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CA Final
| Question | Answer |
|---|---|
| economic principle behind repeated games | repetition helps enforce otherwise unenforceable agreements |
| competition externality | competition implies an externality-- each firm maximizes own profit not joint profit |
| examples of organized public cartels | OPEC or NCAA |
| 4 types of collusion | 1. organized public cartel agreements 2. secret agreements 3. tacit agreements 4. focal points |
| 4 types of collusive agreements (strategies) | 1. increase price 2. reduce supply 3. set levels of service quality/ advertising 4. territory restrictions |
| bertrand game normally | homogenous product duopoly-- firms simultaneously set prices and have the same constant MC |
| bertrand paradox/ trap | equilibrium involves making 0 economic profit-- go from monopoly to perfect competition when you go from 1 to 2 players |
| bertrand game with repeated interactions | use a grim trigger strategy-- collude unless someone deviates and in that case revert to equilibrium of 1 shot game |
| grim trigger strategy | collude to monopoly price unless someone else deviates and in that case revert to 0 economic profit equilibrium of one shot game |
| when is a collusive agreement stable | when the NPV of remaining in the agreement is higher than the NPV of exiting the agreement -- staying in the agreement will lead to higher profits in later periods |
| NPV from staying in agreement with grim trigger strategy | = 1/2 (monopoly profit) x (1/1-discount factor) |
| NPV from undercutting rival given opponent uses grim trigger | = monopoly profit + 0/ 1-discount factor |
| what must discount factor be for a collusive agreement to be stable | greater than or equal to 1/2 |
| formula for discount factor (simple) | = 1/ (1+annual interest rate) |
| what must the annual interest rate be for a collusive agreement to be stable | less than or equal to 100% |
| formula for discount factor (more intense) | = ((1+g)(1-h))/1+r/f f= frequency of interaction g= industry growth rate h= hazard rate (probability of industry/ firm end) |
| relationship between f and discount factor | as frequency of interactions increases, the future becomes more important and the discount factor/ probability of collusion increases |
| relationship between g and discount factor | if growth rate increases, the future becomes more important and the discount factor/ probability of collusion increases |
| relationship between h and discount factor | if h increases, there is a higher probability the firm will end, and the discount factor/ probability of collusion is lower |
| market structure and collusion | collusion is more likely in concentrated industries than fragmented ones since it is easier to establish and maintain a collusive agreement collusion is also more likely with similar firms |
| concentrated industry | a few firms have a lot of market share |
| asymmetric industries | firms are not all alike |
| in what types of industries are price wars initiated by weak firms | industries like the airline industry where fares are dictated by the financially troubled firms |
| why would strong firms initiate price wars | to regain market share or drive out competition with deep pockets |
| multi market contact and collusion | collusion is easier to maintain with multi market contact (when firms compete in more than one market) |
| price wars and observable demand fluctuations (i.e. seasonability) | incentive to undercut is greater during periods of high demand (more to be gained) |
| guessing problem | with unobserved demand fluctuations and low demand-- question if low firm demand is a result of low market demand or price cutting by rival if firm sets high price and assumes market fluctuation, other firm may cut price so the firm must set low p |
| what should firm do if demand is high with observable demand shocks | should keep prices low |
| margin | = (p - mc)/ p |
| Lerner index | average margin for many firms = sum of market share x margin (p-mc/p) |
| herfindahl Hirschmann index (HHI) | way to measure market concentration sum of all of the market shares squared for each firm |
| why do you square market share for HHI | gives greater importance to the bigger firms |
| what does an HHI of 0 mean | less market concentration |
| what does a high HHI mean | more market concentration |
| cons of HHI | hard to get market share of every firm in market and hard to define the boundaries of the market |
| Ci index | sum of market share for a certain number of firms (i) in the market |
| market concentration and market power | Lerner index = HHI/ negative elasticity market performance is better with a smaller elasticity of demand because there is a greater effect of H on L |
| structure- conduct- performance paradigm | structure determines conduct, conduct determines performance, and structure determines performance **weak relation |
| market size and market structure | if market price were constant then relationship between size and number of firms would be proportional but as the number of firms increases, the market becomes more competitive, and the margin decreases which limits the # of firms sustained |
| example of endogenous entry costs | when advertising is an important part of a firm's strategy, entry costs are endogenous (proportional/ directly related) to a firm's market size |
| trend with number of firms when endogenous entry costs are present | number of firms is less sensitive to changes in market size |
| example of exogenous entry costs | taxi medallions-- price doesn't depend on market size |
