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ECO405 Exam 2

Exam 2

TermDefinition
Standard Industrial Classification (SIC) U.S. Census Bureau system to classify business establishments by type of economic activity (typically look at 4-digit codes)
Concentration Ratio Measure how competitive market is (may use sales, revenue)
Concentration Ratio: 4 Firm Ratio - (Sales top 4 firms in market/sales all firms in market) * 100 Con: Doesn't take into account changing size of top 4 firms - Si = (Xi / T) * 100, where Xi = number of firms and T = total sales in market
Concentration Ratio: Herfindahl Hirschman index (HHI) - Calculated by squaring the market share of each firm competing in a market and then summing the resulting numbers - HHI = (S1)^2 + (S2)^2 + (S3)^2 + ........ (Sn)^2, where n (number of firms)
What does it imply if the Concentration Ratio: 4 Firm Ration / Herfindahl Hirschman index (HHI) has a high number? Implies market is less competitive
Problems with concentration ratios? 1) Doesn't consider outside firm ability to enter market 2) Doesn't imply types of conduct taken by existin firms in market
Perfect Competition - Many firms, same product, easy entry/exit - Underlined items, excess capacity: contribute to possible price reductions
Monopoly One firm, no close substitutes, entry barriers
Monopolistic Competition Many firms, different products, easy entry/exit
Oligopoly Few firms, same or different products, entry barriers
Cournot Model Two firms, (sell same product) select QUANTITY
Bertrand Model Two firms, (sell same product) select PRICE
Vertically Differentiated Products - Product is ambiguously better/worse than competing products (enhance product quality) - Goods are different and all consumers would prefer one to the other if they were sold at the same price.
Horizontal Differentiated Products - When only some consumers prefer it to competing products, holding price constant - Goods are different but at the same price some consumers will buy one and some will buy other, it really depends on their preferences. Example: Pepsi y Coca Cola
T/F? Prices can differ among firms in Bertrand model with horizontal differentiated products (products are close but not perfect substitutes) True
Revenue Destruction Effect When one firm output increases, market price decreases, lower revenues from customers who would have paid higher
Sustaining Competitive Advantage (Price - ATC) * Quantity Need scarce resources and resource is imperfectly mobile
Sustaining Competitive Advantage: Perfect Competition If short-run profits: Firms enter, market output increases, marker price decreases, profits go to zero (long-run equilibrium)
Sustaining Competitive Advantage: Monopolistic Competition If short-run profits: Firms enter, more substitute goods, price decreases, profits go to zero (long-run equilibrium)
T/F? High entry barriers can protect profits (monopoly, oligopoly)? True
Resource Based Theory of Firm Competitive Advantage can be sustainable if there are 1) scarce resources and 2) resources are imperfectly mobile
Imperfectly Mobile Resource cannot sell itself to highest bidder. A firm that possesses a scarce resource can sustain its competitive advantage this way (inherently nontradeable)
Co-specialized Resources Resources more valuable used together than separated (make the more scarce, maybe imperfectly mobile)
Isolating Mechanisms Economic forces limiting extent competitive advantage, can be duplicated or neutralized via resource creation activities of other firms
Isolating Mechanism: 1) Impediments to Imitation Impede exisiting firm / new entrant from duplicating actions that form basis for competitive advantage 1) Superior access to inputs/customers 2) Economies of scale/scope 3) Legal restrictions (parents, copyright) 4) Intangible barriers to entry
Impediments to Imitation: Intangible Barriers to Limitation --> Causal Ambiguity 1) Causal Ambiguity: Firm's distinctive capabilities involve dificult to explain knowledge on how to perform capabilities
Impediments to Imitation: Intangible Barriers to Limitation --> Dependence on Historical Circumstances 2) Dependence on Historical Circumstances: Distinctiveness of capabilities is bound up with firm's history. Firm startegy may be viable for only a limited time. Operational efficiency and pattern of labor developed in response to certain conditions
Impediments to Imitation: Intangible Barriers to Limitation --> Social Complexity 3) Social Complexity: Socially complex processes are difficult to create. Interpersonal relations of managers in a firm and relationships between firm managers and those of its suppliers and customers (building trust between firm and input suppliers)
Isolating Mechanism: 2) Early Mover Advantage A firm (move early) gets competitive advantage, raise economic power of advantage over time
