MICROECONOMICS
Chapter 1
Comparative Statics Analysis
Marginal Impact
A Comparative Statics Analysis compares the equilibrium state of a
system before a change in the exogenous variables to the
equilibrium state after the change
The Marginal Impact of a change in the exogenous variable is the
incremental impact of the last unit of the exogenous variable on
the endogenous variable.
Chapter 2
Competitive Markets
Market Demand Function
Demand Curve
Law of Demand
Law of Supply
Market Equilibrium
Excess Supply
Price Elasticity of Demand
Competitive Markets are those with sellers and buyers that are
small and numerous enough that they take the market price as
given when they decide how much to buy and sell.
The Market Demand Function tells us how the quantity of a good
demanded by the sum of all consumers in the market depends on
various factors. Qd = (Q,p,p0,I,…)
The Demand Curve plots the aggregate quantity of a good that
consumers are willing to buy at different prices, holding constant
other demand drivers such as prices of other goods, consumer
income, quality. Qd = Q(p)
The Law of Demand states that the quantity of a good demanded
decreases when the price of this good increases.
The Law of Supply states that the quantity of a good offered
increases when the price of this good increases.
A Market Equilibrium is a price such that, at this price, the
quantities demanded and supplied are the same.
V=A
If sellers cannot sell as much as they would like at the current price,
there is Excess Supply.
If there is no excess supply or excess demand, there is no pressure
for prices to change and thus there is equilibrium.
The Price Elasticity of Demand is the percentage change in
quantity demanded brought about by a one-percent change in the
price of the good.
𝜕𝑄 𝑃
𝜀 = 𝜕𝑃 ∙ 𝑄
Elastic Demand Curve
Inelastic Demand Curve
Unit Elastic Demand Curve
When a one percent change in price leads to a greater than onepercent change in quantity demanded, the demand curve is elastic.
(Q,P < -1)
Demand tends to be more elastic:
*the larger the number of close substitutes
*the more narrowly defined the market
*if the good is a luxury
*the longer the time horizon
When a one-percent change in price leads to a less than onepercent change in quantity demanded, the demand curve is
inelastic. (0 > Q,P > -1)
When a one-percent change in price leads to an exactly onepercent change in quantity demanded, the demand curve is unit
elastic. (Q,P = -1)
Income Elasticity of Demand
Cross-price Elasticity of Demand
Price Elasticity of Supply
Income elasticity of demand measures how much the quantity
demanded of a good responds to a change in consumers’ income.
<0 : Inferior good
>0 : Normal good
Between 0 and 1 : Necessity
>1: Luxury good
𝜕𝑌 𝐼
𝜀𝑌𝐼 =
∙
𝜕𝐼 𝑌
The Cross-price elasticity of demand measures how much the
quantity demanded of a good responds to a change in the price of
another good. (complements – substitutes)
Price elasticity of supply is a measure of how much the quantity
supplied of a good responds to a change in the price of that good.
Chapter 3
Consumer Preferences
Basket
Bundle
Preferences are complete
Preferences are transitive
Preferences are monotonic
Indifference Curve
Indifference Set
Indifference Map
Marginal Rate of Substitution
Utility function
Quasi-linear utility functions
Consumer Preferences tell us how the consumer would rank (that
is, compare the desirability of) any two combinations or allotments
of goods, assuming these allotments were available to the
consumer at no cost.
These allotments of goods are referred to as baskets or bundles.
These baskets are assumed to be available for consumption at a
particular time, place and under particular physical circumstances.
Preferences are complete if the consumer can rank any two
baskets of goods (A preferred to B; B preferred to A; or indifferent
between A and B)
Preferences are transitive if a consumer who prefers basket A to
basket B, and basket B to basket C also prefers basket A to basket C
Preferences are monotonic if a basket with more of at least one
good and no less of any good is preferred to the original basket.
An Indifference Curve or Indifference Set: is the set of all baskets
for which the consumer is indifferent.
*Negatively sloped
*Convex to origin
*Do not intersect
*Each bundle belongs to just one IC
*Cannot be ‘thick’
An Indifference Map : Illustrates a set of indifference curves for a
consumer
The marginal rate of substitution: is the maximum rate at which
the consumer would be willing to substitute a little more of good x
for a little less of good y.
