms adopt policies promoting price transparency? Can you give examples where price transparency appears to have facilitated collusive outcomes?
What is the difference between explicit and implicit collusion? From an economic standpoint, does it matter how firms arrive at a collusive equilibrium? How about from a legal standpoint? What practices have firms used to facilitate collusion? What is a program that antitrust/competition authorities have used to make collusive firms reveal their practices?
-Explicit: Requires a conspiracy to increase prices involving intent/ communication/ coordination between firms (ILLEGAL) -Tactic: Firms arrive at a collusive equilibrium, without explicit conspiracy/ communication/ coordination -Often facilitated by practices as price transparency -Antitrust authorities can attempt to prohibit potential coordinating practices but proving intent is difficult Economically it doesn't matter how firms arrive at a collusive equilibrium, but legally it matters a lot.
Why, in general, does the number of firms in a market increase less than pro-portionally with market size? What is the key economic principle driving this?
-Increasing the number of firms increases price competition: if prices were fixed, then doubling the market size would double the number of firms (since more firms implies more price competition, the equilibrium number of active firms increase less than proportionally with market size)
Why might industries with asymmetric firms have a harder time colluding ? How might multi-market contact alleviate this effect?
-Suppose F1 has a low marginal cost in Market 1, While F2 has a low marginal cost in market 2 -Considering each market individually this asymmetry would make cartel breakdown more likely -But multi market contact alleviates this effect: The efficient cartel involves FQ serving all of market 1 at market 1's monopoly price, while F2 serves all of Market 2 at market 2's monopoly price -Attempts by F1 to undercut F2 in Market 2 can be punished by F2 undercutting F1 in market 1.
What is the Structure-Conduct-Performance paradigm? What is meant by"Structure"? What is meant by "Conduct"? What is meant by "Performance"?
-The Structure-Conduct-Performance (SCP) paradigm is an economic framework used to analyze and understand the relationship between market structure, the conduct of firms operating in that market, and the market's overall performance. -In this context, "Structure" refers to the characteristics of the market, such as the number and size of firms, barriers to entry, and the degree of product differentiation. -"Conduct" relates to the behavior of the firms operating in the market, including pricing strategies, advertising, and levels of competition. -"Performance" encompasses the outcomes of the market, such as efficiency, profitability, and consumer welfare, reflecting how well the market functions based on its structure and the conduct of its participants.
What is the"concentration ratio", and what is the "concentration puzzle"? Why is it a puzzle?
-The concentration ratio is a measure in economics that indicates the proportion of total industry output or sales that is accounted for by a specified number of the largest firms in the industry. It is often expressed as a percentage. -The concentration puzzle refers to the observation that in some industries with a high concentration ratio (few large firms), there is intense competition, while in other industries with low concentration, competition may be relatively weak. -This is a puzzle because one might expect a straightforward relationship between market concentration and the level of competition, but real-world dynamics can lead to variations, challenging traditional expectations.
How might franchise fees (or two-part prices) help a manufacturer solve the double marginalization problem?
-The double marginalization problem occurs when both a manufacturer and a retailer add their own markups to the price of a product, leading to higher overall prices for consumers. Franchise fees, or two-part prices, can help solve this problem by changing the way the manufacturer and retailer set their prices. -In simple terms, imagine a scenario where a manufacturer produces a product and sells it to a retailer. Instead of the manufacturer setting a high wholesale price and the retailer adding a markup on top of that, the manufacturer charges a lower wholesale price along with a fixed franchise fee. This fee is a kind of upfront payment that the retailer pays to the manufacturer for the right to sell the product. -By incorporating franchise fees, the manufacturer incentivizes the retailer to reduce its markup on the product's retail price. This is because the retailer has already paid a fixed fee upfront, and now the retailer wants to maximize its profit by keeping the retail price competitive. As a result, the overall price that the consumer pays can be lower compared to a situation with double marginalization.
What is the key difference in predictions between industries with exogenous sunk costs and industries with endogenous sunk costs? How do endogenous sunk costs help us to resolve the concentration puzzle?
