MGE 302 FINAL EXAM Study Guide Dominick Muto Lecture 4 23 4 28 Chapter 8 Market is any arrangement that brings buyers and sellers together Product Market price brings buyers and sellers together Labor Market Have buyer worker and seller employer who are brought together by wage and providing service Hrs x wage wL Money Market has buyers who gets loan and seller sell loanable funds International Market buyers and sellers internationally price is determined by exchange rate Four Markets Criteria to distinguish between markets 1 Number and Size of the firm in market 2 Degree of product differentiation or type of product ex coke vs Pepsi 3 Entry and Exit in long run Perfectly Competitive Firm ex agriculture stock prices PRICE TAKER output has no impact on price meaning no price strategy Perfectly Elastic Demand NO Market Power 1 Many Small firms 2 Homogenous Standardized products 3 No barriers to entry long run profitability makes ZERO ECONOMIC PROFIT Monopolistic Competition ex retail stores hair salon PRICE MAKER Setter has Limited Market Power competitive and monopolistic 1 Many Small firms 2 Differentiated products not perfect substitutes 3 No barriers to entry long run profitability makes ZERO ECONOMIC PROFIT Monopoly ex DMV national grid PRICE MAKER Setter has Substantial Market Power 1 One Large firm 2 Unique Products gas oil diamond drivers license 3 BLOCKED entry POSITIVE ECONOMIC PROFIT Mark Up Oligopoly ex US airlines taking control of industry Pepsi in soft drink industry PRICE MAKER Setter Substantial Market power 1 Few relatively Large firms 2 Standardized in perfectly comp firm or Differentiated Products in monopolistic comp firm 3 SUBSTANTIAL big BARRIER to entry relatively difficult to get into takes a lot of money Mutual interdependence of Profit Oligopoly uses Game theory MGE 302 FINAL EXAM Study Guide Dominick Muto Regulated Monopoly Natural Monopoly that must be regulated Marginal Cost Pricing 1st best solution for customer not possible because firm loses Lmc P D Fair Rate of Return 2nd best solution when company s breakeven and covers all owner supply and market supply resources used when regulating monopoly LATC P D when regulated you decrease Q and increase P Singe price Monopoly when monopoly charges single price only and doesn t discriminate Always INEFICIENT because P LMC always causing dead weight loss Price Discrimination firms can charge different prices to different customer when cost of the item is exactly the same Must have 1 Market Power monopoly monopolistic competition oligopoly 2 A way to identify customer who will pay more or less ex in vs out of state student 3 No Resale Chapter 10 Oligopoly a market structure in which a few firms are strategically interdependent Strategically interdependent produce dominant share of output in the market oligopolies distinguishing characteristic cannot set price quantities independently Few firms dominate the market Most distinguishing feature of Oligopoly Interdependence of profit from strategic interdependence GAME OF COMPETITION vs STRATEGY Game Theory Used to analyze the behavior of firms an approach to modeling the strategic interaction of oligopoly s in terms of moves and countermoves o Game Theory Analyses increase or decrease price or should you even operate rules payoff listing of profit and strategies should you Prisoners Dilemma a technique for obtaining conviction from criminals commonly used by government Plea bargaining SNITCH when firms engage in Collusion o Used by firms during Plea bargaining o Chart o Dominant Strategy also known as Nash Equilibrium a strategy that is best for a player no matter what strategy the other player chooses what normally breaks Cartels both confess top left The Outcome Nash Equilibrium actions taken by other player each player is taking the best action given o Optimal Strategy when both DON T confess bottom right MGE 302 FINAL EXAM Study Guide Dominick Muto prisoners dilemma two firms in certain location o Duopoly Implicit Agreement indirectly illegal agree not to advertise to save money for both firms Chart Cartel joint profit is the strongest form of collusion an agreement by several firms countries to obey output restrictions in order to increase their joint profits bunch of firms try to collude to act like a monopoly by setting prices cartel have their own specific agreements o need agreement to form a cartel o group of firms or countries come together select a common price o Maximize Industry cartel profit not firm o Illegal in US but maybe not in other countries Production Quota where firms come together to max their joint profit of the cartel Production Quota Set Quantity of firms in cartel Two conflicting tendencies lead to Cartel Breakdown Incentive to Cooperate Incentive to Cheat if everyone does this it will flood the market make customer happy but hurt business EX OPEC oil producing export country South Africa Russia diamonds Cartel Chart ch 10 notes pg 7 Payoff Matrix a table showing the payoffs to each of the two players for each pair of strategies they chose MGE 302 FINAL EXAM Study Guide Dominick Muto THREE OLIGOPOLY MODELS 1 Collusion illegal price fixing o Explicit Collusion direct communication cooperation involving direct communication between competing firms about setting prices illegal o Tacit Collusion when firms do NOT explicitly conspire to collude but accomplish collusion indirectly product price understanding Gentlemen s Agreement Non Price competition advertising leave market share Decide on Set Price NO EXPICIT COLLUSION only implicit understanding say firms are randomly charging low price now all other firms will Tit for Tat set their price even lower PUNISH FIRM for setting lower price Kinked Demand non collusive game shows how Oligopolies don t have smooth demand it depends on the action reaction of rivals illustrates how tacit collusion can make an oligopolies unresponsive to changes in marginal cost Kinked Demand Theory states that if firms are not colluding than price decisions depend on rivals cant set price independently because oligopolies are strategically interdependent Kinked demand curve chart Ch 10 pg 10 THREE OLIGOPOLY MODELS continued 2 Price Leadership common in US o No formal agreement No outright collusion o Implicit understanding gentleman s agreement Can coordinate prices without engaging in outright collusion could cause them to evade law but it s still ILLEGAL o Locate Dominant Firm sets the price and all others