Exam 3 (ECON 3033)

Why does differentiating its product allow an oligopoly to charge a higher​ price? When an oligopoly firm differentiates its​ product, it:

makes demand less elastic.

Optimal price regulation sets price equal to:

marginal cost

A natural monopoly occurs when:

marginal cost is constant. average cost is declining. marginal cost is below average cost.

Price discrimination

practice in which a firm charges consumers different prices for the same good

If two identifiable markets differ with respect to their price elasticity of demand and resale is​ impossible, a firm with market power will:

set a lower price in the market that is more price elastic

Lerner Index

the ratio of the difference between price and marginal cost to the price p - MC / p

Snob effect

the situation in which a person places greater value on a good as fewer and fewer other people possess it

Bandwagon effect

the situation in which a person places greater value on a good as more and more other people possess it.

Network externality

the situation where one person's demand for a good depends on the consumption of the good by others

Best response

the strategy that maximizes a player's payoff given its beliefs about its rivals' strategies.

If a monopoly charges higher prices to consumers who buy smaller quantities than to consumers who buy larger​ quantities, then:

the​ monopoly's profits are larger than under​ single-price monopoly

Charging higher prices to residential customers than to industrial customers is an example of:

third-degree price discrimination.

If a monopoly chooses the optimal price instead of the optimal​ quantity, then its profits will be:

unchanged because the optimal price and quantity yield the same profit

What happens to the​ homogeneous-good Bertrand equilibrium price if the number of firms​ increases? Increasing the number of firms:

will not affect the equilibrium price.

In the monopolistically competitive airlines​ model, what is the​ long-run equilibrium if firms face no fixed​ costs? In the long​ run, firms will earn _______________ economic profit at a price equal to _______________ variable cost. Because fixed costs act as a barrier to​ entry, we'd expect the number of firm in equilibrium to _______________ the same as fixed costs decrease.

zero; average cost; increase

Why do Honda service departments emphasize to customers the importance of using​ "genuine Honda​ parts" when servicing and tuning Honda cars and​ motorcycles? 1) Honda emphasizes using genuine Honda parts in combination with its service offer to practice: 2) Honda is likely to be:

1) bundling 2) less successful if consumers do not believe using genuine Honda parts affects the reliability of their Hondas.

In a repeated​ game, how does the outcome differ if firms know that the game will be​ (a) repeated​ indefinitely, (b) repeated a​ known, finite number of​ times, and​ (c) repeated a finite number of times but the firms are unsure as to which period will be the​ last? Consider a game where the Nash equilibrium in a​ one-period static game is not the cooperative outcome​ (with collusion). 1) If the game is repeated​ indefinitely, then: 2) If the game is repeated a finite number of​ times, then: 3) If the game is repeated a finite number of times but the firms are unsure as to which period will be the​ last, then:

1) cooperation can be achieved with signaling. 2) cooperation cannot be achieved because additional punishment cannot be imposed after the last period. 3) cooperation can be achieved with punishments for cheating.

All else the same, the demand curve a firm faces becomes more elastic as:

1. better substitutes for the firm's product are introduced, 2. more firms enter the market selling the same product, or 3. firms that provide the same service locate closer to this firm.

___________ auction is a descending bid auction that ends dramatically with the first bid. In a​ sealed-bid auction the price the winner pays depends on whether it is a​ first-price auction or ___________ auction. In ____________ auction, the auctioneer starts the bidding at the lowest price that is acceptable to the seller and then repeatedly encourages potential buyers to bid more than the previous highest bidder. The auction ends when no one is willing to bid more than the current highest bid.

A Dutch A second-price An English

Market structure has implications for a​ firm's profitability. Which of the following statements is​ true?

A competitive firm maximizes profits by producing at the quantity where marginal revenue equals marginal cost.

Why are some markets monopolized?

A firm has a cost advantage over other firms or A government created the monopoly.

Suppose there is a relatively large number of​ firms, a high degree of product​ differentiation, and free entry. What market structure is most likely to​ form?

A monopolistically competitive market

Nash equilibrium:

A set of actions taken by the firms is a Nash equilibrium if, holding the actions of all other firms constant, no firm can obtain a higher profit by choosing a different action.

Price discrimination is welfare reducing.