-The key difference in predictions lies in how industries with exogenous sunk costs and endogenous sunk costs handle competition. In industries with exogenous sunk costs, higher concentration may lead to less competition. However, in industries with endogenous sunk costs, higher concentration might result from firms investing more in innovation and efficiency, fostering competition. -Endogenous sunk costs help resolve the concentration puzzle because they indicate that high concentration doesn't necessarily mean weak competition; it can reflect firms investing in ways that make the market more competitive and dynamic.
What does a HHI of 10000 mean? What does a HHI close to zero mean?
1000 means monopoly, close to 0 means perfect competition
What is public policy towards market foreclosure? Why are cases of abuse of dominant position difficult?
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What is a strategy?
A complete contingent plan for how to play the game, specifying which action to take at every point they might have the opportunity to play.
How do prices, quantities, and profits change in the Cournot model as the number of firms in the market increases? In particular, how does the Cournot price compare to the monopoly price, how does it compare to the competitive price, and how does this change as the number of firms increases?
A cournot duopoly yields higher prices and lowe output than under perfect competition, But lower prices and higher output than under a monopoly. Q^d > q^m ——- Pd < p^m When more firms enter the market: - q gets closer to 0 (firm becomes small relative to the market - p gets closer to marginal cost - profit gets closer to 0 (each firm earns 0 economic profit)
What are games, and why might we be interested in studying them?
A game consists of a set of players, a set of rules, and a set of payoff functions which define the profit each player gets as a result of each combination of strategies. We are interested in studying them so that we can provide concepts to forecast the outcome of situations where agents interact strategically.
What does a high Lerner index (L ≈ 1) tell you?
A high Lerner index means that the firm is a price-setter and has high market power
What is the connection between the Lerner index and the price elasticity of demand?
A low Lerner index indicates high price elasticity of demand. A high Lerner index indicates low price elasticity of demand.
What does a low Lerner index (L ≈ 0) tell you?
A low Lerner index means that the firm is a price-taker and has low market power
What is the Nash equilibrium of the Bertrand game? Why, intuitively, is this the equilibrium? What happens if a firm tries to set a non-equilibrium price?
A pair of strategies is a Nash equilibrium if each player is playing the best response to the other. The unique equilibrium of the Bertrand game involved both firms setting prices at marginal cost. If any of the assumptions are dropped the equilibrium changes and we can no longer obtain the extreme Bertrand result.
What rule characterizes the optimal quantity choice of a price setting firm?
A price-setting firm will produce q^m where MR(q^m) = MC(q^m)
What rule characterizes the optimal quantity choice of a price taking firm?
A price-taking firm will produce where p = MC
How do the price and quantity choices of a price setting firm differ from those of a price taking firm?
A price-taking firm will supply the quantity such that price equals marginal cost. A price-setting firm will supply the quantity such that marginal revenue equals marginal cost (This leads the firm to produce less and set a higher price than it would as a price taker.)
What is a two-part tariff?
A two-part tariff is a form of pricing in which consumers are charged both an entry fee (fixed price) and a usage fee (price per-unit).
In the context of industrial organization, what is the difference between a vertical relationship and a horizontal relationship? Can you give examples of each?
A vertical relationship is like teamwork between companies at different steps of making or selling a product. For example, a shoe company owning a factory that makes its shoelaces is a vertical relationship. On the other hand, a horizontal relationship is when companies are more like rivals, doing similar things in the same stage of making or selling products. Think of two smartphone companies competing - that's a horizontal relationship. Vertical is like working together, and horizontal is like competing.
What is a perfectly competitive industry?
An industry with many small firms, all of them are price takers, homogenous products that have the same characteristics, perfect information and no externalities, free entry into the industry, no artificial barriers to entry
Optimal two-part tariff with selection on indicators: What access fee does the firm charge?
As long as CS ≥ FH, the firm can charge whatever. CS = Consumer Surplus FH = The Firm's Access Fee
From the perspective of firms, what is the best collusive outcome in a repeated Bertrand game? Describe strategies for each firm that could sustain this outcome as an equilibrium. What role does the value of the future play in determining whether collusive behavior is possible?
As long as firms are not too impatient, both firms charging the monopoly price can be a (collusive) equilibrium outcome -Even under Bertrand competition where absent collision firms would charge the competitive price -Factors increasing value of the future make collusion easier: Growing markets, frequent price changes, low interest rates -Factors decreasing value of the future make collusion harder: Shrinking markets, high interest rates, high risk of obsolescence -Collusion is harder among more firms -collusion is easier among similar firms -Collusion is easier with multimarket contact.