𝑈𝑥 𝑥, 𝑦 𝑃𝑥
𝑀𝑅𝑆𝑥,𝑦 𝑥, 𝑦 =
=
𝑈𝑦 𝑥, 𝑦 𝑃𝑦
Grafisch: helling van de raaklijn in een punt aan de
indifferentiecurve.
The utility function assigns a number to each basket so that more
preferred baskets get a higher number than less preferred baskets.
Utility is an ordinal concept: the precise magnitude of the number
that the function assigns has no significance.
The only thing that determines your personal trade-off between x
and y is how much x you already have.
U = v(x) + Ay
Marginal Utility
The marginal utility of a good, x, is the additional utility that the
consumer gets from consuming a little more of x when the
consumption of all the other goods in the consumer’s basket
remain constant.
1 good : 𝑀𝑈𝑦 (𝑦) = 𝑈 ′ 𝑦 =
𝑑𝑈𝑦
𝑑𝑦
2 goods: 𝑀𝑈𝑥 (𝑥, 𝑦) = 𝑈𝑥 𝑥, 𝑦 =
𝜕𝑈𝑥,𝑦
𝜕𝑥
𝑀𝑈𝑦 (𝑥, 𝑦) = 𝑈𝑦 𝑥, 𝑦 =
𝜕𝑈𝑥,𝑦
𝜕𝑦
Chapter 4
Budget Constraint
Interior Optimum
Tangent
Corner solution
The set of baskets that the consumer may purchase given the limits
of the available income. 𝑃𝑥 𝑥 + 𝑃𝑦 𝑦 = 𝐼
Interior Optimum: The optimal consumption basket is at a point
where the indifference curve is just tangent to the budget line.
A tangent: to a function is a straight line that has the same slope as
the function.
A corner solution occurs when the optimal bundle contains none of
one of the goods.
Chapter 5
Price consumption curve
Engel curve
Normal good
Inferior good
Income effect
Substitution effect
Giffen good
Consumer surplus
The price consumption curve for good x can be written as the
quantity consumed of good x for any price of x. This is the
individual’s demand curve for good x.
The income consumption curve for good x also can be written as
the quantity consumed of good x for any income level. This is the
individual’s Engel Curve for good x. When the income consumption
curve is positively sloped, the slope of the Engel Curve is positive.
If the income consumption curve shows that the consumer
purchases more of good x as her income rises, good x is a normal
good. Equivalently, if the slope of the Engel curve is positive, the
good is a normal good.
If the income consumption curve shows that the consumer
purchases less of good x as her income rises, good x is an inferior
good. Equivalently, if the slope of the Engel curve is negative, the
good is an inferior good.
As the price of x falls, all else constant, purchasing power rises.
This is called the income effect of a change in price.
The income effect may be positive (normal good) or negative
(inferior good).
As the price of x falls, all else constant, good x becomes cheaper
relative to good y. This change in relative prices alone causes the
consumer to adjust his/ her consumption basket. This effect is
called the substitution effect. The substitution effect always is
negative.
If a good is so inferior that the net effect of a price decrease of
good x, all else constant, is a decrease in consumption of good x,
good x is a Giffen good. For Giffen goods, demand does not slope
down.
The net economic benefit to the consumer due to a purchase (i.e.
the willingness to pay of the consumer net of the actual
expenditure on the good) is called consumer surplus.
Network externalities
Bandwagon Effect
Snob Effect
If one consumer's demand for a good changes with the number of
other consumers who buy the good, there are network
externalities.
If one person's demand decreases with the number of other
consumers, then the externality is positive.
Increased quantity demanded when more consumers purchase
If one person's demand decreases with the number of other
consumers, then the externality is negative.
Decreased quantity demanded when more consumers purchase
Chapter 6
Production function
Technology
Technically efficient firm
Production functions with
single input
The production function Q=f(L,K,…) tells us the maximum possible
output that can be attained by the firm for any given quantity of
inputs.
Technology determines the quantity of output that is feasible to
attain for a given set of inputs.
