ECON 2010 Lecture Notes - Lecture 28: Perfect Competition, Oligopoly, Game Theory

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3 Jan 2016

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ECON 2010 Full Course Notes

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Oligopoly analysis is based on strategic firm interaction. For perfect competition, quantity choices are based on costs and prices that are given. For monopolies, there is no strategic interaction with other firms. An oligopolistic firm influences the market with its choice of quantity. It maximizes profit based on what others do. Game theory is used to analyze this thinking. You can imagine a game between two firms, where each acts based off what it thinks the other will do. Best outcome: firms trust each other and collude. Output effect: increase in profit due to increased output. Price effect: decrease in profit due to lower price. For oligopolies, output effect usually greater than price effect.

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1. Which of the following statements about oligopolies is not correct?

a.		Oligopolistic firms always charge the monopoly price.
b.		Oligopolistic firms are interdependent in a way that firms in perfect competition are not.
c.		An oligopolistic market has only a few sellers.
d.		The actions of any one seller can have a large impact on the profits of all other sellers.

2. Which is true of an oligopoly market that reaches a Nash equilibrium?

a.		The firms will not have behaved as profit maximizers.
b.		A firm will have chosen its best strategy, given the strategies chosen by other firms in the market.
c.		A firm will not take into account the strategies of competing firms.
d.		The market price will be different for each firm.

3. In game theory, what is a dominant strategy?

a.		the best strategy for a player to follow, regardless of the what strategies other players use
b.		a strategy that makes every player better off
c.		a strategy that must appear in every game
d.		the best strategy for a player to follow only if other players are cooperative

4. Which of the following situations produces the largest profits for oligopolists?

a.		The firms reach a Nash equilibrium.
b.		The firms combine to produce the monopoly output level.
c.		The firms set prices equal to marginal cost.
d.		The firms produce a quantity of output that lies between the competitive outcome and the monopoly outcome.

1. Which of the following statements about oligopolies is not correct?

a.		Oligopolistic firms always charge the monopoly price.
b.		Oligopolistic firms are interdependent in a way that firms in perfect competition are not.
c.		An oligopolistic market has only a few sellers.
d.		The actions of any one seller can have a large impact on the profits of all other sellers.

2. Which is true of an oligopoly market that reaches a Nash equilibrium?

a.		The firms will not have behaved as profit maximizers.
b.		A firm will have chosen its best strategy, given the strategies chosen by other firms in the market.
c.		A firm will not take into account the strategies of competing firms.
d.		The market price will be different for each firm.

3. In game theory, what is a dominant strategy?

a.		the best strategy for a player to follow, regardless of the what strategies other players use
b.		a strategy that makes every player better off
c.		a strategy that must appear in every game
d.		the best strategy for a player to follow only if other players are cooperative

4. Which of the following situations produces the largest profits for oligopolists?

a.		The firms reach a Nash equilibrium.
b.		The firms combine to produce the monopoly output level.
c.		The firms set prices equal to marginal cost.
d.		The firms produce a quantity of output that lies between the competitive outcome and the monopoly outcome.

Consider the following market game: An incumbent firm, called firm 3, is already in an industry. Two potential entrants, called firms 1 and 2, can each enter the industry by paying the entry cost of 10. First, firm 1 decides whether to enter or not. Then, after observing firm 1's choice, firm 2 decides whether to enter or not. Then, after observing firm 1's choice, firm 2 decides whether to enter or not. Every firm, including firm 3, observes the choices of firms 1 and 2. After this, all of the firms in the industry (including firm 3) compete in a Cournot oligopoly, where they simultaneously and independently select quantities. The price is determined by the inverse demand curve p = 12 â Q, where Q is the total quantity produced in the industry. Assume that the firms produce at no cost in this Cournot game. Thus, if firm i is in the industry and produces qi, then it earns a gross profit of (12 â Q)qi in the Cournot phase. (Remember that firms 1 and 2 have to pay the fixed cost of 10 to enter).

(a) Compute the subgame perfect equilibrium of this market game. Do so by first finding the equilibrium quantities and profit in the Cournot subgames. Show your answer by designating optimal action on the tree and writing the complete subgame perfect equilibrium strategy profile. [Hint: In an n-firm Cournot oligopoly with demand p = 12 â Q and 0 costs, the Nash equilibrium entails each firm producing the quantity q = 12/(n + 1).]

(b) In the subgame perfect equilibrium, which firms (if any) enter the industry?

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ECON 2010 Lecture Notes - Lecture 28: Perfect Competition, Oligopoly, Game Theory

ECON 2010 Full Course Notes

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