Briefly describe the Bertrand model. What are the key assumptions of the Bertrand model? What is the timing of the game? What is the strategy variable for each firm?
Assumes that firms first choose prices and then produce whatever quantity the market demands. Consists of two firms with the same constant MC, selling homogenous products. Assumptions: 1. No product differentiation (only prices matter) 2. Symmetric costs: If F1 has lower marginal cost than F2, F1 will produce at F2's MC 3. No capacity constraints: each firm can serve the whole market at constant marginal cost 4. No dynamic element so no possibility of collusion
Why would a firm want to discriminate through self selection?
Because they can use it to sort out the high-value consumers from the low-value ones
Compare and contrast the Bertrand and Cournot models. What is the key difference in assumptions between these models? What are the key differences in predictions?
Bertrand: - homogenous products - no capacity constraints - one-time interaction between firms (non-dynamic) - output can adjust quickly Cournot: - capacity constraints - output inventory can't adjust quickly (but prices can) - quantity decisions are long-term decisions and need to be made first - price decisions are short-term decisions (they're made after output decisions)
What is a "best response" function?
Best response function answers the following question: For each possible set of strategies other players could choose, what strategy generates the highest payoffs for player i
Consider the infinitely-repeated Bertrand game we discussed in lecture. What is the competitive equilibrium in this infinitely repeated Bertrand game? In what sense is this competitive equilibrium a bad outcome for firms? Is it also a bad outcome for consumers?What about for society as a whole?
Both firms price at marginal cost and earn zero profit forever
What is bundling? How can bundling be used as a market foreclosure strategy?
Bundling: combining multiple products or services and selling them as a package Bundling increases the firm's market share substantially, therefore increasing profit while reducing the competitor's profit
What do we mean when we say an industry is "collusive"? What is the key difference between collusion and competition? In what sense is collusive behavior a departure from static Nash equilibrium play?
Collusive behavior means that firms are playing cooperatively(not playing their Nash equilibrium strategies) Each firm is not playing a (static) best response to the actions of its rivals. In competition firms operate independently, with collusion firms in the oligopoly market structure try to invite new entrants into the market to make it more competitive
What are price wars, and why might they arise in a well-functioning cartel? What is the role of demand uncertainty in triggering price wars?
Companies within an industry engage in aggressive pricing strategies (cutting prices below competitors)
What does deadweight loss measure, and how is it calculated?
DWL measures the reduction in total surplus as a result of firms choosing to not produce units for which WTP > MC. It's the area under the demand curve, above the line of MC, and to the right of the line of quantity demanded.
What is the difference between a movement along the demand curve and a shift in demand?
Demand curve movement refers to changes in price that affect the quantity demanded. A demand curve shift refers to fundamental changes in the balance of supply and demand that alter the quantity demanded at the same price.
In lecture, we discussed a "double marginalization problem" which could arise between an upstream producer and a downstream supplier. What is double marginalization, and why might it be bad for both firms?
Double marginalization occurs when two firms in different points of the supply chain only care about their profits and they each behave as a monopoly. Double marginalization reduces profits and harms consumers because they face increasing prices.
What is the difference between exogenous sunk costs and endogenous sunk costs?
Exogenous sunk costs: fixed costs that must be paid by any firm to enter the industry. Endogenous sunk costs: investments which a firm may choose to incur to enhance its competitive position in the industry (ex: advertising)
Describe each firm's best response function in the Bertrand model.
F2's optimal price depends on what price it believes F1 will choose. F2 will set a price just below what they believe F1 will set. This means that F1 captures none of the market when F2 is priced lower. Therefore F1 should price slightly lower than F2 as long as the price is at MC.
What is the principle of backward induction, and how do you apply it? How does the principle of backward induction deal with the problem noted above? (I.e., in what sense does backward induction rule out non-credible threats?)
For each node in the last stage of the game, find the optimal choice at this node for the player acting at this stage. Then for each of these nodes, substitute the payoffs corresponding to this choice for the node itself. Finally,move backward and apply the same principle at the next to last stage and so on until the game is solved. This method can only apply in its simplest form when players take turns moving, but sometimes the last period is a game in itself where agents play simultaneously, we then would use sub game perfect Nash equilibrium.
