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What is the marginal cost for each firm in the driveway paving industry?
What is the marginal cost for each firm in the driveway paving industry?
Collusion is easier when there is significant variation in marginal costs across producers.
Collusion is easier when there is significant variation in marginal costs across producers.
False
What price will each firm charge for paving if they collude?
What price will each firm charge for paving if they collude?
$1,000
If Asphalt, Inc. and Blacktop Bros. collude and split the profits evenly, each will pave ______ driveways.
If Asphalt, Inc. and Blacktop Bros. collude and split the profits evenly, each will pave ______ driveways.
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If Asphalt, Inc. considers cheating by paving one more driveway, what is the incentive?
If Asphalt, Inc. considers cheating by paving one more driveway, what is the incentive?
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The time horizon has no effect on the sustainability of collusion.
The time horizon has no effect on the sustainability of collusion.
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How many total driveways will be paved if both firms collude?
How many total driveways will be paved if both firms collude?
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Match the following factors with their role in collusion:
Match the following factors with their role in collusion:
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What is the profit for Asphalt, Inc. when it produces 30 driveways under collusion?
What is the profit for Asphalt, Inc. when it produces 30 driveways under collusion?
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If Asphalt, Inc. paves one more driveway, its profit increases to $9,280.
If Asphalt, Inc. paves one more driveway, its profit increases to $9,280.
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What is the price when the total quantity rises to 32 driveways?
What is the price when the total quantity rises to 32 driveways?
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Asphalt, Inc.'s profit when paving one more driveway from 32 to 33 is __________.
Asphalt, Inc.'s profit when paving one more driveway from 32 to 33 is __________.
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Match the quantity to the corresponding profit for Asphalt, Inc.:
Match the quantity to the corresponding profit for Asphalt, Inc.:
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Which scenario indicates that Asphalt, Inc. has an incentive to cheat?
Which scenario indicates that Asphalt, Inc. has an incentive to cheat?
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Increasing the number of driveways both firms produce results in higher profits for each.
Increasing the number of driveways both firms produce results in higher profits for each.
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If both firms pave one more driveway (to 32), what is the profit for each firm?
If both firms pave one more driveway (to 32), what is the profit for each firm?
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In Bertrand competition, market equilibrium is identical to which type of competition?
In Bertrand competition, market equilibrium is identical to which type of competition?
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In Cournot competition, firms compete by choosing prices rather than quantities.
In Cournot competition, firms compete by choosing prices rather than quantities.
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What is the main assumption about products in the Cournot competition model?
What is the main assumption about products in the Cournot competition model?
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In Cournot competition, the total quantity in the market is represented as Q = q1 + ______.
In Cournot competition, the total quantity in the market is represented as Q = q1 + ______.
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Match the following concepts with their corresponding descriptions related to Cournot competition:
Match the following concepts with their corresponding descriptions related to Cournot competition:
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What happens to firms' profits in Cournot competition?
What happens to firms' profits in Cournot competition?
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Cournot competition allows for advance capacity decisions before firms select output levels.
Cournot competition allows for advance capacity decisions before firms select output levels.
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What is the inverse demand function in the Cournot model?
What is the inverse demand function in the Cournot model?
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What is the profit for firm JC?
What is the profit for firm JC?
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The market price for the output is $64.
The market price for the output is $64.
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In monopolistic competition, why can't firms sustain economic profit in the long run?
In monopolistic competition, why can't firms sustain economic profit in the long run?
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What is JC’s reaction function based on MI's output choice?
What is JC’s reaction function based on MI's output choice?
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In a monopolistically competitive market, firms always minimize average total costs in the long run.
In a monopolistically competitive market, firms always minimize average total costs in the long run.
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The profit for firm MI is calculated as π MI = (P − $______) × qMI.
The profit for firm MI is calculated as π MI = (P − $______) × qMI.
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Match the firm with its profit:
Match the firm with its profit:
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What is one key characteristic of firms in monopolistic competition?
What is one key characteristic of firms in monopolistic competition?
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What is the equation used to find MI's optimal output level?
What is the equation used to find MI's optimal output level?
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In long-run equilibrium, firms in monopolistic competition cannot sustain __________.
In long-run equilibrium, firms in monopolistic competition cannot sustain __________.
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Match the following models of imperfect competition with their descriptions:
Match the following models of imperfect competition with their descriptions:
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The output level set by MI is 14.5.
The output level set by MI is 14.5.
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What is the market price when JC produces 7 units and MI produces 14.5 units?
What is the market price when JC produces 7 units and MI produces 14.5 units?
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What is the output level that JC will choose as the first mover?
What is the output level that JC will choose as the first mover?
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MI produces 10 units when JC produces 14 units.
