Final Micro Econ Exam

What are the two assumptions that underlie the use of game theory to study oligopoly

1. Firms (players) are rational. Their goal is maximization of their own profit (payoff) 2. Firms apply their rationality to the process of strategic decision-making. Each firm uses the knowledge

Calculate the profit

4x4million = 16million

What is the relationship between MR and the demand curve for perfect price discrimination

For a perfect price discriminator, marginal revenue is equal to the price of the additional unit sold. Thus, the firm's MR curve is the same as its demand curve.

Explain why a monopoly exists in each scenario Patents are granted to inventors of a product or process for a certain number of years. The reason for this is to encourage innovation in the economy. Without the existence of patents, it is argued, research and development for improved pharmaceutical products is unlikely to take place, since there's nothing preventing another firm from stealing the idea, copying the product, and producing it without incurring the development costs.

Government-Created Monopolies

Which is more accurate: CR or HHI

HHI

Highly Concentrated Market

HHI above 2500

Unconcentrated Market

HHI below 1500

tit-for-tat strategy

If he or she cooperates until their opponent defects (cheats) and then defects until the opponent cooperates again. In other words, this strategy starts out collusive in nature, penalizes uncooperative behavior, and then forgives that behavior if appropriate.

dominant strategy

If it exists, is a strategy that is best for a player, regardless of the strategies chosen by the other players.

payoff matrix

Is a diagram used to describe all the elements of a game. It displays all the players involved in the game, all their potential strategies, and all possible payoffs to each player that may occur, depending on which strategies are chosen. A payoff matrix is examined via game theory techniques to help predict the outcome of the game.

cartel

Is a group of sellers of a product who have joined together to control its production, sales, and price in the hope of obtaining the advantages of a monopoly

Identify the number of firms present, the type of product, and the appropriate market model The government has granted a patent to a drug company for an experimental AIDS drug. That company is the only firm permitted to sell the drug.

Number of Firms: One Type of Product: Unique Market Model: Monopoly

Price wars

Occur when tacit collusion among oligopolists collapses and prices decline rapidly as the firms attempt to undercut one another. Price wars push prices closer to marginal cost and reduce oligopoly profits. In some cases, firms may retaliate so severely that price dips below marginal cost.

Price leadership

Occurs when an oligopolistic industry is dominated by a producer with a higher market share than the other firms. The dominant firm sets its prices, and the firms with smaller market shares tacitly collude by matching the dominant firm's price changes.

Monopoly Characteristics

One seller Unique product No free entry Not a price-taker

When total revenue is increasing, marginal revenue is...

Positive

Government will not allow a merger if they

Raise the HHI by more than 200 to a value of 2,500 or greater

Collusion

Refers to an agreement among agents in a game about which strategies to implement. A typical application is an agreement among firms in a market about what quantities to produce or what prices to charge. A cartel is one possible outcome of collusion. Once a cartel is formed, the market is effectively served by a monopoly.

output effect

Refers to revenue gained from the sale of additional units of output when production is increased. When price is above marginal cost, the output effect positively affects profits because the revenue obtained from selling one more unit of output exceeds the cost of producing it.

perfect price discrimination

a firm charges each customer the most the customer would be willing to pay for each unit he or she buys

When comparing a monopoly and perfect competition, the price is higher under a

monopoly

CR-4

percentage of sales (output) accounted for by top 4 firms in industry. To calculate: sum the market share percentage of the top 4 firms.

government franchise

A government-granted right to be the sole seller of a product or service.

Is the company making a profit or a loss

A loss

Herfindahl-Hirschman Index (HHI)

A measure of market concentration obtained by summing the squares of each firm's market share percentage. 10000 is the highest HHI possible because 100 squared is 10000.

natural monopoly

A monopoly that arises when, due to economies of scale, a single firm can produce for the entire market at lower cost per unit than could two or more firms.

