| Please describe the barometric price model oligopoly | • A firm announces a price change and the market reacts
• Leader serves as a barometer for the industry and is not necessarily the dominant one
• There are two types of barometric price leadership:
1. Competitive type
o Frequent changes in the identity of the leader
o No immediate, uniform price response to price changes
o Variations in market share
2. Monopolistic type
o A small number of large firms
o Large entry barriers
o Limited product differentiation
o Low price elasticity of demand, deterring price-cutting
o Similar cost functions |
| Please describe the barometric price model oligopoly | • A firm announces a price change and the market reacts
• Leader serves as a barometer for the industry and is not necessarily the dominant one
• There are two types of barometric price leadership:
1. Competitive type
o Frequent changes in the identity of the leader
o No immediate, uniform price response to price changes
o Variations in market share
2. Monopolistic type
o A small number of large firms
o Large entry barriers
o Limited product differentiation
o Low price elasticity of demand, deterring price-cutting
o Similar cost functions |
| What are the 3 types of market structures we have worked with in this course? | 1. Perfect competition
2. Monopoly
3. Oligopoly |
| What characterizes Perfect competition? | Firms are price takers and demand are perfectly elastic at market price:
• MR does not vary with the firm’s output
• Firms are price takers, P = MC.
• There is allocative efficiency, the price consumers is willing to pay = marginal utility they receive.
• Free entry ensures all firms achieve full efficiency, otherwise they incur losses as their MC is higher than P. Then, the firm goes out of business. |
| What are the assumptions behind Perfect competition? | 1. Large number of buyers and sellers – agents with negligible share
2. Free entry and exit – no barriers and extra costs due to entry and exit
3. Firms produce homogeneous products – no product differentiation
4. Firms and consumers have perfect information
5. No transportation cost – no effect of geographic location of markets
6. Firms behave independently to maximize profit |
| What is the short run equilibrium in Perfect Competition? | For the industry SRMC = P |
| What is the long run equilibrium in Perfect Competition | P = MC for the industry |
| How does perfect competition move from short run equilibrium to long run equilibrium | Firms are price takers, hence they compete on price. If there are profits available in the market, new firms will enter until MC = P (No more profits in the market) |
| What characterises a monopoly market, and what is the consequence of monopoly for economic welfare? | There is only one firm on the market. Under monopoly, equilibrium market price is higher and output lower than perfect competition, leading to dead weight loss (reduced economic welfare). |
| Why is monopoly worse for the economy than perfect competition? | A monopolist earns abnormal profit in the long run. Total welfare is higher under perfect competition.
Perfect competition and monopoly CS, PS, TS and DWL (welfare) can be seen in picture below. As can be seen, TS is higher under perfect competition as there is no dead weight loss. Meaning, total welfare is higher under perfect competition. The opposite is true for monopoly. |
| What characterises an Oligopoly, and how does it differ from perfect competition/monopoly? | Perfect competition and monopoly models cannot explain market activities such as price wars, parallel pricing, product differentiation, and advertising. Oligopoly theory recognizes the number of firms in the industry and degree of product differentiation:
• A small number of firms account for substantial share of industry sales
• Closely substitute product imply rivalry between competitors |
| What are the 4 important concepts of oligopoly? | 1. Conjectural variation: each firm makes assumptions on the actions rival firms take in response to the firm’s own actions
2. Interdependence: each firm’s action depends on what it thinks about what actions the other firms will take
3. Collusion: can arise when two or more rival firms recognize the interdependence of their actions might lead to formulation of joint action
4. Independent action: firm acknowledges that actions are interdependent but reaches conclusion that taking a unilateral decision is better for her (not contacting rivals) |
| Please characterise the non-collusive oligopoly model Bertrand competition (Which in fact is a duopoly) | Bertrand model (Competing on price only) (Duopoly):
- There are two firms A and B
- Market barriers to entry exist
- Firms produce identical product – consumers buy only from the firm with the lowest price
- There are no transaction or search costs – consumers are indifferent - between firms given same price
- Both firms face a constant marginal cost: MCA = MCB
- Firms have no capacity constraint
Strategy assumptions:
- Zero conjectural variation – each firm takes the rival’s price as fixed and does not expect any reaction by the rival
- Firms act independently after assessing the rival firm’s strategy
- Firms set their price sequentially
- Equilibrium is P_C=MC_A=MC_B
- Bertrand equilibrium corresponds to perfectly competitive equilibrium. |
| Please characterise the non-collusive oligopoly model Bertrand-Edgeworth (Competing on price with capacity constraint) (Duopoly): | • Same assumption as in Bertrand model but with capacity constraint
• Capacity constraint implies firms cannot serve the entire market individually
• At Bertrand equilibrium, firms are producing at their maximum capacity
• Firms have incentive to increase price and earn more profits without fear of losing all their customers
• Equilibrium: not stable |
| Please describe the non collusive dominant price model oligopoly | - The market is characterized by one large firm (dominant) and a large number of small firms (competitive fringe)
- Leader firm has complete information about its demand and cost conditions and that of the competitive fringe. And it sets the price and others follow
- The competitive fringe are price takers and face perfectly elastic demand at the price set by the dominant firm
Equilibrium:
- Dominant firm: MR_Leader=MC_Leader
- Competitive fringe: dominant firm price equals their marginal costs |
| Please describe the non collusive barometric price model oligopoly | • A firm announces a price change and the market reacts
• Leader serves as a barometer for the industry and is not necessarily the dominant one
• There are two types of barometric price leadership:
1. Competitive type
o Frequent changes in the identity of the leader
o No immediate, uniform price response to price changes
o Variations in market share
2. Monopolistic type
o A small number of large firms
o Large entry barriers
o Limited product differentiation
o Low price elasticity of demand, deterring price-cutting
o Similar cost functions |
