Imperfect Competition Flashcards
AKA
Monopolistic competition
What are the assumptions of a imperfectly competitive market?
- Number of agents: very large number of buyers and sellers (n = 100, market share of each firm 1/n)
- Perfect information for both buyers and sellers in market
- Differentiated product: same base product, but repackaged into something slightly different, justifying different price levels (e.g. toothpaste and flavour options)
1,2,3: MPC firms -> price setters -> downward sloping demand with no supply curve
like monopoly - Free entry and exit for all firms
4: LR, MPC firms can only make 0 profit where P(x) = AC
like perfect competition
What profit does MPC firm make initially?
Tend to assume 0 profit unless stated otherwise
P0 = AC(x0), MC must cut AC at AC’s minimum
Exactly like monopoly making initial breakeven profit
What are the most important forms of market structure?
(1) monopolistic competition (2) oligopoly (3) pure monopoly
(3) conferred by legislation (industry is nationalised or temporary patent is awarded). When minimum efficient scale very large relative to industry demand curve: innocent entry barrier may be sufficiently high to produce natural monopoly (where all threat of entry can be ignored)
(2) opposite extreme, entry & exit may be costless. Market: contestable (easy for new firms to enter), incumbent firms must mimic perfectly competitive behaviour to avoid flood of entrants. oligopoly when there’s intermediate size of entry barrier
(1) free entry and exit from industry, but individually small and make similar (though not identical) products. Each firm: limited monopoly power in its special brand. LR: price = average cost but exceeds MR and MC at tangency equilibrium
What tensions to oligopolists face?
(1) collusion to maximise joint profits (cooperation to be like monopoly) and (2) competition for larger share of smaller joint profits (undercutting price and producing greater output, not maximising profit)
What is collusion?
Where firms cooperate formally (cartel) or informal (under the table) to act like a monopoly by setting an agreed output and price (as MPC are price setters) and share equal profits between each other (profit by each firm: monopoly’s profit / n (n: number of firms engaged in collusion))
Without credible punishment threats from partners in collusion, each firm will face a temptation to cheat for extra profit -> threat must be irreversible to be credible: contracts (defection, compensation, contract breach clauses involving cheating firms reputation like posting letter of apology to a media company)
What is game theory?
Theory that analyses interdependent decisions (decision that relies on other party’s action) where each player chooses a strategy
What is the Nash equilibrium?
A pair of strategy where each party/player chooses the best strategy given the other players’ strategy, and no player has an incentive to deviate away from the dominant strategy chosen given opponent’s strategy
What is the pure Nash equilibrium?
A pair of dominant strategy (best strategy which player(s) will stick with regardless of rival’s decision), where no players have incentive to deviate from that dominant strategy given opponent’s dominant strategy (basically nash equilibrium but all players have dominant strategy)
Prisoner’s Dilemma game
Simultaneous game (both players play the game at the same time so can start with husband or wife first)
Wife’s jail term:
Confess: 10 (if husband C) or 0 (if husband D)
Deny: 20 (if husband C) or 2 (if husband D)
Husband’s jail term:
Confess: 10 (if wife C) or 0 (if wife D)
Deny: 20 (if wife C) or 2 (if wife D)
Thought process: assumes if other party (1) confess, if player confess, jail: 10 years but if deny: 20 years, so choose confess (bc punishment is lower). (2) deny, if player confess, jail: 0 years but if deny: 2 years, so choose confess again (bc punishment minimised). Therefore dominant strategy: confess regardless of whichever strategy other party chooses (separate when essay writing wife and husband)
Both’s dominant strategy regardless of other person’s decision: confess (10,10 years outcome) -> not the best outcome
Best outcome: deny, deny
Pure Nash equilibrium: confess, confess
What are the characteristics of prisoner’s dilemma?
- Must be a pure nash equilibirium (both players must have a dominant strategy)
- Pure nash equiibrium isn’t the best outcome among the rest of the outcomes
What is a sequential game?
Game where players take turn to play the game
Usually 2 players (player 1 or 2; leader or follower)
Example: Centipede game
P1 starts w/ prize amount of 10 cents
2 choices: (1) take 10 cents and end game or (2) pass 10 cents to P2 so prize amount accumulates to 20 cents & game continues where P2 makes the choice
P2: (1) take 20 cents and end game or (2) pass 20 cents to P1 so prize amount accumualtes to 30 cents and game continues where P1 makes the choice
On and On…
What is the Nash equilibrium if the sequential game is repeated finitely (prize amount = 50 cents)?
P1 takes 10 cents at the start of game and let game end immediately
Based on Backward Induction: analysis of best strategy based on last player’s action and moving backwards
First mover’s advantage: P1
What is the Nash equilibrium if the sequential game is repeated infinitely (game ending is indefinite)?
Nash equilibrium: collusion between P1 and P2 to maximise profit/returns
Example: P1 and P2 want return of 20 cents each, regardless of who’s turn it is, when prize amount accumulates to 40 cents, player who as that turn will take 40 cents and let game end -> share 40 cents with opponent -> each obtain 20 cents
What is the Cournot model?
Where firms compete in terms of QUANTITY simultaneously (like prisoner’s dilemma)