| free entry and welfare | when a new firm enters the market: - price drops -output increases -consumer surplus increases -entrant gains -incumbent firm loses (business stealing effect) |
| business stealing effect | part of entrant's variable profit is a transfer from incumbents negative entry externality because A is a gain for entrant not for society |
| consumer surplus effect | entry implies an increase in consumer surplus positive entry externality |
| excess entry | if business stealing effect is greater than consumer surplus effect |
| insufficient entry | is business stealing effect is less than consumer surplus effect (still room for improvement) |
| when does excess entry occur | production differentition unimportant and competition soft |
| when does insufficient entry occur | product differentiation important and competition fierce |
| horizontal merger | between competitors in the same industry |
| vertical/ complementary mergers | between firms in different or complementary stages of the value chain |
| conglomerate mergers | between industry-unrelated firms (ex amazon and Whole Foods) |
| 4 reasons to merge | 1. synergies 2. entry into new market 3. supplier power 4. distribution efficiencies |
| 3 interested parties in a merger | 1. merging firms 2. non-merging firms 3. consumers |
| effects of horizontal merger on merging firm | 1. efficiencies like common cost savings/ synergies 2. unilateral and coordination effects |
| unilateral effects of a merger | closer to monopoly |
| coordination effects of a merger | closer to collusion |
| effect of horizontal merger on non merging firm | may be the main beneficiaries of the merger-- without having to incur any costs they see the number of their competitors decrease by one could also lose if the merged firm becomes very efficient and non-merging firms see profit decreases |
| effect of horizontal merger on consumers | market price increases but if cost efficiencies are strong consumers may benefit from the merger |
| extensive forms games | *aka tree form games *best for games with sequential actions *branches denote possible choices *games solved by backwards induction |
| subgame perfect equilibrium | equilibrium strategies form an equilibrium at each and every subgame |
| commitment | for decision problems typically think that having many options is a good thing with strategic interaction, it is sometimes useful to have fewer options so you are committed to a particular course of action |
| value of commitment | value of a company's payoff in sequential move game where they are the first mover - value of company's payoff in simultaneous move game |
| 3 strategies to deter entry | 1. capacity expansion 2. product proliferation 3. exclusive contracts |
| entry accommodation | reduce capacity such that your payoffs are maximized |
| entry deterrence | strategic behavior from the incumbent with presence of negative payoffs- choose capacity such that entrant won't enter |
| blockaded entry | back at monopoly capacity and entrant doesn't enter |
| incumbent's strategy when there is low entry probability/ high entry costs | blockaded entry (incumbent behaves like monopolist and ignores threat of entry) |
| incumbent's strategy when there is medium entry probability | entry deterrence (incumbent chooses large enough capacity to deter entry) |
| incumbent's strategy when there is high entry probability | accommodated entry |
| product proliferation strategy | increase number of varieties so as to leave no room for potential entrants uses hotelling model to place varieties sacrifices short run monopoly profits for value of entry preemption |
| 7 exclusion and foreclosure strategies | 1. entry deterrence by capacity expansion/ product proliferation 2. pay for delay 3. long term contracts, exclusive dealing 4. all unit discounts 5. raising rival's costs 6. bundling 7. predatory pricing |
| long term contract | *advantage for incumbent with large market share *sign long term contracts specifying lower prices with major buyers *buyers will sign because they are worried they may not find an alternative |
| naked exclusion/ divide and conquer | with long term contracts incumbents buy up buyers in the market and make it unprofitable for entrants |
| all unit discounts | *advantage for firms with a variety of products needed for downstream firms along with dominance in some products *strategy is to offer firms a discount if they buy from your firm exclusively |
| bundling | *advantage for firms with large market share of important product *strategy is to bundle complementary products with important products |
| market foreclosure policy goals | *long term surplus of consumers *healthy competitive atmosphere for firms |
| difference between anti-trust policy in the US and the EU | EU is competitor focused US is consumer focused |
| raising rival's costs | *advantages for firms with different cost structures than rivals *strategy is to adopt or support a policy that affects rivals' costs but not own costs |
| predatory pricing | pricing below cost with the intent of driving rival out of the market; once rival is out of the market raise prices and make up profit |
| 2 conditions conducive to predatory pricing | 1. number of other rivals small 2.barriers to entry exist |
| areeda turner test | if prices are below average variable cost or marginal cost in the short run |
| Chicago school approach to predation | no predatory behavior should be observed in practice if an incumbent responds to entry by lowering its price, that is simply the competitive effect |
| Sherman Act | makes it illegal for any person to monopolize; goal is to protect the public from the failure of the market |