A. ​False, price discrimination can increase the coverage of a market thereby increasing welfare.

Cournot Oligopoly

All firms are identical in the sense that they have the same cost functions and produce identical, undifferentiated products. We initially illustrate each of these oligopoly models for a duopoly The market lasts for only one period. Each firm chooses its quantity or price only once.

Double auction

All potential buyers and sellers in a double auction may make public offers stating prices at which they are willing to buy or sell. They may accept another participant's offer to buy or sell.

Duopoly

An oligopoly with only two firms

Why Cartels Fail

Cartels fail if noncartel members can supply consumers with large quantities of goods. Each member of a cartel has an incentive to cheat on the cartel agreement.

Which of the following is not an example of price​ discrimination?

Charging young men more than young women for auto insurance.

Three models of duopolies:

Cournot model Stackelberg model Bertrand model

Mergers

If antitrust or competition laws prevent firms from colluding, firms could try to achieve the same end by merging to form a monopoly. U.S. laws restrict the ability of firms to merge if the net effect is to harm society.

Will the price be lower if duopoly firms set price or if they set​ quantity? Under what conditions can you give a definitive answer to this​ question?

If duopoly firms produce an identical​ good, then price will be lower if they set​ price; if the goods are​ heterogeneous, then the answer is indeterminate.

Private value

If each potential bidder places a different personal value on the good.

Differentiated Products

In differentiated products markets, the Bertrand equilibrium is plausible, and the two "problems" of the homogeneous-goods model disappear: Firms set prices above marginal cost, and- prices are sensitive to demand conditions and the number of firms

Winner's curse

auction winner's bid exceeds the common-value item's value.

Monopolistic Competition

Monopolistically competitive markets do not have barriers to entry, so firms enter the market until no new firm can enter profitably. monopolistically competitive firms face downward- sloping residual demand curves, so they charge prices above marginal cost.

Barriers to Entry

Sometimes governments own and manage monopolies, forbidding other firms from entering. In the United States, as in most countries, the postal service is a government monopoly. Frequently, however, governments create monopolies by preventing competing firms from entering a market

As an​ economist, you are asked to model an oligopoly market with the following​ characteristics: firms produce an undifferentiated​ product, choose​ quantities, and then let the market determine the price. ​ Further, when making output​ decisions, there is one firm that the other firms follow. Which oligopoly model would best predict actual behavior in this​ market?

Stackelberg

English auction

The auctioneer starts the bidding at the lowest price that is acceptable to the seller and then repeatedly encourages potential buyers to bid more than the previous highest bidder.

What is the​ profit-maximizing amount of​ advertising?

The point where the marginal benefit of advertising is equal to the marginal cost of advertising

Each​ week, a department store places a different item of clothing on sale. Which of the following is an explanation based on price discrimination for why the store conducts such regular​ sales?

The store attempts to sell the item to customers with high reservation prices​ first, and then sells to customers with lower reservation prices later. The store attempts to sell the item to customers with relatively inelastic demand​ first, and then sells to customers with relatively elastic demand later.

Maintaining Cartels

To keep firms from violating the cartel agreement, the cartel must be able to detect cheating and punish violators, and keep their illegal behavior hidden from customers and government agencies.

Market Failure Due to Monopoly Pricing

Welfare, W, is lower under monopoly than under competition. Competition maximizes welfare because price equals marginal cost.

Bertrand Versus Cournot

When firms produce identical products and have a constant marginal cost, firms receive positive profits and the price is above marginal cost in the Nash- Cournot equilibrium. However, in the Nash-Bertrand equilibrium, firms earn zero profits and price equals marginal cost

What is the optimal strategy in a​ second-price sealed bid​ auction?

You should always bid your maximum value.

Bertrand equilibrium (Nash-Bertrand equilibrium)

a Nash equilibrium in prices; a set of prices such that no firm can obtain a higher profit by choosing a different price if the other firms continue to charge these prices.

Mixed strategy

a firm (player) chooses among possible actions according to probabilities it assigns.

Which Firms Can Price Discriminate

a firm must have market power. Groups of consumers or individual consumers must have demand curves that differ, and a firm must be able to identify how its consumers' demand curves differ. a firm must be able to prevent or limit resale.

Limit Pricing

a firm sets its price (or its output) so that another firm cannot enter the market profitably.

Prisoners' dilemma

a game in which all players have dominant strategies that result in profits (or other payoffs) that are inferior to what they could achieve if they used cooperative strategies.