A technically efficient firm is attaining the maximum possible
output from its inputs
Single input production functions Q=f(L)
𝑄
𝑓(𝐿)
Average product 𝐴𝑃 = =
𝐿
𝐿
𝑑𝑓𝐿
′
Production functions with
multiple inputs
Isoquant
Returns to scale
Scale
Marginal Rate of Technical
Substitution
Technological progress
Marginal product 𝑀𝑃 = 𝑓 𝐿 =
𝑑𝐿
Production functions with multiple inputs Q=f(L,K)
𝜕𝑓 𝐿, 𝐾
𝑀𝑃𝐿 𝐿, 𝐾 =
= 𝑓𝐿 𝐿, 𝐾
𝜕𝐾
𝜕𝑓 𝐿, 𝐾
𝑀𝑃𝐾 𝐿, 𝐾 =
= 𝑓𝐾 𝐿, 𝐾
𝜕𝐿
All combinations of L and K that yield the same output level
Let Q=f(L,K)
Globally increasing returns to scale ↔ for all (L,K) and for all λ>1:
𝑓(𝜆𝐿, 𝜆𝐾) > 𝜆𝑓(𝐿, 𝐾)
Globally decreasing returns to scale ↔ for all (L,K) and for all λ>1:
𝑓(𝜆𝐿, 𝜆𝐾) < 𝜆𝑓(𝐿, 𝐾)
Globally constant returns to scale ↔ for all (L,K) and for all λ>0:
𝑓(𝜆𝐿, 𝜆𝐾) = 𝜆𝑓(𝐿, 𝐾)
By what % does output rise if all inputs are increased by 1%,
starting from a given input combination:
𝜕𝑓 𝐿, 𝐾
𝐿
𝜕𝑓 𝐿, 𝐾
𝐾
𝜀𝑠𝑐𝑎𝑙𝑒 =
∙
+
∙
𝜕𝐿
𝑓 𝐿, 𝐾
𝜕𝐾
𝑓 𝐿, 𝐾
We have increasing, decreasing or constant returns to scale for a
given input combination (L,K) if 𝜀𝑠𝑐𝑎𝑙𝑒 is larger than, smaller than,
or equal to 1.
Marginal Rate of Technical Substitution (MRTS) - or Technical Rate
of Substitution (TRS) - is the amount by which the quantity of one
input has to be reduced ( − Δx2) when one extra unit of another
input is used (Δx1 = 1), so that output remains constant (
).
𝑀𝑃
Capital-saving: 𝑀𝑅𝑇𝑆𝐿,𝐾 = 𝑀𝑃 𝐿 rises
𝐾
Labor-saving: 𝑀𝑅𝑇𝑆𝐿,𝐾 =
𝑀𝑃𝐿
𝑀𝑃𝐾
declines
Chapter 7
Explicit costs
Explicit costs require a direct outlay of money by the firm
Implicit costs
Economic profit
Accounting profit
Long-run Costs
Short-run Costs
Total cost
Implicit costs do not require an outlay of money by the firm.
Economists measure a firm’s economic profit as total revenue
minus total cost, including all opportunity costs (both explicit and
implicit costs)
Accountants measure accounting profit as the firm’s total revenue
minus the firm’s explicit cost.
All inputs are variable
Some inputs cannot be freely chosen
The cost of the optimal input choice for a given output level and
given output prices is:
𝑇𝐶 𝑄, 𝑤, 𝑟 = 𝑤𝐿*𝑄, 𝑤, 𝑟 + 𝑟𝐾*𝑄, 𝑤, 𝑟
Chapter 8
Total cost function
Average cost function
The total cost function (TC) gives, for any set of input prices and for
any output level, the minimum cost incurred by the firm.
Total cost = TC(w,r,Q)
The average cost function (AC) is found by computing total costs
per unit of output.
Average cost = 𝐴𝐶(𝑤, 𝑟, 𝑄) =
Marginal cost function
𝑇𝐶(𝑤,𝑟,𝑄)
𝑄
The marginal cost function (MC) is found by computing the change
in total costs for a change in output produced.
