Final exam and review informa0on

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1 Final exam and review informa0on Monday, May 7th, at 4 PM in Boyden Gym Covers chapters on perfect compe00on, monopoly and monopolis0c compe00on Has 40 mul0ple choice and choice of 1 out of 2 of short answer/graphing ques0on Review session Friday, May 4 th, 2 3 in Thompson 102 See my for office hours and loca0ons

2 To do today One last look at monopolis0c compe00on What does the US economy look like? Indicators of compe00on What is oligopoly and how is it related to related to è

3 How do we know the market structure? Four- Firm Concentra/on Ra/o The percentage of the value of sales accounted for by the four largest firms in the industry. Herfindahl- Hirschman Index A ra0o that exceeds 60 percent is an indica0on of oligopoly. A ra0o of less than 40 percent is an indica0on of a compe00ve market monopolis0c compe00on. Range goes down to almost zero close to perfect compe00on for a few sectors

4 Herfindahl- Hirschman Index (HHI) The square of the percentage market share of each firm summed over the largest 50 firms in a market. A market with an HHI less than 1,000 is regarded as compe00ve and between 1,000 and 1,800 is moderately compe00ve.

5 Concentra0on ra0os and H- H Index, 2002 Sector # Companies % of All Herfindahl- Shipments Hirschman Food largest largest largest largest Chocolate largest 69 8 largest largest largest Petroleum manufacturing largest largest largest largest Computer equipment 4 largest largest largest largest Apparel cut and sew largest largest largest largest


7 Why adver0se? Signaling quality Some adver0sing is very costly and has almost no informa0on content about the item being adver0sed. Such adver0sing is used to signal high quality. Signaling works because it is profitable to signal high quality and deliver it but unprofitable to signal a high quality product and not deliver it.

8 Efficiency of adver0sing and brand names Adver0sing and brand name can be efficient if the marginal cost of the informa0on equals its marginal benefit. The final verdict on the efficiency of monopolis0c compe00on is ambiguous: there are benefits (consumer choice of differen0ated products) and costs (deadweight loss and higher than minimum ATC)

9 Important note on efficiency More than one defini0ons is used MC = MB (and P in perfect compe00on but not otherwise This gives deadweight loss (i.e., less than maximum consumer and surplus) Also though: point of lowest ATC - used just now in the discussion of monopolis0c compe00on

10 Introduc0on to oligopoly Core concept - interdependence of firm decisions Structure only a few firms Interdependence if one firm lowers its price, others must do the same to keep its customers Asymmetry but if one firm raises price, others won t and that firm loses customers

11 Collusion and Cartels Temptation to Collude When a small number of firms share a market, they can increase their profit by forming a cartel and acting like a monopoly. Cartel is a group of firms acting together to limit output, raise price, and increase economic profit. Illegal but they do operate in some markets Tend to collapse

12 Interdependence Firms are involved in a game with each other The game is to set a price taking into account all the moves by the other players You know that other firms will respond to you moves on price

13 Game Theory What Is a Game? All games involve three features: Rules Strategies Payoffs Prisoners dilemma is a game between two prisoners that shows why it is hard to cooperate, even when it would be beneficial to both players to do so.

14 The Beau0ful Mind game If all players go for the blonde, only one will get a date with her The others will find that the neglected women won t want to be the second to be asked for a date and will refuse Therefore it is bejer not to go for the blonde knowing what happens when they all do

15 The Prisoner s Dilemma game Art and Bob been caught stealing a car: sentence is 2 years in jail. DA wants to convict them of a big bank robbery: sentence is 10 years in jail. DA has no evidence and to get the conviction, he makes the prisoners play a game.

16 Rules of the game and payoffs Players cannot communicate with one another before decide whether to confess to robbery Both confess: both get 3 years One confesses: confessor gets 1 year but accomplice gets 10 years Neither confesses: both get a 2-year sentence

17 Equilibrium When each player takes the best possible action given the action of the other player. Nash equilibrium: each player takes the best possible action given the action of the other player. The Nash equilibrium for Art and Bob is to confess. The equilibrium of the prisoners dilemma is not the best outcome for the players.

18 The payoff matrix

19 Collusion is Difficult The duopolists dilemma explains why it is difficult for firms to collude and achieve the maximum monopoly profit. Individually rational for each firm to cheat on a collusive agreement and increase output. Collectively irrational to cheat lowers profit for both. How does OPEC succeed? A leading member Saudi Arabia

20 Advertising Game Coke and Pepsi have two strategies: advertise or not advertise. Table shows the payoff matrix as the economic profits for each firm in each possible outcome.

21 Nash Equilibrium The Nash equilibrium for this game is for both firms advertise. But they could earn a larger joint profit if they could collude and not adver/se.