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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The Value of a Bond

A bond is a contract in which a borrower agrees to pay the bondholder (the lender) a stream of money. For example, a corporate bond (a bond issued by a corporation) might make “coupon” payments of $100 per year for the next ten years, and then a principal payment of $1000 at the end

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The Net Present Value Criterion for Capital Investment Decisions

One of the most common and important decisions that firms make is to invest in new capital. Millions of dollars may be invested in a factory or machines that will last—and affect profits—for many years. The future cash flows that the investment will generate are often uncertain. And once the factory has been built,

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Adjustments for Risk

We have seen that a risk-free interest rate is an appropriate discount rate for future cash flows that are certain. For most projects, however, future cash flows are far from certain. At our electric motor factory, for example, we would expect uncertainty over future copper prices, over the future demand and the price of

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Investment Decisions by Consumers

We have seen how firms value future cash flows and thereby decide whether to invest in long-lived capital. Consumers face similar decisions when they pur­chase durable goods, such as cars or major appliances. Unlike the decision to purchase food, entertainment, or clothing, the decision to buy a durable good involves comparing a flow of

Investments in Human Capital

So far, we have discussed how firms and consumers can decide whether to invest in physical capital—buildings and equipment, in the case of firms, and durable goods such as cars and major appliances, in the case of consumers. We have seen how to apply the net present value rule to these decisions: Invest when

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Intertemporal Production Decisions— Depletable Resources

Production decisions often have intertemporal aspects—production today affects sales or costs in the future. The learning curve, which we discussed in Chapter 7, is an example of this. By producing today, the firm gains experience that lowers future costs. In this case, production today is partly an investment in future cost reduction, and the

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How Are Interest Rates Determined?

We have seen how market interest rates are used to help make capital invest­ment and intertemporal production decisions. But what determines interest rate levels? Why do they fluctuate over time? To answer these questions, remember that an interest rate is the price that borrowers pay lenders to use their funds. Like any market price,

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General Equilibrium Analysis

So far, our discussions of market behavior have been largely based on partial equilibrium analysis. When determining the equilibrium prices and quantities in a market using partial equilibrium analysis, we presume that activity in one market has little or no effect on other markets. For example, in Chapters 2 and 9, we presumed that

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