Marginal cost = 𝑀𝐶(𝑤, 𝑟, 𝑄) =
Economies of scale
Diseconomies of scale
Minimum efficient scale
Output elasticity of total cost
Short term costs of production
Short-run average costs
Average fixed costs
Average variable costs
Short-run average costs
𝜕𝑇𝐶(𝑤,𝑟,𝑄)
𝜕𝑄
If average cost decreases as output rises, all else equal, the cost
function exhibits economies of scale.
When the production function exhibits increasing returns to scale,
the long run cost function exhibits economies of scale, so that
AC(Q) decreases with Q, all else equal.
If the average cost increases as output rises, all else equal, the cost
function exhibits diseconomies of scale.
When the production function exhibits decreasing returns to scale,
the long run cost function exhibits diseconomies of scale, so that
AC(Q) increases with Q, all else equal.
The smallest quantity at which the long run average cost attains its
minimum is called the minimum efficient scale (MES).
The percentage change in total cost per one percent change in
output is the output elasticity of total cost.
𝑑𝑇𝐶(𝑄) 𝑄
𝑀𝐶(𝑄)
𝜀𝑇𝐶,𝑄 =
=
𝑑𝑆 𝑇𝐶(𝑄) 𝐴𝐶(𝑄)
Short term costs of production may be divided into fixed costs and
variable costs.
STC(Q) = TFC + TVC(Q)
Short-run average costs (SAC) can be determined by dividing the
firm’s costs by the quantity of output it produces.
SAC is the slope of a ray through the origin to STC.
𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡
𝑇𝐹𝐶
= 𝑄
𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡
𝑇𝑉𝐶
Average Variable Costs (AVC) = 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = 𝑄
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡
𝑆𝑇𝐶
Short-run average Costs (SAC) = 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = 𝑄 =
𝐹𝑖𝑥𝑒𝑑+𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡
= 𝐴𝐹𝐶 + 𝐴𝑉𝐶
𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
Average Fixed Costs (AFC) =
Short-run Marginal cost
Economies of scope
Short-run Marginal cost (SMC) measures the increase in short term
total cost that arises from an extra unit of production.
𝑑𝑆𝑇𝐶
𝑆𝑀𝐶 =
𝑑𝑄
Consider two outputs Q1 and Q2. Let production costs (at given
input prices) of producing the two products separately be given by
TC(Q1,0) and TC(0,Q2). Let production cost of producing jointly in
one firm be TC(Q1,Q2). Economies of scope exist if joint production
of given quantities of the two products is cheaper than separate
production of the same quantities.
TC(Q1,Q2) < TC(Q1,0) + TC(0,Q2)
Chapter 9
Perfectly Competitive Markets
Economic profit
Economic Value Added
Total Revenue
Average Revenue
Marginal Revenue
Optimal profit in short run
Shutdown
Sunk Fixed Costs (SFC)
1. There are many buyers and sellers in the market (market is
fragmented)
*Each buyer’s purchases are so small that he/she has a negligible
effect on market price.
*Each seller’s sales are so small that he/she has an negligible
impact on market price. Each seller’s input purchases are so small
that he/she perceives no effect on input prices
2. Firms produce undifferentiated products in the sense that
consumers perceive them to be identical
3. Consumers have perfect information about the prices all sellers
in the market charge
4. Free entry: all firms (industry participants and new entrants)have
equal access to resources (technology, inputs).
Profit = Total Revenue (TR) –Total opportunity Cost (TC)
A firm maximizes economic profit.
Economic Value Added is a measure of economic profit.
It is calculated as the difference between the Net Operating Profit
After Tax and the opportunity cost of invested Capital.
Total revenue (TR) for a firm is the selling price times the quantity
sold : TR(Q) = (P x Q). In competition, the price is exogenous to the
firm.
Average revenue (AR) is total revenue per unit: equals price P
Marginal revenue (MR) is the change in total revenue from an
additional unit sold. For competitive firms, MR equals the price of
the good.
1.Output is such that price equals marginal cost
2. Marginal cost is increasing at the optimal output
3. Profit is higher at optimal output than at zero output: producing
is more profitable than temporarily shutting down production
operations.