Early Mover Advantage: Learning Curve Output increases now, experience or productivity increases, lower per unit cost later: ATC shift down over time (takes advantage of learning at earlier stage)
Early Mover Advantage: Reputation and Buyer Uncertainty Early on build reputation for quality product, buyers less willing to switch to competitor's product. Buyer uncertainty about early mover's new product
Early Mover Advantage: Buyer has Higher Switching Cost Buyer has higher switching cost for other products (brand loyalty): 1) Firms offer coupons/discounts/offers 2) Seller may offer set of complement products fitting together along product line
Early Mover Advantage: Network Effects Occur when buyers place higher value on good if others use it
Early Mover Advantage: Actual Network Buyers physically linked, can communicate with each other. More users, more communication, greater value of network (with network effect, first firm advantage, new customers lean towards large network)
Early Mover Advantage: Virtual Network Buyers not physically linked. Come from use of complementary goods. More consumers in network, demand and supply of complementary goods rises, enhances value of network (with network effect, first firm advantage, new customers lean towards large network)
Creative Destruction Innovation causing market to evolve in characteristic pattern: Comparative quiet period (positive profits from superior products/tech) then shocks (replace old source advantage with new ones obtaining positive profits), pattern continues
Factors Impacting Incentive of large firms or small firms to innovate: Productivity Effect Large firm may not be as productive at research as small firm (if large firm not have economies of scope in research area, small firm can explore all research directions (patent race))
Factors Impacting Incentive of large firms or small firms to innovate: Sunk Cost Effect Firms committed to specific technology, resources committed so less valuable if switch to another technology (investment sunk in current technology). Stick to current technology. A firm not committed can evaluate different technologies before deciding
Factors Impacting Incentive of large firms or small firms to innovate: Replacement Effect Potential entrant has more gain from innovation (becoming monopolist) than current monopolist has to gain from innovation (maintain position, maybe expand profits, market size)
Factors Impacting Incentive of large firms or small firms to innovate: Efficiency Effect If monopolist anticipates that potential entrant has opportunity to innovate, monopolist has more incentive to innovate (monopolist loses more by firm entering than new firm gains from entering) When entry occurs output quantity goes up and price down
Commiment can work if: Visible (observed), understood, credible (believable)
Strategic Complements Firm A selects action (more of), if firm B selects the same (more of): Bertrand Model
Strategic Substitutes Firm A selects action (more of), firm B selects less of same action: Cournot Model
Tough Commitment Rival firm initilly worse off
Soft Commitment Rival firm initially better off
DIRECT impact on commitment on profits of firm moving first: Impact assuming firm moving first adjust variable, rival not respond
STRATEGIC impact on commitment on profits of firm moving first: Impact on firm moving first when rival responds, firm moving first not respond
Competing Across Time: Action -> Invest in technology, impacts production cost
Competing Across Time: Stage 1 -> Firm 1 deciding on making commitment
Competing Across Time: Stage 2 -> Firm 1 selects action regarding output or price
Competing Across Time: Undertake commitment? Undertake commitment if sum of effects (direct/strategic) of commitment add to firm profits (also if Rev = Cost). Not undertake if negative profits from commitment
Stage 2 Scenarios: Cournot Tough Commitment Q1 rises: P falls, possible Profit1 rise (Q1 rising), likely Profit2 falls, (P falls). Firm 2 response: Q2 falls: P rises, likely Profit1 rise (P rising), possible Profit2 falls (Q2 falls)
Stage 2 Scenarios: Cournot Soft Commitment Q1 falls: P rises, possible Profit1 fall (Q1 falling), likely Profit2 rises (P rises). Firm 2 response: Q2 rises: P fall, likely Profit1 fall (P falling), possible Profit2 rises (Q2 rise)
Stage 2 Scenarios: Bertrand Tough Commitment P1 falls: Q1 rises, possible Profit1 rises (Q1 rising), likely Profit2 falls (Q2 falls). Firm 2 response: P2 falls: Q2 rises, likely Profit1 falls (Q1 falls), possible Profit2 rises (Q2 rises)
Stage 2 Scenarios: Bertrand Soft Commitment P1 rises: Q1 falls, possible Profit1 falls (Q1 falls), likely Profit2 rises (Q2 rises). Firm 2 response: P2 rises: Q2 falls, likely Profit1 rises (Q1 rises), possible Profit2 falls (Q2 falls)
Created by: lorenzofranciosi
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