MI produces 10 units when JC produces 14 units.
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What is the market price when JC's output is 14?
What is the market price when JC's output is 14?
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The equation for MI's reaction function is qMI = 14 - __qJC.
The equation for MI's reaction function is qMI = 14 - __qJC.
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What is the formula for marginal revenue in this context?
What is the formula for marginal revenue in this context?
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The total output in the market is the sum of qJC and qMI.
The total output in the market is the sum of qJC and qMI.
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Setting marginal revenue equal to marginal cost results in the equation MR = __.
Setting marginal revenue equal to marginal cost results in the equation MR = __.
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Match each firm to their calculated output level when JC moves first.
Match each firm to their calculated output level when JC moves first.
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Study Notes
Imperfect Competition
- Markets rarely perfectly fit the assumptions of perfect competition or monopoly
- Imperfect competition encompasses market structures intermediate between perfect competition and monopoly
- Market structures are explored with varying degrees of competition, differentiated products, and strategic behavior
Chapter Outline
- What Does Equilibrium Mean in an Oligopoly?
- Oligopoly with Identical Goods: Collusion and Cartels
- Oligopoly with Identical Goods: Bertrand Competition
- Oligopoly with Identical Goods: Cournot Competition
- Oligopoly with Identical Goods with First-Mover: Stackelberg Competition
- Oligopoly with Differentiated Goods: Bertrand Competition
- Monopolistic Competition
- Conclusion
Introduction (1/2)
- Markets rarely fit all assumptions of perfect competition or a monopoly
- This chapter explores market structures that are referred to as imperfect competition.
- These market structures have characteristics between those of perfect competition and monopoly
Introduction (2/2)
- Assumptions of markets are relaxed to evaluate more realistic market scenarios
- Varying degrees of competition are allowed
- Differentiated products are allowed
- Strategic behavior is now considered
What Does Equilibrium Mean in an Oligopoly? (1/2)
- Oligopoly is characterized by a few large firms competing
- Analysing market equilibrium in oligopoly is more complex
- Firms' decisions regarding price and quantity are interlinked
- Nash equilibrium is crucial for determining an output outcome where firms have no incentive to change their decisions in reaction to the actions of other firms
What Does Equilibrium Mean in an Oligopoly? (2/2): Question 1
- A question presents a 2x2 payoff matrix
- Nash equilibrium is revealed (Option D)
Oligopoly with Identical Goods: Collusion and Cartels (1/6)
- Firms in oligopolistic markets have an incentive to collude or form a cartel
- Collusion is a form of economic behavior in which firms in an oligopoly coordinate their output and pricing decisions to act collectively as a monopoly
- The goal is to gain monopoly profits and share them among the firms in the cartel
Oligopoly with Identical Goods: Collusion and Cartels (2/6)
- The instability of collusion is due to each firm's incentive to cheat
- An example is presented with two firms, inverse demand, and marginal cost functions.
- The monopoly output and profit are determined, assuming firms split production, and each firm's profit is calculated
Oligopoly with Identical Goods: Collusion and Cartels (3/6)
- The problem with maintaining collusion is that each firm has an incentive to cheat.
- An example calculation shows how a cheating firm can increase its own profit at the expense of the cartel as a whole.
Oligopoly with Identical Goods: Collusion and Cartels (4/6)
- A diagram illustrates cartel instability
- Cartel stability is difficult to maintain because of firms' incentive to cheat.
- Market diagrams illustrate how a cheating firm's gain comes at the expense of the other firms.
Oligopoly with Identical Goods: Collusion and Cartels (5/6)
- Increasing the number of firms in a cartel complicates the cartel's attempts to hold to the agreed production level and thus the firms' agreements.
- Profit loss is shared across more firms, but each firm remains incentivized to cheat.
Oligopoly with Identical Goods: Collusion and Cartels (6/6)
- Factors making collusion easier are high cartel member stability.
- Little variation in marginal costs across producers, and a long time horizon which makes defection costly as it affects future profits, all help maintain a collusive agreement.
Oligopoly with Identical Goods: Bertrand Competition (1/3)
- Firms in imperfect competition can also focus on price decisions rather than output decisions.
- Bertrand competition is a framework where firms in an oligopoly choose the price at which to sell their identical products
- Simultaneous pricing decisions determine the market outcome
Oligopoly with Identical Goods: Bertrand Competition (2/3)
- The described example displays how firms compete on prices, similar to perfect competition, where price decisions are simultaneous.
- Two firms, target and Walmart, sell identical products (Nintendo Switches).
- A demand function depicts quantity sold based on firm's price relationships.
Oligopoly with Identical Goods: Bertrand Competition (3/3)
- Firms aim to match or undercut competitor prices to maximize sales and profit.
