Monopolistic Competition, Oligopoly, and Game Theory Flashcards

Monopolistic Competition

• Characteristics:
  • Many buyers and sellers.
  • Differentiated products.
  • No barriers to market entry or exit.
  • Some control over price (market power).
  • No long-run economic profit.
• Product Differentiation: It gives the firm some control over price and is key to success.
• Advertising:
  • Informational: Informs consumers and reduces search costs.
  • Persuasive: Influences emotions and can drive up product costs.
• Demand Curve: Monopolistically competitive firms face a downward-sloping, relatively flat (elastic) demand curve.
• Profit Maximization: Firms maximize profit in the short run by producing where marginal revenue (MR) equals marginal cost (MC).
• Long-Run Adjustments:
  • Economic profit attracts new firms.
  • Increased competition reduces demand for individual sellers, shifting the demand curve to the left.
  • In the long run, firms earn only a normal profit: Price (P) = Average Total Cost (ATC).

Oligopoly

• Characteristics:
  • Relatively few firms.
  • Mutual interdependence.
  • Substantial barriers to market entry.
  • Shared market power and considerable control over price.
  • Potential for long-run economic profit.
• Barriers to Entry: High fixed costs can create prohibitive barriers.

Cartels

• Definition: An agreement between firms (or countries) to collude on price and output and agree on the distribution of output.
• Objective: Reduce overall supply to increase prices and profit.
• Cheating Incentive: If one firm cheats and produces more, it can gain individually even if it harms the industry as a whole.
• Example: If one of five firms increases production by 20 units, the price falls to 8. The cheating firm gains at the expense of the others.
• Cartel Stability:
  • More stable when: few members with similar goals, maintained with legal provisions, firms cannot differentiate products, similar cost structures, significant barriers to entry.

Game Theory

• Definition: The study of how individuals and firms make strategic decisions to achieve goals when other players or factors can influence that outcome.
• Components of a Game:
  • Players
  • Information
  • Strategies
  • Outcomes
  • Payoffs
• Applications: Business strategies, conflict and war, litigation, politics, global relations, sports, card games.
• Assumptions:
  1. Preferences are clearly defined.
  2. Players rationally choose strategies to achieve objectives.
• Types of Games:
  • Sequential-move games: Players move one at a time.
  • Simultaneous-move games: Actions occur at the same time.
• Solving for Nash Equilibrium in Simultaneous-Move Games:
  • Use a game table to illustrate the game.
  • Use a best-response analysis: Each player selects the best response to every possible move by the other player.
  • A Nash equilibrium is an outcome where all players' strategies are best responses to each other. No player can do better by changing their mind unilaterally. It maximizes the expected payoff given all possible scenarios.
• Dominant Strategy: A player chooses the same action no matter what other players choose. If all players have a dominant strategy, a single Nash equilibrium results.
• John Nash (1928–2015):
  • Mathematician who developed important concepts in game theory, including the Nash equilibrium.
  • Won the Nobel Prize in Economics in 1994.
• Coordination Games:
  • Games with multiple Nash equilibria where players must coordinate independently using focal points (clues that lead to a greater probability of success).
• Prisoner’s Dilemma:
  • Occurs in noncooperative games.
  • The Nash equilibrium outcome is inferior to another outcome achievable with cooperation.
  • Common in: International trade disputes, political campaigns, legal disputes, and competitive business pricing.
  • In a pricing game, it can lead to very low prices for consumers.
• Repeated Games:
  • Games can be endlessly repeated or repeated a specific number of rounds.
  • Lead to strategies that consider rivals' past behavior.
  • Use of trigger strategies: Actions depend on the other player’s past decisions.
  • Types of Trigger Strategies:
    1. Grim trigger: Retaliation is permanent.
    2. Trembling hand trigger: Allows for a mistake before retaliating.
    3. Tit-for-tat: Cooperation is rewarded, and defection is punished.
• Leadership Games: Competitive games in which one player is dominant.
• Chicken Games: Competitive games where players hold out for the optimal outcome, but if neither gives in, the worst outcome occurs.

Key Concepts

• Monopolistic competition
• Product differentiation
• Oligopoly
• Mutual interdependence
• Cartel
• Kinked demand curve
• Game theory
• Simultaneous-move games
• Sequential-move games
• Nash equilibrium
• Dominant strategy
• Prisoner’s dilemma
• Trigger strategies
• Tit-for-tat strategies