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Berkeley ECON 100A - Section Notes 22

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Section Notes 22, Econ 100A Spring ’06 1Section Notes 22Covering material from Lecture on April 13thClass Outline1. Monopolistic Competition2. Cartels3. Nash Equilibrium1 Monopolistic CompetitionMonopolistic competition happens when firms are large enough to face a downward sloping demand, yetthere is free entry. This implies two main things:1. There will be no long-run profits.2. Price can be set above Marginal Cost.To see this graphically, let’s focus on the residual demand curve (the demand curve seen by the singlefirm once all other firms have produced) and observe zero profits with market power:-6Section Notes 22, Econ 100A Spring ’06 22 CartelsAs we saw in class, Cartels exist when a group of oligopolists act cooperatively in a market. They do thisin order to maximize profits in the industry and then share them amongst each other. But also, as we sawin class, there is an incentive to cheat. This is because any single producer can increase their individualprofits by expanding output, which would lower the profits of all other producers. To make this explicit,assume there are perfect barriers to entry, and there are currently 5 identical firms in the market. Eachhas a cost function given by C(q) =52q2− 20q + 90, and market demand given by P = 100 − Q. Findthe equilibrium cartel solution by graphing the individual cost curves on the left panel and the marketequilibrium on the right panel. Then show why there is an incentive to cheat for each individual firm.-6-6Section Notes 22, Econ 100A Spring ’06 33 Nash EquilibriumA nash equilibirum (NE) exists between two individuals who are acting non-cooperatively when both oftheir actions are most preferred given the action of the other. To see if we are at a NE simply ask the samequestion for each individual: “Given what the other guy is doing, do I want to deviate from my currentchoice?” If the answer is no for both individuals, then it’s a


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Berkeley ECON 100A - Section Notes 22

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