Why might it benefit an economy to provide patents? Explain, with referenceto the types of efficiency identified in lecture. What key tradeoff (between types of efficiency) do patents involve?
Giving patents helps inventors because it protects their creations, encouraging them to come up with new ideas. This benefits the economy by promoting progress and cool inventions. But, there's a tradeoff - while patents make sure people keep inventing things, they also mean fewer companies can use those inventions right away, which might make things a bit more expensive for everyone.
What is the economic meaning of the incentive constraint?
High-end customers need to prefer (or be incentivized) to buy high-end products
General Premise of the Stackleberg Model
If a firm (Firm 1) is able to predict that another firm (Firm 2) will be entering the market, then Firm 1 will corner as much of the market as possible, to prevent Firm 2 from gaining access to that portion of the market.
How does the pricing rule compare to that used by a standard monopoly? (Note: the takeaway here is that the two rules are very similar. A firm using selection on indicators essentially acts as a monopolist in each market separately. Once we know how to solve monopoly problems, we know how to price using selection on indicators.)
If the firm can set prices using selection by indicators, it should charge lower prices in the market segments with more elastic demand
How do economic outcomes (producer surplus, consumer surplus, quantity) under perfect price discrimination differ relative to the same outcomes under simple monopoly?
If you can perfectly price discriminate, there is zero consumer surplus because each individual pays their exact willingness to pay. It's seemingly efficient because TS is maximized, but it's distributed differently, with the producers taking most if not all of the surplus
What is the connection between elasticity of demand and revenue?
If |E| > 1, then an increase in price leads to a decrease in total revenue. If |E| < 1, then an increase in price leads to an increase in total revenue.
How do strategies in a sequential game differ from strategies in a simultaneous game?
In a sequential game the strategy for player (i) is a complete contingent plan for how to play the game, specifying what action to take at every decision node. While in a simultaneous game there is only one decision node, so to specify a strategy it is enough to indicate an action.
Consider the following industries: sugar, flour, soft drinks, breakfast cereal. In which of these industries would we expect concentration to approach zero in large markets? In which would we expect concentration above zero in large markets? Why? [Hint: Think of advertising as an endogenous sunk cost.]
In large markets, we would expect concentration to approach zero in industries like sugar and flour, where products are similar and many competitors can enter easily, leading to more competition. On the other hand, in industries like soft drinks and breakfast cereal, concentration might be above zero in large markets because firms invest heavily in advertising as an endogenous sunk cost. This investment creates brand loyalty and makes it harder for new competitors to enter, resulting in higher concentration.
How do you represent the payoff matrix of a sequential game? How do you represent a sequential game in game tree form?
In the game tree Decision nodes are placed where one agent or the other must make a choice
In lecture, we saw that in the long run, a perfectly competitive industry will lead to production at minimum average cost. Explain how long-run firm entry and exit gives rise to this result. What type of efficiency does this represent?
In the long run, as firms enter the market, they will not be able to produce much profit due to the fact that their incumbent competitors are all selling their products for less money than the new firm. That new firm will then be forced to conform to the status quo / low price that the incumbent firms have been selling at, or they will be forced to leave the market due to lack of profit. This would lead to productive efficiency
In lecture, we saw that in the long run, a perfectly competitive industry will lead to production at minimum average cost. Explain, in words, how long-run firm entry and exit gives rise to this result. What type of efficiency does this represent? write this answer in a few sentences
In the long run, in a perfectly competitive industry, firm entry and exit contribute to the attainment of minimum average cost. When firms make economic profits, new entrants are attracted, increasing industry supply and lowering prices. Conversely, if firms incur losses, some exit, reducing supply and causing prices to rise. This dynamic process continues until all firms earn zero economic profit, resulting in production at the minimum average cost. This represents both allocative and productive efficiency, as resources are allocated based on consumer preferences, and firms operate at their most cost-efficient scale.
In what sense is a perfectly competitive industry efficient in the short run, and why?
In the short run, competitive firms set p = MC and produce the quantity which maximizes total surplus (using allocative efficiency)
Teva and Turing are both accused of taking actions which increase the prices of prescription pharmaceuticals. How do these actions affect producer surplus, consumer surplus, and total surplus?
