ECON 3050

Nash equilibrium strategy

A condition describing a set of strategies in which no player can improve her payoff by unilaterally changing her own strategy, given the other players' strategies.

Subgame perfect equilibrium

A condition describing a set of strategies that constitutes a Nash equilibrium and allows no player to improve his own payoff at any stage of the game by changing strategies.

Price matching

A firm advertises a price and a promise to match any lower price offered by a competitor. (Walmart)

Randomized pricing

A firm intentionally varies its price in an attempt to "hide" price information from consumers and rivals.

Two-part pricing

A firm with market power charges a fixed fee for the right to purchase its goods, plus a per-unit charge for each unit purchased.

Cournot Oligopoly: Isoprofit Curves

A function that defines the combinations of outputs produced by all firms that yield a given firm the same level of profits.

Best-response or reaction function.

A function that defines the profit-maximizing level of output for a firm given the output levels of another firm

Infinitely repeated game

A game that is played over and over again forever, and in which players receive payoffs during each play of the game.

Game theory

A general framework to aid decision making when agents' payoffs depends on the actions taken by other players.

Monopoly

A market structure in which a single firm serves an entire market for a good that has no close substitutes.

Oligopoly market structure

Characterized by only a few firms, each of which is large relative to the total industry. - Typical number of firms is between 2-10 - Products can be identical or differentiated

Third-degree price discrimination

Charging different prices based on systematic differences in demand across demographic consumer groups. MR will be different for each group.

First-degree price discrimination

Charging each consumer the maximum price he or she would be willing to pay for each unit of the good purchased.

Long-Run and Monopolistic Competition

In the long run, monopolistically competitive firms produce a level of output such that: - P > MC - P = ATC > minimum of average costs

Brand loyal customers

continue to buy a firm's product even if another firm offers a (slightly) better price. Coke vs. Pepsi.

Bertrand oligopoly "price war" would end when

the price each firm charged equaled marginal cost

A market is contestable if

- All producers have access to the same technology. - Consumers respond quickly to price changes. - Existing firms cannot respond quickly to entry by lowering price. - There are no sunk costs

Benefits of randomized pricing to firms:

- Consumers cannot learn from experience which firm charges the lowest price in the market. - Reduces the ability of rival firms to undercut a firm's price.

Sources of monopoly power

- Economies of scale - economies of scope - cost complementary -patents and other legal barriers

Perfectly competitive markets

- Interaction between many buyers and sellers that are "small" relative to the market - Each firm produces identical products -Each firm produces identical products -Buyers and sellers have perfect information -free entry into and exit from the market

Components of games

- Players or agents who make decisions. - Planned actions of players, called strategies. - Payoff of players under different strategy scenarios. - A description of the order of play. - A description of the frequency of play or interaction.

Conditions for Bertrand Oligopoly

- There are few firms in the market serving many consumers. - Firms produce identical products at a constant marginal cost. - Firms engage in price competition and react optimally to prices charged by competitors. - Consumers have perfect information and there are no transaction costs. - Barriers to entry exist.

Conditions for Cournot Oligopoly

- There are few firms in the market serving many consumers. - The firms produce either differentiated or identical products. - Each firm believes rivals will hold their output constant if it changes its output. - Barriers to entry exist.

Conditions for Stackelberg Oligopoly

- There are few firms serving many consumers. - Firms produce either differentiated or identical products. -A single firm (the leader) chooses an output before all other firms choose their outputs. - All other firms (the followers) take as given the output of the leader and choose outputs that maximize profits given the leader's output. -Barriers to entry exist.

Monopolistic Competition: Key Conditions

- There are many buyers and sellers. - Each firm in the industry produces a differentiated product. - There is free entry into and exit from the industry.

Multistage games

- Timing is a key factor - Players make sequential, rather than simultaneous, decisions. - Represented by an extensive-form game.

Sustaining collusion via trigger strategies is easier when firms know:

- who their rivals are, so they know whom to punish, if needed. - who their rival's customers are, so they can "steal" those customers with lower prices. - when their rivals deviate, so they know - - - when to begin punishment. be able to successfully punish rival.

Absence of a supply curve

A monopolist's market power implies P > MR = MC. Thus, there is no supply curve for a monopolist, or in markets served by firms with market power

Short run

A period of time over which some factors of production are fixed

Output rule

A profit-maximizing monopolist should produce the output, Q^M, such that marginal revenue equals marginal cost: MR (Q^M) = MC (Q^M)

Normal-form game

A representation of a game indicating the players, their possible strategies, and the payoffs resulting from alternative strategies.