- The Nash equilibrium occurs when firms produce at their marginal cost
- The market outcome resembles perfect competition with price equaling marginal cost.
Oligopoly with Identical Goods: Cournot Competition (1/14)
- Cournot competition describes an oligopoly where firms compete by choosing quantities rather than prices
- Firms set their quantities assuming others' production will stay unchanged
- Each firm's output decision affects the market price, affecting all firms
Oligopoly with Identical Goods: Cournot Competition (2/14)
- This section uses two firms in a Cournot oligopoly with constant marginal cost and inverse demand functions are presented.
- Firm 1's profit is determined by its quantity and the market price.
- Firm 2's profit function is similar.
Oligopoly with Identical Goods: Cournot Competition (3/14)
- Equilibrium in a Cournot oligopoly is set using inverse demand and constant marginal costs for two countries.
- Similar to a monopoly model but the firms' output are combined
- Formula for prices are determined by combining quantities
Oligopoly with Identical Goods: Cournot Competition (4/14)
- The slope of the marginal revenue curve is twice the slope of the inverse demand curve, for Saudi Arabia
- Output for Saudi Arabia is determined
- Equation derived for calculating Iran's profit-maximizing output is similar
Oligopoly with Identical Goods: Cournot Competition (5/14)
- There is a residual demand curve based on competitor production that explains this type of competition
- The model shows how the firms' outputs affect the firm's profit by considering the actions of the opponents.
Oligopoly with Identical Goods: Cournot Competition (6/14)
- Reaction curves are used to show the relationship between firms outputs and their reaction to competitor actions.
Oligopoly with Identical Goods: Cournot Competition (7/14)
- Diagrams illustrating reaction curves are used, and how each firm best responds to competitor's output decisions.
- Nash equilibrium graphically is explained.
Oligopoly with Identical Goods: Cournot Competition (8/14)
- Mathematical approach is used to solve for Cournot equilibrium using each firm's reaction curves.
- The equilibrium output for each firm is determined when using this approach
- Market prices are derived using the given quantities in the derived equilibrium
Oligopoly with Identical Goods: Cournot Competition (9/14)
- A calculation shows the profit earned by Saudi Arabia given its equilibrium output.
Oligopoly with Identical Goods: Cournot Competition (10/14)
- Comparison of Cournot to Collusion and to Bertrand Oligopoly is shown.
- This shows how the overall output will differ based on the competition approach
- Total Profit is calculated
Oligopoly with Identical Goods: Cournot Competition (11/14)
- Comparing Cournot to collusion and Bertrand oligopoly
- The factors, including output and price, of a monopoly, Cournot, and Bertrand oligopoly model are compared.
Oligopoly with Identical Goods: Cournot Competition (12/14)
- A comparison table is used to display the Cournot, collusion, and Bertrand models, showing how total output, price per barrel, and profit per day differ by model type.
Oligopoly with Identical Goods: Cournot Competition (13/14)
- A summary of the outputs under the three industry structures is shown
- The comparison of the market price, and profit levels among the three competition types are summarised
Oligopoly with Identical Goods: Cournot Competition (14/14)
- The approach in previous sections generalises to multiple firms in a Cournot oligopoly
- Output, market price, and profit decreases as the number of firms increases. This resembles the perfectly competitive market more and more as the number of firms approaches infinity
Oligopoly with Identical Goods: Stackelberg Competition (1/7)
- Stackelberg competition occurs when one firm moves first in setting its output or price, giving it an advantage in setting its production level.
- Firms make output choices sequentially.
Oligopoly with Identical Goods: Stackelberg Competition (2/7)
- The Cournot model outcomes are considered, taking competitors actions as given for the decision making
- The best response to an opponent increasing output is to reduce output.
- A first-mover advantage is derived by the initial firm in setting the quantity output.
Oligopoly with Identical Goods: Stackelberg Competition (3/7)
- The example of Saudi Arabia and Iran illustrates the Stackelberg Model.
- Reaction curves and inverse demand model is shown for a given constant marginal cost for both countries.
Oligopoly with Identical Goods: Stackelberg Competition (4/7)
- Saudi Arabia acts as a Stackelberg leader.
- Iran's reaction function determines optimal output, remaining the same for any quantity Saudi Arabia chooses to produce.
Oligopoly with Identical Goods: Stackelberg Competition (5/7)
- Iran's reaction curve is substituted into the inverse demand function to calculate Saudi Arabia's optimal output
Oligopoly with Identical Goods: Stackelberg Competition (6/7)
- A comparison between the Cournot and Stackelberg equilibria is presented.
- Prices and profit levels differ when comparing the two models showing the difference in profits when the firm moves first in the Stackelberg approach.