Increase producer surplus, decrease consumer surplus, decrease total surplus due to Dead Weight Loss
What are some strategies that incumbent firms use to raise entrant firm's costs?
Incumbent and buyer sign exclusive contract, i.e. colluding and setting the entry "price", i.e. the fee the buyer must pay the incumbent to break the exclusive contract
Briefly describe the Cournot model. What are the key assumptions of the Cournot model? What is the strategy variable for each firm? What is the timing of the game?
Interpret firms as choosing quantity rather than price. The timing: two firms F1 and F2 simultaneously choose quantities. After both firms choose their quantities the market price is determined to clear the market given the total quantity produced. (Both firms produce and sells its quantity at the market price which depends on the total quantity.
What is a Nash equilibrium?
It is the combination of strategies such that no player would like to change their mind if the other player does not change either (stable point). We find Nash equilibrium by analyzing each player's best response function.
Why do we care about Nash equilibria?
It's useful to understand how firms interact with eachother, what yields the highest profit, and what moves other people will make.
What is the best response function for Firm 1 in the Cournot model? Whatis the best response function for Firm 2? Plot these best response functionson the same graph, with q1 on the vertical axis and q2 on the horizontal axis.(Pay careful attention to the intercepts of each best response function: what isF1's best response when F2 produces 0, and what quantity choice q2 leads F1to produce zero?) Where on this graph is the Nash equilibrium?
Look up how to do it
For a given quantity q2 produced by Firm 2, graphically illustrate (1) themarket-level demand curve facing both firms, (2) the residual demand curvefacing Firm 1, and (3) Firm 1's best response quantity choice to Firm 2's quan-tity choice q2. (Hint: Your answer should contain a standard monopoly graphagainst residual demand, including F1's marginal revenue and F1's marginalcost, with F1's optimal quantity where these intersect)
Look up the graph and how to do it
Suppose the upstream firm (manufacturer) merges with the downstream firm(retailer). The integrated firm now acts as a standard monopolist, producingits product at price c and selling it directly to consumers. Graphically illustratethe retail price, quantity sold, and profit for the vertically integrated firm. Howdo these compare to the retail price, quantity sold, and profit arising when themanufacturer and retailer are separate firms as illustrated above
Look up the graph for this answer
Consider an upstream firm (manufacturer) who produces a good at constant marginal cost c, then sells this good to a downstream firm (retailer) at wholesaleunit price pu. The downstream firm (retailer) then costlessly resells the goodto consumers at retail price pd.Suppose that both the upstream firm and the downstream firm are monopolists in their respective markets. On one graph, illustrate (i) the market demandcurve, (ii) the marginal revenue curve for the downstream monopolist, (iii)the marginal revenue curve for the upstream monopolist, and (iv) the man-ufacturer's marginal cost. Where, on this graph, is the final quantity sold?Graphically illustrate pu, pd, and the profits for each firm.2
Look up the graph learn how to graph it
What capacity level should an incumbent firm adopt, based on the level of entry costs? Where do we see these strategies at play in real-world industries?
Low entry costs: the incumbent should choose capacity taking into account the entrant's best response Intermediate entry costs: the incumbent should choose capacity large enough to induce the entrant not to enter Very high entry costs: the incumbent should set monopoly capacity and ignore the threat of entry Real-world industry examples: ?
Why does market power lead to DWL?
Market power leads firms to set higher prices and produce lower quantities
What is the "merger paradox"?
Mergers are generally unprofitable unless most firms merge. Otherwise, the un-merged firms will simply adapt their strategies to the new environment and the merger is no longer profitable.
What is meant by non-linear pricing?
Non-linear pricing occurs when sellers set a combination of a fixed fee and a price per unit (ex. A gym membership with a monthly fee and a zero unit price).
What is price discrimination through selection on indicators (market segmentation)?
Occurs when a seller divides buyers into groups and charges a different prices to each group
What is price discrimination through self selection?
Occurs when a seller indirectly sorts consumers into groups by offering different deals or packages
Calculating Price Elasticity of Demand (2 Options)
Option 1: (Q2 - Q1) / Q1 / (P2 - P1) / P1 Option 2: (Change in Q / Change in P) / (P1 / Q1)
What is the economic meaning of the participation constraint?