Cartel

a group of firms that explicitly agree to coordinate their activities

Monopolistic competition

a market structure in which firms have market power but no additional firm can enter and earn positive profits

Why​ can't a monopoly choose both price and​ quantity? A monopoly​ can't choose both price and quantity because:

a monopoly has the power to set​ price, not the demand curve.

Two-part pricing

a pricing system in which the firm charges a customer a lump-sum access fee for the right to buy as many units of the good as the consumer wants at a per-unit price

Auction

a sale in which property or a service is sold to the highest bidder. Three key components: the number of units being sold, the format of the bidding, and the value that potential bidders place on the good.

Cournot equilibrium (Nash-Cournot equilibrium)

a set of quantities sold by firms such that, holding the quantities of all other firms constant, no firm can obtain a higher profit by choosing a different quantity

Game theory

a set of tools that economists, political scientists, military analysts and others use to analyze decision making by players who use strategies.

Group price discrimination (third-degree price discrimination)

a situation in which a firm charges each group of customers a different price, but it does not charge different prices within the group

Oligopoly

a small group of firms in a market with substantial barriers to entry.

Dominant strategy

a strategy produces a higher payoff than any other strategy the player can use for every possible combination of its rivals' strategies.

Requirement tie-in sale

a tie-in sale in which customers who buy one product from a firm are required to make all their purchases of another product from that firm

Tie-in sale

a type of nonlinear pricing in which customers can buy one product only if they agree to buy another product as well

Bundling (package tie-in sale)

a type of tie-in sale in which two goods are combined so that customers cannot buy either good separately. Bundling a pair of goods pays only if their demands are negatively correlated

Subgame

all the subsequent decisions that players may make given the actions already taken and corresponding payoffs.

Credible threat

an announcement that a firm will use a strategy harmful to its rival and that the rival believes because the firm's strategy is rational in the sense that it is in the firm's best interest to use it.

Patent

an exclusive right granted to the inventor to sell a new and useful product, process, substance, or design for a fixed period of time.

If the inverse demand curve a monopoly faces is p​ = 100 − ​2Q, and MC is constant at​ 16, then profit maximization:

cannot be determined solely from the information provided.

When a firm practices perfect price​ discrimination, it:

captures all the social gain charges each consumer her reservation price produces the same quantity as would be produced by a competitive market takes all consumer surplus from consumers

Block-pricing schedules

charge one price for the first few units (a block) of usage and a different price for subsequent blocks

Nonuniform pricing

charging consumers different prices for the same product or charging a single customer a price that depends on the number of units the customer buys

Uniform pricing

charging the same price for every unit sold of a particular good

Based on the feature​ "Strategic Advertising," would cola advertising or cigarette advertising correspond more closely to a​ prisoners' dilemma​ game? The​ prisoners' dilemma game is represented most closely by?

cola advertising because the​ firms' dominant strategy is to​ advertise, but not advertising maximizes joint profits

Does an oligopoly or a monopolistically competitive firm have a supply​ curve? Why or why​ not? Oligopoly and monopolistically competitive firms:

do not have supply curves because there is no unique relationship between price and quantity supplied.

What is the effect of a​ lump-sum tax​ (which is like an additional fixed​ cost) on a​ monopoly? In the short​ run, a​ lump-sum tax __________________ the​ monopoly's profit-maximizing quantity if it produces and ________________ the​ monopoly's likelihood of shutting down. In the long​ run, a​ lump-sum tax __________________ the​ monopoly's profit-maximizing quantity if it produces and _____________________ not affect the​ monopoly's likelihood of shutting down.

does not effect; does not effect does not effect; increases

Pure strategy

each player chooses an action with certainty.

Dutch auction

ends dramatically with the first "bid." The seller starts by asking if anyone wants to buy at a relatively high price. The seller reduces the price by given increments until someone accepts the offered price and buys at that price.

The possibility that a firm can earn positive​ long-run profits is determined​ by:

entry conditions

Sealed-bid auction

everyone submits a bid simultaneously without seeing anyone else's bid (for example, by submitting each bid in a sealed envelope), and the highest bidder wins. first-price auction - the winner pays its own highest bid. second-price auction - the winner pays the amount bid by the second-highest bidder.

Backward induction

first determine the best response by the last player to move, next determine the best response for the player who made the next to-last move, then repeat the process back to the move at the beginning of the game.