Extensive form game

A representation of a game that summarizes the players, the information available to them at each stage, the strategies available to them, the sequence of moves, and the payoffs resulting from alternative strategies.

Cournot Oligopoly: Equilibrium

A situation in which neither firm has an incentive to change its output given the other firm's output.

Secure stragey

A strategy that guarantees the highest payoff given the worst possible scenario.

Dominant strategy

A strategy that results in the highest payoff to a player regardless of the opponent's action.

Commodity bundling

Bundling several different products together and selling them at a single "bundle price."

This price is the competitive firm's marginal revenue

D^f = P = MR

Strategy

Decision rule that describes the actions a player will take at each decision point.

Implications of Product Differentiation

Implies that firms in these industries must continually convince consumers that their products are better than their competitors.

Transfer pricing

Firm optimally sets the internal price at which an upstream division sells an input to a downstream division.

Conditions for a Bertrand oligopoly imply:

Firms in this market will undercut one another to capture the entire market leaving the rivals with no profit. All consumers will purchase at the low-price firm.

Simultaneous-move game

Game in which each player makes decisions without the knowledge of the other players' decisions.

Sequential-move game

Game in which one player makes a move after observing the other player's move.

Repeated game

Game in which players interact to make decisions more than once.

One-shot game

Game in which players interact to make decisions only once.

Finitely repeated games

Games in which a one-shot game is repeated a finite number of times.

Peak-load pricing

Higher prices are charged during peak hours than during off-peak hours.

Block pricing

Identical products are packaged together in order to enhance profits by forcing customers to make an all-or-none decision to purchase.

Long-run equilibrium

If firms in monopolistically competitive markets earn short-run - Profits, additional firms will enter in the long run to capture some of those profits. -Losses, some firms will exit the industry in the long run.

Long-run competitive equilibrium

In the long run, perfectly competitive firms produce a level of output such that P = MC P= minimum of AC

Firm's short run supply curve for a perfectly competitive firm

Its marginal cost curve above the minimum point on the AVC curve

Monopolist's marginal revenue function

MR = P [(1+E)/E] - where E is the elasticity of demand for the monopolist's product and P is the price charged

Simple Pricing Rule: Monopoly and Monopolistic Competition

Managers have a "crude" estimate of marginal cost; the price paid to a supplier. the price elasticity of demand, since it is typically available for a representative firm in an industry.

Cournot Oligopoly: Collusion

Markets with only a few dominant firms can coordinate to restrict output to their benefit at the expense of consumers. (Restricted outputs leads to higher market prices)

A monopolist may earn positive economic profits, which in the presence of barriers to entry prevents other firms from entering the market to reap a portion of those profits.

Monopoly profits will continue over time provided the monopoly maintains its market power.

Factors Affecting Collusion in Pricing Games

Number of firms in the market Firm size History of the market Punishment mechanisms

Duopoly

Oligopoly market composed of two firms

Marginal revenue and linear demand

P(Q) = a +bQ, where a > 0 and b< 0, the associated marginal revenue is MR (Q) = a + 2bQ

Bertrand oligopoly in equilibrium

P1 =P2 = MC

Monopoly: Pricing rule

P^M = P (Q^M)

Second-degree price discrimination

Posting a discrete schedule of declining prices for different ranges of quantity

Cross-subsidy

Profits gained from the sale of one product are used to subsidize sales of a related product.

Transfer pricing rule

Sets the internal price at which an upstream division sells inputs to a downstream division in order to maximize the overall firm profits.

Monopoly power

Sole seller of a good in a market gives that firm greater market power than if it competed against other firms.

Deadweight loss of monopoly

The consumer and producer surplus that is lost due to the monopolist charging a price in excess of marginal cost.

Monopoly: Profit-maximization

The maximum price per unit that consumers are willing to pay for the profit-maximizing level of output

Price discrimination

The practice of charging different prices to consumers for the same good or service.

Short-run output decision

To maximize short-run profits, a perfectly competitive firm should produce in the range of increasing marginal cost where P = MC. Only is P is greater than or equal to AVC

Conditions for Sweezy Oligopoly

There are few firms in the market serving many consumers. - The firms produce differentiated products. - rivals will cut their prices in response to a price reduction but will not raise their prices in response to a price increase. - Barriers to entry exist.

Surplus Extraction: Third-Degree Price Discrimination Rule

To maximize profits, a firm with market power produces the output at which the marginal revenue to each group equals marginal cost.

Monopoly: Profit-maximization rule

To maximize profits, a monopolistically competitive firm produces where its marginal revenue equals marginal cost.

Competitive output rule

To maximize profits, a perfectly competitive firm produces the output at which price equals marginal cost in the range over which marginal cost is increasing. P= MC (Q)