Miro Exam 3

Monopolistic competition

market structure in which barriers to entry are low and many firms compete by selling similar, but not identical, products

Productive efficiency

producing items at the lowest possible cost

Allocative efficiency

producing all goods up to the point where the marginal benefit to consumers is just equal to the marginal cost to firms

excess capacity

if it increased its output, the firm could produce at a lower average total cost.

Brand management

The actions of a firm intended to maintain the differentiation of a product over time

Monopolistic competition example

Blue Bottle Coffee is a third wave coffeehouse chain in several large U.S. cities and Japan. Some customers view its coffee as special and unique, different from the coffee offered by other coffeehouses

Oligopoly

a market structure in which a small number of interdependent firms compete, and it will require completely different tools to analyze

four-firm concentration ratio

The fraction of an industry’s sales accounted for by its four largest firms

barriers to entry

Anything that keeps new firms from entering an industry in which firms are earning economic profits

economies of scale

The situation in which a firm’s long-run average cost falls as it increases the quantity of output it produces

Patent

The exclusive right to a product for a period of 20 years from the date the patent is filed with the government

Game theory

The study of how people make decisions in situations in which attaining their goals depends on their interactions with others; in economics, the study of the decisions of firms in industries where the profits of a firm depend on its interactions with other firms

characteristics of “games”

1.Rules that determine what actions are allowable

2.Strategies that players employ to attain their objectives in the game

3.Payoffs that are the results of the interactions among the players’ strategies

payoff matrix

A table that shows the payoffs that each firm earns from every combination of strategies by the firms

dominant strategy

The best strategy for a firm, no matter what strategies other firms use

Nash equilibrium

A situation in which each firm chooses the best strategy, given the strategies chosen by the other firm

collusion

An agreement among firms to charge the same price or otherwise not to compete

noncooperative equilibrium

An equilibrium in a game in which players do not cooperate but pursue their own self-interest

cooperative equilibrium

An equilibrium in a game in which players cooperate to increase their mutual payoff

prisoner’s dilemma

A game in which pursuing dominant strategies results in noncooperation that leaves everyone worse off

price leadership

a form of implicit collusion in which one firm in an oligopoly announces a price change, and the other firms in the industry match the change

cartel

a group of firms that collude by agreeing to restrict output to increase prices and profits

sequential games

One firm makes its decision, and the other makes its decision having observed the first firm’s decision

simultaneous games

The players have made their decisions at the same time

decision tree

indicating who gets to make their decision at what point, and what the consequences of their decision will be

subgame-perfect equilibrium

Where no player can improve their outcome by changing their decision at any decision node

Five competitive forces model

Competition from existing firms, threat from potential entrants, competition from substitute goods or services, bargaining power of buyers, bargaining power of suppliers

Horizontal integration

why do firms produce different goods for the same market

Vertical integration

why do some firms produce goods which are used as intermediate inputs in production of a final good

Two types of horizontal integration

1.Firms with the same product produced at separate plants (multiplant firm)

–Toyota produces Camry at different plants

2.Firms with multiple products produced by different divisions (multiproduct firm)

Toyota produces Corolla and Camry models

Economies of scope

•when a firm producing two products can do so at lower cost than two single firms

Economies of Scale

when a large firm producing the same product can do so at lower cost than a smaller firm

Two components of pricing by the multiproduct firm

–a change in price affects the sales of both products and therefore revenue

–a change in price also affects costs

Compared to a single firm, a multiproduct firm sets

–higher prices for substitutes

lower prices for complements

Transfer price

the price at which the intermediate product is transferred between divisions within the firm

Transfer price affects profitability of

–upstream division

–downstream division

–whole firm

Horizontal Merger

: a merger or purchase of a firm in the same industry. Use of the HHI Index

Vertical Merger

The purchase or merger with a supplier or a customer

Herfindahl-Hirschman Index (HHI)

the square of each firm’s market share in the industry. Determines if an oligopoly exists

If HHI is < 1,500

competitive market

If HHI is between 1,500 and 2,500

somewhat competitive market

HHI> 2,500

concentrated industry

Calculating HHI

Company’s total sales (revenue or units) / total sales in the market * 100

Consider the following hypothetical industry with four total firms:

1. Firm 1 market share = 40%

2. Firm 2 market share = 30%

3. Firm 3 market share = 15%

4. Firm 4 market share = 15% 

The HHI is calculated as:

40²+30²+15²+15²

Duopoly

an oligopoly with only two firms

Noncoperative behavior

when firms ignore the effects of their actions on each others’ profits

Price War

occurs when tacit collusion breaks down and prices collapse (Airlines, Laptops, Cell phone providers, etc!)

Price Leadership

occurs when a dominant firm in an industry sets the price that maximizes its profits and the smaller firms in the industry follow by setting their prices to match the price of price leader.

Tit for Tat

involves playing cooperatively at first, then doing whatever the other player did in the previous period

monopoly

a firm that is the only producer of a good / service that has no close substitute

How do monopolies happen?

1.)     Control of a Scarce resource or input

2.)     Increasing returns to scale

3.)     Technological Superiority

4.)     Network Externality Exists when the value of a good or service to an individual is greater when many other people use the good or service as well.

 5.) Government Created Barriers

Patents

Give an inventor a temporary monopoly in the use or sale of an invention

Copyright

gives the creator of literary or artistic sole rights to profit from that work

Natural Monopoly

arises when average total cost is declining over the output range relevant for the industry. This creates a barrier to entry

Marginal Cost Production Rule

Where the MC intersects the Demand Curve gives the Monopolist’s production and price

Public Ownership

Instead of allowing a private firm to provide services, a public agency is established to provide the good/service and so protect consumers’ interest

Regulation

limits the price that a monopolist is allowed to charge

Betrand Competition with Identical Goods

1.)      Firms sell identical products

2.)      Firms compete by choosing the price at which they sell their products.

3.)      The firms set their prices simultaneously.

Firms sell the same product, and consumers compare prices and buy the product with the lowest price.  (In the end it is like perfect competition!) You compete on PRICE.

Cournot Oligopoly

1.)               Firms sell identical products

2.)               Firms compete by choosing a QUANTITY to produce or sell.

3.)               All goods sell for the same price – the market price, which is determined by the sum of the quantities produced by all firms in the market.

4.)               Firms choose quantities simultaneously.

Stackelberg Competition and the first mover advantage/  price leadership

The firms make production decisions sequentially. In this competition, the advantage gained by the initial firm in setting its production quantity.