Monopolistic Competition

In many industries, the products are differentiated. For one reason or another, con- sumers view each firm’s brand as different from other brands. Crest toothpaste, for example, is perceived to be different from Colgate, Aim, and other toothpastes. The difference is partly flavor, partly consistency, and partly reputation—the con- sumer ’s image (correct or

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Oligopoly

In oligopolistic markets, the products may or may not be differentiated. What matters is that only a few firms account for most or all of total production. In some oligopolistic markets, some or all firms earn substantial profits over the long run because barriers to entry make it difficult or impossible for new firms

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Price Competition

We have assumed that our oligopolistic firms compete by setting quantities. In many oligopolistic industries, however, competition occurs along price dimen- sions. For example, automobile companies view price as a key strategic variable, and each one chooses its price with its competitors in mind. In this section, we use the Nash equilibrium concept to

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Competition versus Collusion: The Prisoners’ Dilemma

A Nash equilibrium is a noncooperative equilibrium: Each firm makes the deci­sions that give it the highest possible profit, given the actions of its competitors. As we have seen, the resulting profit earned by each firm is higher than it would be under perfect competition but lower than if the firms colluded. Collusion, however,

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Implications of the Prisoners’ Dilemma for Oligopolistic Pricing

Does the prisoners’ dilemma doom oligopolistic firms to aggressive competition and low profits? Not necessarily. Although our imaginary prisoners have only one opportunity to confess, most firms set output and price over and over again, continually observing their competitors’ behavior and adjusting their own accordingly. This allows firms to develop reputations from which trust

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Cartels

Producers in a cartel explicitly agree to cooperate in setting prices and output levels. Not all the producers in an industry need to join the cartel, and most cartels involve only a subset of producers. But if enough producers adhere to the cartel’s agreements, and if market demand is sufficiently inelastic, the cartel may

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Dominant Strategies

How can we decide on the best strategy for playing a game? How can we deter- mine a game’s likely outcome? We need something to help us determine how the rational behavior of each player will lead to an equilibrium solution. Some strategies may be successful if competitors make certain choices but fail if

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Gaming and Strategic Decisions

First, we should clarify what gaming and strategic decision making are all about. A game is any situation in which players (the partici­pants) make strategic decisions—i.e., decisions that take into account each other’s actions and responses. Examples of games include firms competing with each other by setting prices, or a group of consumers bidding

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The Nash Equilibrium Revisited

To determine the likely outcome of a game, we have been seeking “self-enforc- ing,” or “stable” strategies. Dominant strategies are stable, but in many games, one or more players do not have a dominant strategy. We therefore need a more general equilibrium concept. In Chapter 12, we introduced the concept of a Nash equilibrium

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Repeated Games

We saw in Chapter 12 that in oligopolistic markets, firms often find themselves in a prisoners’ dilemma when making output or pricing decisions. Can firms find a way out of this dilemma, so that oligopolistic coordination and coopera­tion (whether explicit or implicit) could prevail? To answer this question, we must recognize that the prisoners’

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Sequential Games

In most of the games we have discussed so far, both players move at the same time. In the Cournot model of duopoly, for example, both firms set output at the same time. In sequential games, players move in turn. The Stackelberg model discussed in Chapter 12 is an example of a sequential game;

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Threats, Commitments, and Credibility

The product choice problem and the Stackelberg model are two examples of how a firm that moves first can create a fait accompli that gives it an advantage over its competitor. In this section, we’ll take a broader look at the advantage that a firm can have by moving first. We’ll also consider what

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Entry Deterrence

Barriers to entry, which are an important source of monopoly power and profits, sometimes arise naturally. For example, economies of scale, patents and licenses, or access to critical inputs can create entry barriers. However, firms themselves can sometimes deter entry by potential competitors. To deter entry, the incumbent firm must convince any potential competitor

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Auctions

In this section, we examine auction markets—markets in which products are bought and sold through formal bidding processes.19 Auctions come in all sizes and shapes. They are often used for differentiated products, especially unique items such as art, antiques, and the rights to extract oil from a piece of land. In recent years, for

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Competitive Factor Markets

A competitive factor market is one in which there are a large number of sellers and buyers of a factor of production, such as labor or raw mate­rials. Because no single seller or buyer can affect the price of a given factor, each is a price taker. For example, if individual firms that buy

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Equilibrium in a Competitive Factor Market

A competitive factor market is in equilibrium when the price of the input equates the quantity demanded to the quantity supplied. Figure 14.10 (a) shows such an equilibrium for a labor market. At point A, the equilibrium wage rate is wC and the equilibrium quantity supplied is L. Because they are well informed, all

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Factor Markets with Monopsony Power

In some factor markets, individual buyers have buyer power that allows them to affect the prices they pay. Often this happens either when one firm is a mon­opsony buyer or there are only a few buyers, in which case each firm has some monopsony power. For example, we saw in Chapter 10 that automobile

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Factor Markets with Monopoly Power

Just as buyers of inputs can have monopsony power, sellers of inputs can have monopoly power. In the extreme, the seller of an input may be a monopolist, as when a firm has a patent to produce a computer chip that no other firm can duplicate. Because the most important example of monop­oly power

Stocks versus Flows

Before proceeding, we must be clear about how to measure capital and other factor inputs that firms purchase. Capital is measured as a stock, i.e., as a quantity of plant and equipment that the firm owns. For example, if a firm owns an electric motor factory worth $10 million, we say that it has

Present Discounted Value

We will return to our $10 million electric motor factory in Section 15.4, but first we must address a basic problem: How much is $1 paid in the future worth today? The answer depends on the interest rate: the rate at which one can borrow or lend money. Suppose the annual interest rate is

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