Chapter 8 - Profit Maximising under Imperfect Competition

independence of firms

where the decisions of one firm in a market will not have any significant effect on the demand curves of its rivals

product differentiation

where one firm’s product is sufficiently different from that of its rivals to allow it to raise the price of the product without consumers all switching to the rival’s products

non-price competition

competition in terms of product promotion or product development

excess capacity

in the long-run firms under monopolistic competition will produce at an output below their minimum-cost point

interdependence under oligopoly

a key factor of an oligopoly, each firm will be affected by its rival’s decisions

collusive oligopoly

where oligopolies agree (formally or informally) to limit competition between themselves

non-collusive oligopoly

where oligopolists have no agreement between themselves, formal, informal or tacit

cartel

a formal collusive agreement

quota set by a cartel

the output that a given member of a cartel is allowed to produce or sell

tacit collusion

where oligopolists take care not to engage in price cutting, excessive advertising or other forms of competition

dominant firm price leadership

where firms (the followers) choose the same price as that set by a dominant firm (the leader)

barometric firm price leadership

where the price leader is the one whose prices are believed to reflect market conditions in the most satisfactory way

average cost pricing

where a firm sets its price by adding a certain percentage for (average) profit on top of average cost

price benchmark

a price that is typically used.

Cournot model

a model of duopoly where each firm makes its price and output decisions on the assumption that its rival will produce a particular quantity

duopoly

an oligopoly where there are just two firms in the market

residual demand curve

illustrates the relationship between the output it produces and the market price for the product, holding constant the output produced by other firms

reaction function

shows how a firm’s optimal output varies according to the output chosen by it’s rival(s)

cournot equilibrium

where each of two firm’s actual output is the same as what the other firm predicted it would produce (where the two firm’s reaction curves cross)

takeover bid

where one firm attempts to purchase another by offering to buy the shares of that company from its shareholders

nash equilibrium

the position resulting from everyone making their optimal decision based on their assumptions about their rivals’ decisions. Without collusion there is no incentive for any firm to move from this position

kinked demand theory

the theory that oligopolies face a demand curve that is kinked at the current price, demand being significantly more elastic above the current price than below

countervailing power

where the power of a monopolistic/oligopolistic seller is offset by powerful buyers who can prevent the price from being pushed up

oligopsony

a goods market with just a few buyers (or employers in the case of labour markets)

game theory

a mathematical method of decision making in which alternative strategies are analysed to determine the optimal course of action for the interested party, depending on assumptions about rivals’ behaviour

simultaneous single-move game

a game where each player has just one move, and plays at the same time without knowledge of the actions chosen by other players

dominant strategy game

where the firm’s optimal strategy remains the same, irrespective of what it assumes its rivals are going to do

normal-form game

where the possible pay-offs from different strategies or decisions are presented as a matrix

prisoners’ dilemma

where two or more firms, by attempting independently to choose the best strategy, end up in a worse position than if they had cooperated

trigger strategy

once a firm observes that its rival has broken some agreed behaviour it will never co-operate with them again

backwards induction

a process by which firms think through the most likely outcome in the last period of competition and then work backwards step by step thinking through the most likely outcomes in earlier periods of competition

sequential-move game

one firm (the first mover) makes and implements a decision. Rival firms (second movers) can observe the actions taken by the first mover before making their own decisions.

decision tree

a diagram showing the sequence of possible decisions by competitor firms and the outcome of each combination of decisions.

first-mover advantage

when a firm gains from being the first one to take action

credible threat

one that is believable to rivals because it is in the threatner’s interests to carry it out

maxmin

the strategy of choosing the policy whose worst possible outcome is the least bad, usually low risk

maximax

the strategy of choosing the policy that has the best possible outcome, usually high risk

price discrimination

where a firm sells the same product at different prices

first-degree price discrimination

where the seller of the product charges each consumer the maximum price they are prepared to pay for each unit

second-degree price discrimination

where a firm offers consumers a range of different pricing options for the same or similar product

third-degree price discrimination

where a firm divides consumers into different groups based on some characteristic that is relatively easy to observe and informative about how much consumers are willing to pay

personalised pricing

where firms use information obtained on consumers to enable them to charge people a price specific to them and as close as possible to their willingness to pay

predatory pricing

where a firm temporarily charges a price below its short-run profit-maximising price in order to drive one or more competitors out of the market