Oligopoly with Identical Goods: Stackelberg Competition (7/7)
- Saudi Arabia's profit and Iran's profit differ from the Cournot output when considering the Stackelberg Model
- A potential scenario of market warfare is illustrated if both companies were Stackelberg leaders
Oligopoly with Differentiated Goods: Bertrand Competition (1/6)
- Every model in imperfect competition assumes a similar product.
- More realistic situations require different products that are differentiated by consumers.
- Differentiation is key to competition in more realistic markets, which is how brands differentiate products via product design, marketing strategies, advertising etc.
Oligopoly with Differentiated Goods: Bertrand Competition (2/6)
- This example demonstrates two snowboard manufacturers (Burton and K2) that are imperfect substitutes.
- Firms faces unique demand curves that are differentiable from each other (i.e. not identical)
- Each firm's demand is dependent on prices for both firms as shown by their demand functions
Oligopoly with Differentiated Goods: Bertrand Competition (3/6)
- Each firm's marginal cost is zero.
- For both firms, demand functions are shown as an inverse relationship between the price of products of the other firm and own firm's quantity sold.
- This shows how prices and demand for products can be affected by competitor's price changes and that firms choose prices to maximize profit.
Oligopoly with Differentiated Goods: Bertrand Competition (4/6)
- Calculating the equilibrium price for firms given the reaction curve.
- Equilibrium pricing for each firm is reached by plugging the reaction curves for each firm into the other's price function
- Finding equilibrium by graphically displaying price and demand functions is also shown
Oligopoly with Differentiated Goods: Bertrand Competition (5/6)
- Diagrams illustrate the concept of reaction curves and the equilibrium
- The graphs show that as one firm's price rises, the other adjusts the price as well. This shows an upward-sloping relationship unlike the Cournot approach which shows a downward-sloping reaction curve.
Oligopoly with Differentiated Goods: Bertrand Competition (6/6)
- Firms can self-differentiate
- Products are not viewed as perfect substitutes and the prices charged by competitors affect the demand for a firms products. This shows how a firms strategic interactions when selling different products determines equilibrium prices overall.
Monopolistic Competition (1/7)
- There are no barriers to entry when differentiated products in a marketplace allow for free entry and differentiation.
- Similar to perfect competition but firms' products are differentiated and not identical
- Characterized by many firms selling diverse but related products.
Monopolistic Competition (2/7)
- Considering a single fast-food burger restaurant in a town, that restaurant is effectively a monopolist with a downward-sloping demand curve indicated by its unique, non-perfect substitute offerings.
- The restaurant maximizes profit by setting production levels which equal marginal revenue and marginal cost.
Monopolistic Competition (3/7)
- Illustrations are shown to calculate the production level of a single monopolist and show how this calculation is achieved.
- Identifying a monopoly's production level using diagrams to show the relationship between marginal revenue, marginal cost, and price.
Monopolistic Competition (4/7)
- When new entrants emerge, the established restaurant's demand curve shifts as new substitute offerings are added to the market.
- The firm's demand now becomes more elastic (flatter) as more similar offerings are added to the market.
- This change in demand occurs because the availability of substitute products affects the demand for a firm's product.
Monopolistic Competition (5/7)
- Diagrams illustrate how the arrival of a new competitor shifts the existing firm's demand curve downward which shows how it becomes more elastic
- Firms in this model take the actions of the other firms as given and do not strategically respond to other firms' actions. The firm's decisions do not affect the other firms.
Monopolistic Competition (6/7)
- Just as in perfect competition, entry to a monopolistic market will continue to happen until economic profit is zero
- Firms in monopolistic competition face downward-sloping demand curves, unlike in perfect competition where price equals marginal cost.
- Equilibrium occurs when a firm's demand curve becomes tangent to the average total cost curve.
Monopolistic Competition (7/7)
- A diagram shows the long-run equilibrium in a monopolistically competitive market.
- At this point, price equals average total cost, and economic profit is zero.
- Entry and exit continue in this market, thus making average total cost not minimized for the firm. It's a non-optimal outcome for firms if price is higher than marginal cost.
Conclusion (1/1)
- Multiple models of imperfect competition are considered and examples of various competitive situations are shown
- Key market structures analyzed: Bertrand, Cournot, and Stackelberg competition with identical goods, collusion, Bertrand competition with differentiated goods, and monopolistic competition
- Determining a good market model for a specific case requires judgment from the economist. The models are used for various types of strategic interactions to help better understand the interactions and dynamics of imperfect competition markets.
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Description
This quiz explores the concepts of marginal costs, collusion, and pricing strategies in the driveway paving industry. It examines the implications of collusion between firms and the incentives for cheating on agreements. Test your understanding of these economic principles and their application in a real-world scenario.
