Notes: Class Notes + Pages 273-280

Class Notes:

Oligopoly: (chapter 13)

• Ex: Verizon, Sprint, OPEC, cereal companies, car producers 

• Characteristic:

  • A few large producers (less than 10)

  • Identical OR differentiated products

  • High barriers to entry

  • Price makers

  • Mutual independence (means that you are associated with those in your industry, you can not make decisions independently, you must do it with others)

  • Firms use strategic pricing 

• How do markets become oligopolies:

  • Oligopolies occur when only a few large firms start to control an industry 

  • High barriers to entry keeping others from entering 

  • Types of barriers to entry:

    • Economies of scale (ex: the car industry is difficult to enter because only large firms can make cars at the lowest cost) 

    • High start-up costs (similar to economies of scale)

    • Ownership of raw materials

• Game theory:

  • Sort of like chess (same sort of concept)

  • ”Where can I set my price so that the response for my competition won’t beat me”

  • The study of how people behave in strategic situations

  • Helps companies have an understanding on how to maximize their profit

  • WHy do we learn about game theory:

    • Oligopolies are interdependent since they have to anticipate and react to the decisions made by competitors 

    • In an oligopoly, pricing and output decisions must be strategic as to avoid economic losses

    •  Game theory helps determine the best strategy for a firm 

    • Classic ex: “Prisoner’s Dilemma”

      • Prisoner's Dilemma: charged with a crime, each prisoner has one of two choices: deny or confess 

  • Game theory matrix:

    • Nash equilibrium: the optimal outcome that will occur when both firms make decisions simultaneously and have no incentive to change 

• oligopolies must use strategic pricing (they have to worry about the other guy)

• Oligopolies have a tendency to collude to gain profit

  • Collusion is the act of cooperating with rivals in order to “rig” a situation 

  • Collusion results in the incentive to cheat 

• Firms make informed decisions based on their dominant strategies 

Significance of Resource Pricing

Importance of Resource Pricing

• Money-income determination: Resource prices significantly influence household income through expenditures firms make to acquire economic resources, resulting in income streams like wages, rent, interest, and profit.

• Cost minimization: For firms, resource prices represent costs. To maximize profit, firms need to produce at the most efficient and least costly combination of resources.

• Resource allocation: Just as product prices allocate goods to consumers, resource prices allocate resources among industries and firms. This allocation must adjust continually in response to changes in technology and product demand.

• Policy issues: Resource pricing impacts various policy debates such as income redistribution, subsidies, labor unions, and wage regulations.

Marginal Productivity Theory of Resource

MRP and Resource Demand

• In discussing resource demand within a purely competitive market, firms are price takers in both product and resource markets.

• Resource Demand: It reflects how much of a resource buyers will purchase at various prices. Demand is derived from the product demand that the resource helps produce.

• Marginal Revenue Product (MRP): Measures the addition to total revenue from employing one more unit of a resource.

Key Factors Affecting Resource Demand:

1. Productivity of the resource: Higher productivity leads to greater demand.

2. Market value of the product: Greater market prices for goods result in higher demand for the resources required to produce them.

Rule for Employing Resources

• MRP = MRC (Marginal Resource Cost): Profit maximization occurs when firms hire additional units of a resource as long as MRP exceeds MRC. In a competitive labor market, MRC equals the market wage rate.

• The firm's demand schedule for labor (MRP curve) indicates how many workers would be hired at different wage rates.

Changes in Productivity

• Increases in productivity lead to increased resource demand, while declines in productivity decrease it. Several factors modify productivity:

  • Solitary quantities of other resources (e.g., more capital increases labor's productivity)

  • Technological advances boost productivity

  • Improved quality of labor increases its demand

Changes in the Prices of Other Resources

• Substitutes: A decline in capital price can lead to opposing effects on labor demand; substitution effect may decrease demand, while the output effect may increase it.

• Complements: A decrease in the price of capital increases the demand for labor if they are used in fixed proportions.

Quick Review 14.1

• MRP measures the additional contribution from an extra unit of input (e.g., labor). MRC represents the additional cost from hiring that extra unit.

• The application of the MRP = MRC rule shows that a firm's MRP curve represents the demand for labor.