Three companies, Optimax, Megachug, and Thirstoid, each with about the same market share, dominate the sports drink market. In an attempt to increase profits, the three companies coordinate their actions and agree to restrict their collective output of sports drinks, thereby increasing the price of sports drinks in the market. This is an example of: Price leadership price war cartel

Cartel

Tacit Collusion

Collusion where there is no formal agreement. Example: price leadership

Limits to collusion

Constrained by the market demand curve Cartels are often weakened by new technologies Powerful incentives to cheat

Consider the market for diamonds. Throughout much of the twentieth century, South Africa's De Beers group was viewed as a monopoly because it controlled a large percentage of diamond production and sales. Which of the following best explains the barriers to entry that exist in this scenario? Legal restrictions Economies of scale Control of a necessary resource

Control of a necessary resource; The market for diamonds exhibited barriers to entry due to control of a necessary resource, namely, diamond mines. The exclusivity of this essential resource prevented the entry of rival firms. Two other sources of monopoly power include government restrictions and economies of scale. Governments grant monopolies by means of patents or licenses, which protect inventors of goods or processes from rivals or limit entry to an industry. Economies of scale (which occur when average total cost decreases as more goods are produced or supplied) also serve as an entry barrier, protecting the monopolist from competition and new entrants.

What does the shaded region represent

Dead Weight Loss

Explain why a monopoly exists in each scenario In the natural gas industry, low average total costs are obtained only through large-scale production. In other words, the initial cost of setting up all the necessary pipes and hoses makes it risky and, most likely, unprofitable for competitors to enter the market.

Economies of Scale

Consider the market for public water. In this industry, low average total costs are obtained only through large-scale production. In other words, the initial cost of setting up all the necessary pipes and treatment plants makes it risky and most likely unprofitable for a competitor to enter the market. Which of the following best explains the barriers to entry that exist in this scenario? Legal restrictions Control of a necessary resource Economies of scale

Economies of scale; Companies that provide public utilities, such as public water, are called "natural monopolies." In cases of natural monopoly, economies of scale (which occur when average total cost decreases as more goods are produced or supplied) serve as an entry barrier, protecting the monopolist from competition and new entrants.

Product-variety externality

Entry of a new firm conveys a positive externality on consumers because they get some consumer surplus from the introduction of a new product.

Business-stealing externality

Entry of a new firm imposes a negative externality on existing firms because this causes other firms to lose customers and profit.

Explain why a monopoly exists in each scenario The Aluminum Company of America (Alcoa) formerly controlled all U.S. sources of bauxite, a key component in the production of aluminum. Given that Alcoa did not sell bauxite to any other companies, Alcoa was a monopolist in the U.S. aluminum industry from the late 19th century until the 1940s.

Exclusive Ownership of a Key Resource

True or False: The game between Snapface and Instashot is not an example of the prisoners' dilemma.

False; When each firm acts in its own self-interest and prices low to maximize its individual profit, each firm earns a profit of $10 million. However, both firms would be better off if they both chose a high price because each would earn $11 million. Just as in the prisoners' dilemma, the firms would be better off if they both chose the alternative option (in this case, a high price); however, each firm has the individual incentive to choose a low price instead. Therefore, this statement is false.

Oligopoly Characteristics

Few sellers either identical or differentiated products Not Price-taker Strategic behavior (mutual interdependence)

Consider the market for digital cable television services. Suppose that Tomcat Cable is the only firm with enough capital resources to build the necessary infrastructure to deliver cable television to residents in a specific geographical region. As such, Tomcat is the only firm operating in this market. Which of the following best explains the barriers to entry that exist in this scenario? Control of a necessary resource Large sunk costs Legal restrictions

Large Sunk Cost; Entry into an industry will be risky if it requires a substantial up-front investment. Such entry is even more risky if that investment is sunk—meaning that it cannot be recouped for a long period of time. For example, production in an industry may require the firm to construct a large and expensive building, or large infrastructure such as a master facility for receiving television signals (referred to as a cable television headend). The need for such large sunk costs discourages entry into an industry.