People need to believe that they're better off participating in the market / buying something rather than not participating in the market at all
Are those areas in which a perfectly competitive industry might be inefficient?
Perfectly competitive markets may not always work perfectly. For example, companies might not invest enough in new ideas because they don't have much control over prices. There could be overlooked side effects, like pollution. Sometimes, people and businesses might not have all the right information, leading to mistakes in how resources are used. Also, perfect competition assumes everyone is equal, but in reality, some people have more opportunities and money than others.
What is predatory pricing? What are some explanations of predatory pricing?
Predatory pricing: pricing below cost with the intent of driving the rival out of the market Good for consumer in the short term: lower prices; bad in the long term: the monopolistic firm that was predatory now has more market control and can raise prices higher Example: ?
What are the three main areas of antitrust enforcement?
Price fixing, merger policy, and abuse of dominant position
Suppose that the Department of Justice (DOJ) is evaluating a merger between two firms, which reduces the marginal costs of the merged firms, but also reduces the number of firms in the market from four to three. What is the key tradeoff the DOJ must weigh in evaluating this merger? I.e., why might such a merger be good for society? And why might it be bad?
Pro of the merger (for the firm): marginal costs are decreased - Lower marginal cost might mean that consumers face lower prices (pro) Cons of the merger (for consumers): less options to choose from in the market - This is a pro for the firm
We identified several examples of firms which deliberately damaged their products (Intel 486SX versus 486DX, IBM LaserPrinter E). How does price discrimination explain this behavior?
Producers want to see if they can sell you a cheaper product, so they can get information from you on what you're willing to buy, leading you to a sort of self-selection
What is product proliferation? What are some examples of industries where this strategy has been used successfully to keep potential entrants out of the market?
Product proliferation: a strategy in which you market many variations of the same product Example: breakfast cereals— they successfully keep out potential entrants by increase the number of varieties so as to leave no room for potential entrants
How might repeated interaction allow firms to sustain collusive behavior? Explain (without solving in detail) using a simple example.
Repeated interaction can sustain cooperation, even in a game where the static Nash equilibrium is to defect. Example: -P1 cooperates as long as P2 cooperates, both players will cooperate forever -each round where both cooperate, each get a payoff of 5 -Each round, both players expect 10 more rounds -Each round the expected future payoff to P2 from cooperating forever is 10 x 5= 50
What is Retail Price Maintenance? Why might a manufacturer wish to employretail price maintenance with a price ceiling? Why might a manufacturer wishto employ retail price maintenance with a price floor?
Retail Price Maintenance (RPM) is when a manufacturer sets the price at which retailers must sell their products. If a manufacturer wants to employ RPM with a price ceiling, it means they want to make sure the price doesn't go above a certain limit. This can help maintain affordability for customers. On the other hand, if a manufacturer employs RPM with a price floor, they are ensuring that the price doesn't go below a certain minimum. This can help maintain a certain level of profit for both the manufacturer and the retailers.
What is the pricing rule for a firm using selection on indicators?
Sellers divides buyers into groups, charges a different price to each group
What is the difference between a simultaneous game and a sequential game?
Simultaneous Game: Uses the grid to decide the Nash Equilibrium. Players choose their options without knowing the other players' decisions. Sequential Game: Uses the decision tree and reverse induction to find Nash Equilibrium. The secondary player reacts to the choices of the first player when making their decisions.
Assuming that market concentration, as measured by the HHI, is a good measure of market power, about which of these potential mergers should the DOJ be more concerned? Three Firms: HHI = 3800 F1 merges w/ F2: HHI = 6800 F2 merges w/ F3: HHI = 5000
The DOJ should be more concerned with the market in which F1 merges with F2 (HHI is highest in that scenario, i.e. closest to monopoly)
What is the Lerner Index and how does it measure market power?
The Lerner index measures a firm's market power in terms of its price-cost margin. L measures the fraction of price that is markup.
What is the "discount factor" and what does it measure? What economic considerations enter the discount factor measure?
The discount factor δ∈(0,1) describes how much firm's value the future -Interest rates: Lower interest rates—> higher δ -Length of relevant period: Shorter periods—> higher δ -Possible "end of game": Will a new technology render firms in the current industry obsolete?