| 3 things the upstream firm can't control | 1. retail price 2. advertising 3. sales service |
| real marginal cost | c, the marginal cost facing the manufacturer |
| marginal cost for retailer | wholesale price |
| vertical separation | no integration between upstream and downstream firms |
| double marginalization | how the manufacturer margin/ retailer margin are combined when upstream and downstream firms integrate-- allows them to charge consumers a lower price |
| 2 effects of upstream/ downstream merger | 1. retail price is lower for consumers 2. profit is higher |
| downstream competition | when 1 manufacturer sells to 2 retailers leads to lower retail prices and higher quantity sold increased demand for manufacturer leads to higher wholesale price |
| effect of manufacturer integrating with 1 retailer in downstream competition | *gets rid of double marginalization *softens competition by raising rival's costs *retail price change ambiguous-- goes down because no double marginalization or up to inc demand for inputs |
| competition softening effect | give competitor larger market share so they will demand more inputs from you |
| hold up problem | results from separation of production and retailer *new product but consumers only learn about it if retailer invests *retailer designs new product but needs manufacturer to invest to produce |
| investment incentives and vertical integration | vertical integration can help solve the hold up problem by automatically choosing the efficient level of investment-- helps hold up problem but increases the agency problem |
| agency problem | if manufacturer is at order of retailer can create an agency problem from asymmetric information if manufacturer is better informed than retailer |
| 3 categories of vertical arrangements | 1. integration 2. pricing restraints 3. exclusive territories/ dealings |
| resale price maintenance | manufacturer imposes a minimum price on retailers to minimize free rider effect when manufacturer educates retailers on selling and consumers visit retailers for information buy buy online |
| exclusive territories | manufacturer awards exclusive territories bc there is a disincentive for local retailers to advertise since it benefits all retailers selling the same product |
| exclusive dealing | manufacturer awards exclusive dealing to prevent investment in downstream sales training from benefitting competitors |
| network externalities | each consumer's valuation is increasing in the number of other consumers |
| example of indirect network externalities | computer operating systems-- more people who own the operating system-- the more people who will develop software for it |
| example of tariff-mediated network externalities | cell-phone plans; AT&T charges different rates to call people in and out of network |
| restaurant problem and network externalities | *when p too high, demand choked to 0 *at high p, demand either 0 or 1 *at lower p, demand = 1 |
| 3 theories of innovation adoption | 1. diffusion: agent heterogeneity 2. epidemic: word of mouth/ social networks 3. catastrophe: network externalities |
| diffusion: agent heterogeneity | *high valuation users go first *fixed cost to adopting at first so larger players start *once price cheaper, smaller players adopt *ex: hybrid corn |
| epidemic: word of mouth, social networks | *matching informed and uninformed users *slow adoption, rapid adoption, then slow adoption *example: gmail *adopters are similar |
| catastrophe: network externalities | *value increases in # of other users *ex: fax machines *at first low adoption rate *later very high adoption rate *in the middle, tipping point that starts snowball effect |
| excess inertia | nobody buys a product because nobody buys it (multiple equilibria) |
| excess momentum | market tips very quickly toward new product even when it does not represent a great improvement |
| excess inertia with game theory | *2 players *cost for adopting new product *becomes like a lottery of making or losing money depending on what other person does *if cost is very large (O,O) not (N,N) equilibrium plays out |
| Pareto dominant | in multiple equilibria when 1 has a higher payoff for both parties than another |
| excess momentum with game theory | equilibrium is inefficient since 1 player will lose moving from old to new lead adopter has small benefit and imposes large loss on second adopter |
| bandwagon effect/ domino effect/ snowball effect | what second player is a victim of with excess momentum |
| standards war | 2 versions of technology and adopters arrive sequentially with no network effects-- each market share approaches 50% with network effects-- snowball in long run to one having the majority market share path dependent |
| cyclical price war | unobservable demand shocks price low, demand low |
| countercyclical price war | observable demand shocks price low, demand high |
| Lerner Index with perfection competition | =0 |
| market power measure | ability to charge a price higher than the marginal cost of production aka Lerner Index |
| Cournot model's prediction about bundling | *incentive for prices to go down --> raise profits by dropping the price *if the price of your good increases, demand for both of your goods would decrease *when prices go down for bundling may be pushing other competitors from market |
| market foreclosure | = entry deterrence |
| how are sales from supplier to retailer different than sales from supplier to consumer | suppliers have more bargaining power retailers compete with each other and consumers do not |
Created by:
graceatnyu