A shutdown refers to a short-run decision not to produce anything
during a specific period of time because of current market
conditions.
*The price at which the firm prefers to temporarily shut down
operations and produce nothing is the shut down price, Ps
*Profit at zero output depends on nature of costs: how much of the
fixed cost can be recovered if production is shut down?
The costs of the firm’s fixed input that are unavoidable at Q = 0 (i.e.
sunk) and output insensitive for Q > 0 (i.e. fixed)
Non-Sunk Fixed Costs (NSFK)
Total Variable Costs (TVC)
Supply Curve
SRSC all fixed costs sunk
SRSC some fixed costs are sunk
SRSC all fixed costs non-sunk
Short run supply curve of a
competitive firm
Market supply
Long run
Long-Run Supply Curve
Firm exits
Firm enters
Long-run competitive
equilibrium
Constant cost industry
The cost of the firm’s inputs that are avoidable if the firm produces
zero output (i.e. nonsunk) and output insensitive for Q > 0 (i.e.
fixed)
TVC(Q): Total Variable Costs (output sensitive costs)
In each case supply curve is the marginal cost curve to the extent
that it lies above the curve (AVC+NSFC)
Short Run Supply Curve when all fixed costs are sunk : NSFC = 0
*Shut down price is minimum average variable cost
*Supply zero if price below shut down price
*Supply curve coincides with marginal cost curve if price above
minimum average variable cost (shut down price)
*Losses perfectly possible at optimal output
STC(Q) = SFC + NSFC + TVC(Q)where NSFC > 0
ANSC = TVC(Q)/Q + NSFC/Q… average non-sunk cost
Shutdown if P < ANSC
Section of the firm’s SMC-curve that lies above the SAC-curve is
also the firm’s supply curve.
*Coincides with vertical axis if price is below shutdown price
*Coincides with marginal cost curve if price exceeds shutdown
price
*Shut down price is minimum of (AVC+ANSFC)
*Average variable cost plus average fixed cost that is avoidable
when not producing
*Losses may be consistent with optimal behavior when not all fixed
costs can be avoided at zero production
The market supply at any price is the sum of the quantities each
firm supplies at that price.
The short run market supply curve is the horizontal sum of the
individual firm supply curves.
The long run is the period of time in which all the firm’s inputs can
be adjusted, and the number of firms in the industry can change.
*Firms adapt capacities (capital investment or disinvestment)
*Depending on short-run profitability, there is entry in or exit out
of the industry
The marginal cost curve above the minimum point of its average
cost curve
In the long run, the firm exits if the revenue it would get from
producing is less than its total cost.
Exit if TR < TC
Exit if TR/Q < TC/Q
Exit if P < AC
A firm will enter the industry if such an action would be profitable.
Enter if TR > TC
Enter if TR/Q > TC/Q
Enter if P > AC
All firms maximize profits, hence P=LMC(Q)
Market demand equals supply
All firms make zero economic profit
If input prices remain constant when the industry expands, then
the long-run market supply curve is horizontal.
Increasing cost industry
Decreasing cost industry
Economic rent
Producer surplus
If input prices rise when an industry expands, the long-run supply
curve is upward sloping
If input prices decline when an industry expands, the long-run
supply curve is downward sloping.
Economic rent is the maximum willingness to pay for an input
minus the reservation value of the input outside the industry
Price P minus minimum price at which willing to supply ANSC
Chapter 10
Excise tax
Specific tax
Ad valorem tax
Tax incidence
Deadweight loss
Laffer curve
Price ceiling
Price floor
World price
Tariffs
Import quota
An excise tax(or a specific tax)is a tax per unit (denoted T) paid by
either the consumer or the producer
An ad valorem tax is a % tax
Tax incidence is the manner in which the burden of a tax is shared
among participants in a market
A deadweight loss is the fall in total surplus that results from a
market distortion, such as a tax.
The Laffer curve depicts the relationship between tax rates and tax
revenue.
A tax cut would induce more people to work and thereby have the
potential to increase tax revenues.
A legal maximum on the price at which a good can be sold.
A legal minimum on the price at which a good can be sold. Price
floors sometimes are referred to as price supports.