When comparing a monopoly and perfect competition, a monopoly the quantity is

Lower than perfect competition

Monopolistically competitive market

Many sellers Product differentiation Free entry Not price-taker

Perfect Competition Characteristics

Many small firms Identical products No market power Price-taker Free entry

What must a firm have to have in order to price discriminate?

Market power; This means the firm will face a downward-sloping demand curve Identify Willingness to pay; a firm must be able to identify how much different customers or groups of customers are willing to pay Prevention of resale; a firm must be able to prevent low-price customers from reselling its product to high-price customers

Is this price discrimination? Why or why not? Hotels charge a higher price for rooms with a nicer view, such as a skyline view or a coastal view. Assume that all consumers receive a higher utility when staying in a room with a nicer view.

No; The existence of various prices is not considered price discrimination if the good being sold is not identical. For example, a hotel room with a nice view is technically a different good from a hotel room with a standard view. Therefore, the difference in price is simply a result of the difference in the quality of the good, not of price discrimination.

Identify the number of firms present, the type of product, and the appropriate market model In a small town, there are four providers of broadband Internet access: a cable company, the phone company, and two satellite companies. The Internet access offered by all four providers is of the same speed. Almost everyone in the city already has broadband, so any potential new company would have to engage in a price war with the existing companies and would be unlikely to cover its costs for years, if ever.

Number of Firms: Few Type of Product: Identical Market Model: Oligopoly

Identify the number of firms present, the type of product, and the appropriate market model In a major metropolitan area, there are many coffee shops, but one chain has gained a large market share because customers feel its coffee tastes better than its competitors'.

Number of Firms: Many Type of Product: Differentiated Market Model: Monopolistic competition

Identify the number of firms present, the type of product, and the appropriate market model There are hundreds of high school students in need of algebra tutoring services. Dozens of companies offer tutoring services; parents view the quality of the tutoring at the different companies to be largely the same.

Number of Firms: Many Type of Product: Identical Market Model: Perfect competition

price effect

Refers to the decline in price of each unit sold when output is increased. Thus, the price effect negatively affects profits on all previous units sold. Producers choose to increase output when the output effect is greater than the price effect, and to reduce output when the price effect is greater than the output effect.

concentration ratio

The percentage of total output or sales by a given number of the largest firms in the market.

prisoners' dilemma

This game, defined by a certain payoff structure and an inability of players to collude, provides insight into the difficulty of maintaining cooperation. The story of the prisoners' dilemma contains a more general lesson that applies to any group of individuals or firms trying to maintain cooperation among its members without enforceable punishments.

Is this price discrimination? Why or why not? Last-minute "rush" tickets can be purchased for most Broadway theater shows at a discounted price. They are typically distributed via lottery or on a first-come, first-served basis a few hours before the show. Assume that the theater in question does not hold seats in reserve for this purpose, but rather offers rush tickets only for seats not sold before the day of the performance.

Yes; A variety of theaters in New York City offer rush tickets at a discounted price in an attempt to capture theatergoers with a lower willingness to pay. Presumably, consumers with a higher willingness to pay will purchase their tickets ahead of time at the retail price to ensure that they are able to see the show and sit in a particular seat. Therefore, the system of rush tickets is an example of theaters trying to exploit different consumers' demands and is a price-discriminatory practice.

how will a monopolist generally react to an increase in demand? To a decease in demand?

increase in demand: by producing more output, charging a higher price, and earning a larger profit. decrease in demand: by reducing output, lowering price, and suffering a reduction in profit

Nash equilibrium

is a set of strategies (one for each player) in which each player's strategy is the best option for that player, given the chosen strategy of the player's opponent. Economics uses game theory, the study of how people behave in strategic situations, to solve for such an equilibrium.