Common value

good that has the same fundamental value to everyone, but no buyer knows exactly what that common value is.

A game with a finite number of players and a finite number of​ actions:

has at least one Nash​ equilibrium, which may involve mixed strategies.

A competitive firm observing a rival firm raising its price​ will:

ignore its​ rival's action.

As discussed in the​ "Google Advertising"​ application, advertisers on​ Google's web site bid for the right for their ads to be posted when people search for certain phrases. Should a firm that provides local services​ (such as plumbing or pest​ control) expect to pay more or less for an ad in a small town or a large​ city? ​ Why? A firm that provides local services should be willing to pay more for an ad?

in a small town because there are fewer​ self-identified potential customers.

Two-stage game

is played once and hence can be said to occur in a "single period."

Product differentiation:

is possibly welfare enhancing if new products match consumer preferences better.

The more block prices a monopoly can set instead of setting a single​ price, the:

more producer surplus larger the total welfare smaller the deadweight loss

If two​ quantity-setting firms act​ simultaneously, is the Stackelberg outcome​ likely? Why or why​ not? If two​ quantity-setting firms act​ simultaneously, then the Stackelberg outcome is:

not likely because neither firm can credibly commit to producing the Stackelberg output

A firm is a natural monopoly if:

one firm can produce the total output of the market at lower cost than two or more firms could.

Grocery store chains often set​ consumer-specific prices by issuing​ frequent-buyer cards to willing customers and collecting information about their purchases. Grocery store chains use that data to offer customized discount coupons to individuals. Which type of price discrimination—​perfect, ​group, or nonlinear—are these personalized​ discounts? Personalized grocery store discounts are a type of _______________ price discrimination. How should a grocery store use past purchase data to set individualized prices to maximize its​ profit? ​(Hint​: Refer to a​ customer's price elasticity of​ demand.) A grocery store could increase profits by using past purchase data to charge lower prices to customers whose demand is relatively more _______________.

perfect; elastic

Dynamic games

players move sequentially or move simultaneously repeatedly over time, so a player has perfect information about other players' previous moves.

Nonlinear price discrimination (second-degree price discrimination)

situation in which a firm charges a different price for large purchases than for small quantities, so that the price paid varies according to the quantity purchased

Perfect price discrimination (first-degree price discrimination)

situation in which a firm sells each unit at the maximum amount any customer is willing to pay for it, so prices differ across customers and a given customer may pay more for some units than for others

Natural monopoly

situation in which one firm can produce the total output of the market at lower cost than several firms could.

Which of the following is NOT an explanation for a positive network​ externality?

snob effect

Extensive form

specifies the n players, the sequence in which they make their moves, the actions they can take at each move, the information that each player has about players' previous moves, and the payoff function over all the possible strategies.

Which of the following is NOT an example of a good with network​ externalities?

supermarket bonus cards

Market power

the ability of a firm to charge a price above marginal cost and earn a positive profit.

Alexx's monopoly currently sells its product at a single price. What conditions must be met so that he can profitably price​ discriminate? The firm must​ have:

the ability to set​ price, consumers with different price​ elasticities, the ability to identify the different types of​ consumers, and the ability to prevent or limit resales.

Bundling sales are most advantageous to the seller when:

the demands for the two goods are negatively correlated

Reasons for cost advantages:

the firm uses a superior technology or has a better way of organizing production. the firm controls an essential facility: a scarce resource that a rival needs to use to survive.

Which of the following must be true for a natural monopoly to​ occur?

the marginal cost must be below the average cost

Reservation price

the maximum amount a person would be willing to pay for a unit of output

Markets differ according to:

the number of firms in the market, the ease with which firms may enter and leave the market, and the ability of firms in a market to differentiate their products from those of their rivals.

Monopoly

the only supplier of a good for which there is no close substitute. A monopoly can set its price - not a price taker. All firms, including competitive firms and monopolies, maximize profits by setting marginal revenue equal to marginal cost. In the short run, a monopoly shuts down to avoid making a loss if its price is below its average variable cost at its profit-maximizing quantity. In the long run, the monopoly shuts down if the price is less than its average cost.

A monopolist observes that a potential rival is poised to enter the market. The monopolist can invest in an expensive piece of equipment that will significantly lower its marginal​ cost, but will raise its total costs. Should the monopolist make the​ investment?

​Yes, if the investment deters entry and the post investment profit is higher than post entry profit without the investment.