The effects of free trade can be shown by comparing the domestic
price of a good without trade and the world price of the good. The
world price refers to the price that prevails in the world market for
that good.
Tariffs are taxes levied by a government on goods imported into
the government's own country. Tariffs sometimes are called duties.
An import quota is a limit on the total number of units of a good
that can be imported into the country.
Chapter 11
Monopoly
Natural monopoy
Market Power
Lerner Index of market power
Multi-plant monopoly
A firm is considered a monopoly if …
*it is the sole seller of its product.
*its product does not have close substitutes.
An industry is a natural monopoly when a single firm can supply a
good or service to an entire market at a smaller cost than could
two or more firms
An agent (not just monopolist) has Market Power if s/he can affect,
through his/her own actions, the price that prevails in the market.
Sometimes this is thought of as the degree to which a firm can
raise price above marginal cost
The Lerner Index of market power is the price-cost margin, (P*MC)/P*. This index ranges between 0 (for the competitive firm) and
1 (for a monopolist facing a unit elastic demand)
𝑃∗ − 𝑀𝐶(𝑄 ∗)
1
=
∗
𝑃
𝜀𝑄𝐷 ,𝑃
The monopolist should make sure he allocates production so that
the marginal costs in the two plants are equal at the optimal
output levels, and that marginal cost equals marginal revenue
Cartel
A cartel is a group of firms that collusively determine the price and
output in a market. In other words, a cartel acts as a single
monopoly firm that maximizes total industry profit.
Monopsony
A market consisting of a single buyer an many sellers
Chapter 12
Price discrimination
Monopolist : uniform price
Monopolist : price discrimination
First-degree discrimination
Perfect price discrimination
Reservation price
Second-degree discrimination
Block pricing
Two part tariff
Linear two part tariff
Third-degree discrimination
Building ‘fences’
Versioning
Tie-in sale
Package tie-in sales
Bundling
Price discrimination is the business practice of selling the same
good (i.e. identical products) at different prices to different
customers, even though the production costs are the same.
A monopolist charges a uniform price if it sets the same price for
every unit of output sold.
A monopolist price discriminates if it charges more than one price
for its output.
Individualized unit price
The monopolist has information about the willingness to pay of
each customer and can charge each customer a different price.
First-degree price discrimination means the firm wants to produce
the quantity at which price is exactly equal to marginal cost
Customer’s willingness to pay
Unit price depends on how much you buy
Consumers pay different unit prices for different ‘blocks’ of output.
The firm charges a lump sum fee for the right to buy the good plus
a price per unit.
Buyers must pay a fixed fee for the right to consume a good and a
uniform price for each unit consumed :
Cost for consumer = S + PQ
If the firm knows the demand curve of the customer, an easy way
to grasp all consumer surplus (and to maximize profit) is to
*set P= MC
*set S equal to the full consumer surplus at that price
Unit price depends on group you belong to or on when you buy
Identify different groups or segments with different demand curves
(or different elasticities of demand)
𝑀𝑅1 (𝑄1 ) = 𝑀𝑅 2 (𝑄2 ) = 𝑀𝐶
Sometimes the firm can identify different groups with different
price elasticities, but it may be difficult to charge a different price
for the different groups.
If more elastic groups care less for quality than less elastic groups
then one way is to offer the product in (maybe slightly) different
qualities
Selling different versions of same product
A tie-in sale occurs if customer can buy one product only if they
agree to purchase another product as well.
A tie-in sale may be used in place of price discrimination when the
firm cannot observe the relative willingness to pay of different
customers.
Package tie-in sales (or bundling) occur when goods are combined
so that customers cannot buy either good separately.
Bundling may be used in place of price discrimination to increase
producer surplus when consumers have different willingness to pay
for the goods sold in the bundle.
Bundling pair of goods → only if demands are negatively correlated
Mixed bundling
Optimal advertising
Firms allow consumers to buy separate products as well as the
bundle
Optimal advertising implies marginal benefit of advertising equals
its (total) marginal cost
𝜕𝑄
𝜕𝑇𝐶 𝜕𝑄
𝑃
=1+
𝜕𝐴
𝜕𝑄 𝜕𝐴
Chapter 13
Imperfect competition
Oligopoly
Competitive interdependence
The Cournot model of
homogeneous goods oligopoly
Homogeneous Bertrand Oligopoly
Monopolistic Competition
Stackelberg model of oligopoly
Imperfect competition refers to those market structures that fall
between perfect competition and pure monopoly.