What is the goal of antitrust policy?
The goal of antitrust policy is to promote effectiveness of competition and mitigate market failures due to market power
How does intensity of competition affect the relationship between the size of a market and the number of firms in the market?
The intensity of competition can influence how many firms are in a market relative to its size. In simpler terms, when competition is high, you might see more firms in the market, even if it's large. This is because businesses are actively trying to offer better products or lower prices to attract customers. On the other hand, in a less competitive market, you might find fewer firms, even if the market is big, because they face less pressure to differentiate or improve. So, competition plays a role in determining the number of companies you see in a given market.
How does intensity of competition (conduct) affect the equilibrium number of firms in the market?
The intensity of competition, or conduct, significantly influences the equilibrium number of firms in a market. In highly competitive markets where firms aggressively compete with each other, new firms find it challenging to enter and survive. This can lead to a smaller equilibrium number of firms as existing competitors fiercely vie for market share, making it difficult for new entrants to establish themselves. Conversely, in less competitive markets, new firms may find it easier to enter, potentially resulting in a larger equilibrium number of firms as competition is less intense.
What are the key laws on which US antitrust enforcement is based?
The main laws for keeping competition fair in the U.S. are the Sherman Antitrust Act, the Clayton Act, and the Federal Trade Commission Act. These laws prevent companies from doing things that would hurt fair competition, like forming monopolies or engaging in unfair practices. They're in place to make sure businesses compete fairly, which benefits consumers.
What is the margin-elasticity rule for a price setting firm?
The margin-elasticity rule says that if we can measure the price elasticity of demand, we can measure margins, and therefore the extent of market power.
What is the Bertrand paradox? Why is it a paradox? What are the key assumptions driving the Bertrand paradox?
The prediction of the Bertrand game (both firms setting prices at marginal cost- just as in perfect competition) is sometimes referred to as the Bertrand paradox. Since it does not seem very realistic since in the real world we hardly ever see perfect competition with only 2 firms
Describe, intuitively, the profit maximization problem for each firm in the Cournot model, taking their rival's quantity choice as given. What is Firm 1's optimal quantity choice as a function of Firm's 2 quantity and in what sense is this connected to the solution of a monopoly problem?
The profit is maximized at MR= MC just as in a monopoly. If F1 anticipates F2's entry they would also anticipate that the quantity that F2 chooses to produce will depend on the quantity produced by F1. F1 would therefore flood the market with production because the more they produce the less F2 will be able to produce.
Despite the fact that the market for beer in the US is 30-50 times bigger than the market for beer in Portugal, it is observed that the number of major national beer chains is similar in the US and in Portugal. Meanwhile, the number of small craft breweries is much larger in the US than Portugal.
The similar number of major national beer chains in the US and Portugal despite the much larger market size in the US suggests that the beer market in the US might have higher concentration due to factors like advertising and brand loyalty. Meanwhile, the greater number of small craft breweries in the US could be explained by the ease of entry into the market, driven by factors like consumer preferences for diverse and unique beer options. In simple terms, the US has both big, nationally recognized beer brands with concentrated market power and a thriving craft beer scene due to more accessible entry opportunities.
Why, in a sequential game, might a Nash equilibrium fail to yield a reasonable prediction for the outcome? (Hint: Nash equilibrium doesn't rule out non credible threats. Can you give an example of this?)
The standard definition of Nash equilibrium does not allow us to discard such "unreasonable" equilibria." This is why in sequential games we need to add a new element to ensure that the equilibria are "reasonable", we do this using backward induction.
How do you represent the payoff matrix of a simultaneous game?
This is when players do not know the choices of the other players in the game when they make their choices. The prisoner's dilemma is an example of this.
Optimal two-part tariff with selection on indicators: In what sense is the outcome of this pricing strategy efficient? How is this outcome for consumers?
This outcome is efficient for the firms but is terrible for the consumers because they make little to no Consumer Surplus.
Why would a firm wish to employ market segmentation?
This way, they can effectively target the segments that are most valuable to their business
What is information rent in a self-selection problem?
To induce high-value consumers to select the high-value product, the firm must leave them some consumer surplus, also known as information rent
Why might secret price cuts make it harder for firms to collude,especially in a world where firms are uncertain about realizations of demand? Why are simple grim trigger strategies no longer sensible in industries facing such uncertainty? How might firms attempt to collude instead?