Only a few sellers; products can be homogeneous or
heterogeneous; entry barriers
Each firm faces downward-sloping demand because each is a large
producer compared to the total market size
Firm’s strategies and market outcomes depend on the behavior of
competitors + the decisions of every firm affect the profits of
competitors
*Homogeneous Products, so there is only one price on the market
*Non-cooperative behavior: firms determine strategies
independently, without colluding with other firms
*Simultaneous output decisions : each firm makes its strategic
decision (at the same time) without prior observation of the other
firm's decision.
*Market price is not known until both firms have made their
output choice
*Homogeneous product, so a single price will result in equilibrium
*Non-cooperative
*Simultaneous price decisions : each firm makes its strategic
decision without prior observation of the other firm's decision.
Many firms selling products that are heterogeneous ( i.e., similar
but not identical); no entry barriers.
A situation in which one firm acts as a quantity leader, choosing its
quantity first, with all other firms acting as followers.
leader has first-mover advantage (larger profit)
Dominant firm markets
Horizontal Product Differentiation
Vertical Product Differentiation
Monopolistic competition
Monopolistic competition ESR
Monopolistic competition ELR
Market with 1 dominant firm (usually in terms of market share) and
a „competitive fringe‟ (usually large number of smaller firms)
The dominant firm takes into account the behaviour of the
competitive fringe in deciding the output it will put on the market
(“Substitutability“) : at the same price, some consumers would
prefer the characteristics of product A while other consumers
would prefer the characteristics of product B.
(“Superiority”) : one product is viewed as unambiguously better
than another so that, at the same price
Many Buyers
Many Sellers
Free entry and Exit (>< oligopoly)
(Horizontal)Product Differentiation
*Price exceeds MC
*Positive profits attract new entrants Market
*New entry implies declining demand for individual firms
*Long run economic profit goes down to zero
*Firms charge more than marginal cost
Chapter 14
Game theory
Strategy
Simultaneous-move,
one-shot games
Nash equilibrium
Prisoners’ dilemma
Dominant strategy
Dominated strategy
Repeated games
Trigger strategies
Tit-for-tat strategy
Sequential-move games
Game tree
Backward induction
Strategic moves
Predatory pricing
The branch of microeconomics concerned with the analysis of
optimal decision making in competitive situations.
A plan for the actions that a player in a game will take under every
conceivable circumstance that the player might face.
*Situations that occur once in a relation between actors/players
*Players make their moves simultaneously
*The payoffs are the players‟ gains from a particular outcome of
the game
A Nash equilibrium is a situation in which (economic) actors each
choose their best strategy given the strategies that all the others
have chosen.
Each player chooses a strategy that gives him/her the highest
payoff, given the strategy chosen by the other player(s) in the
game.
The prisoners’ dilemma provides insight into the difficulty in
maintaining cooperation.
Often people (firms) fail to cooperate with one another even when
cooperation would make them better off.
A dominant strategy for a player is the best strategy for a player to
follow, regardless of the strategies chosen by the other players.
A player has a dominated strategy when she has another strategy
that gives a higher payoff no matter what the other player does.
In many real-world settings, players play the same game over and
over again. Cooperation is much more likely in repeated games
Cooperate only as long as everyone else does
Revert to the harshest punishment possible
Involves only one round of punishment for cheating
Return to cooperation the next round
Sequential-move games are games in which the order of moves
matters
A player that can move later in the game can see how others have
played up to that point
A game tree shows the different strategies that each player can
follow in the game and the order in which those strategies get
chosen.
Game trees are often solved by starting at the end of the tree and,
for each decision point, finding the optimal decision for the player
at that point:
A strategic move by a player A is a move early in a game that
changes opponents‟ behavior later in the game in a way that is
favorable to player A.
The firm may charge an artificially low price to prevent potential
rivals from entering.