When aiming to collude, firms benefit from making prices as transparent as possible -Price transparency alleviates fears of secret cheating, minimizing the risk of price wars and preventing cartel breakdown -If all firm prices are perfectly observed we return to a world where simple grim trigger strategies can be employed. -Firms may face greater temptation to cheat when demand is high than when demand is low - To achieve a collusive equilibrium a cartel may need to reduce its price when demand is high
Why might collusive behavior lead prices to be countercyclical (low when demand is high, high when demand is low)? Can you give an example of such countercyclical pricing behavior?
When demand is high there may be greater temptation to cheat that is why to achieve collusive equilibrium a cartel needs to reduce price when demand is high. -U.S. cement market: 1% increase in GDP associated with between 0.5 and 1% decrease in relative price of cement
How does exclusive dealing help induce manufacturers to provide the appropriate level of services?
When you think of exclusive dealing, think of how a restaurant will serve either Pepsi or Coke products, but never both. One of those firms signs an exclusivity contract with the retailer, and so the retailer only sells one of those goods. [This next part I'm iffy on] Because there is a contract and the retailer is almost doing the manufacturer a favor of not also selling their competitors' products, the manufacturer is willing to treat the retailer better and provide them with the appropriate level of services.
What features of an industry might lead us to expect firm behavior to be well described by the Bertrand model? What features might lead us to expect behavior more in line with Cournot behavior? In particular, why do capacity constraints lead us to expect behavior more in line with the Cournot model?
Which is more realistic depends on the industry and speed that quantity can be adjusted** -When output is difficult to adjust in the short run the Cournot model is more relevant as price competition is limited by current production. -When output is easily adjusted (or industry's are large relative to output) Then the Bertrand model is more realistic -In real world -Cournot: (cars steel cement computers houses) -Bertrand: (banks, games, softwares)
Why might industries with more firms have a harder time colluding?
With more firms we need a larger value for the discount factor for collusion to be an equilibrium. Facing more competition firms must place more weight on the future to sustain collision.
What is price fixing? (as an area of antitrust enforcement)
an conspiracy by firms to increase prices
What is the economic definition of the inverse demand curve?
answers the question, "what price will induce each quantity demanded?"
What does |E| > 1 mean in terms of demand?
demand is elastic
What does |E| < 1 mean in terms of demand?
demand is inelastic
What does |E| = 1 mean in terms of demand?
demand is unit elastic
What is abuse of dominant position? (as an area of antitrust enforcement)
includes exclusive dealing, predatory pricing, tying arrangements, etc. in which firms attempt to create and exploit market power
What is merger policy? (as an area of antitrust enforcement)
mergers which substantially increase the firm's concentration of their share of the market
Productive Efficiency
output should be produced in the most efficient way possible (firms should minimize costs)
Optimal two-part tariff with selection on indicators: What is the unit price charged by a firm under this type of pricing?
p = MC
Price Elasticity of Demand
represents the percent change in quantity demanded in response to a given change in price
Allocative Efficiency
resources should be allocated to their most valuable uses (output should be at the right level)
Dynamic Efficiency
resources should be allocative at the right rates to lead the development and improvement of technology over time
What is Block Pricing?
selling fixed quantity bundles at fixed quantity prices (ex. regular vs family size)
How to calculate Consumer Surplus
the area below the demand curve and above the market price
Marginal costs
the derivative cost with respect to output quantity; MC(q) = Cʼ(q) = VC'(q)
What does Consumer Surplus represent?
the difference between what a consumer pays for a good or service and what they are willing to pay for that good or service
Variable costs
the portion of cost which would be zero if output were zero; for example, hourly wages in the factory
Fixed costs
the portion of the cost that does not depend on the output level; for example, the cost of renting a factory
What is the economic definition of the demand curve?
the quantity demanded of a good as a function of the price of the good, holding everything else constant
Producer Surplus
the total revenue that a producer receives from selling their goods minus the marginal cost of production
What is the goal of price discrimination?
to transfer surplus to firms / producers
Average costs
total costs divided by output quantity
Average variable costs
variable cost divided by output quantity
