ECON 1B03 Chapter Notes - Chapter 17: Strategic Dominance, Market Power, Invisible Hand

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ECON 1B03 Full Course Notes

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Game theory: the study of how people behave in strategic situations. Key feature is the tension between cooperation and self-interest. Collusion: an agreement between firms in a market about quantities to produce or prices to charge. Cartel: a group of firms acting in unison. Once in a cartel the market is served by a monopoly (socially inefficient production) A cartel must agree on the total level of production and the amount produced by each member (each firm wants to produce the greater amount as it results in a greater profit) Not always possible to form cartels as prohibited by law. If they decide how much to produce on their own the will end up with less profit than the monopoly. Nash equilibrium: a situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen. Maximize joint profit if they cooperate with one another.

Related Questions

2. Deviating from the collusive outcome

Mays and McCovey are beer-brewing companies that operate in a duopoly (two-firm oligopoly). The daily marginal cost (MC) of producing a can of beer is constant and equals $0.80 per can. Assume that neither firm had any startup costs, so marginal cost equals average total cost (ATC) for each firm.

Suppose that Mays and McCovey form a cartel, and the firms divide the output evenly. (Note: This is only for convenience; nothing in this model requires that the two companies must equally share the output.)

Place the black point (plus symbol) on the following graph to indicate the profit-maximizing price and combined quantity of output if Mays and McCovey choose to work together.

Monopoly Outcome PRICE (Dollars per can)QUANTITY (Thousands of cans of beer)DemandMRMC = ATC

When they act as a profit-maximizing cartel, each company will producecans and chargeper can. Given this information, each firm earns a daily profit of, so the daily total industry profit in the beer market is.

Oligopolists often behave noncooperatively and act in their own self-interest even though this decreases total profit in the market. Again, assume the two companies form a cartel and decide to work together. Both firms initially agree to produce half the quantity that maximizes total industry profit. Now, suppose that Mays decides to break the collusion and increase its output by 50%, while McCovey continues to produce the amount set under the collusive agreement.

Maysâs deviation from the collusive agreement causes the price of a can of beer to toper can. Mays's profit is now, while McCoveyâs profit is now. Therefore, you can conclude that total industry profit when Mays increases its output beyond the collusive quantity.

limedog21

1. When two or more large companies in the same industry set prices or quantities in unison, economists refer to them as:

a. Monopolist competitors

b. A cartel

c. Dominant firms

d. Perfect competitors

e. Jerks

2. According to our discussion, oligopoly markets will generally result in the same price and quantity as we would observe in a monopoly market

a. True

b. False

3. The example of the prisoner's dilemma is primarily meant to demonstrate

a. The difficulty of maintaining cooperation in decisions that involve strategic interdependence

b. The concept that each person looking out for his or her own best interests results in the best overall outcome for the group involved in the decision

c. The benefits of government regulation in a non-competitive market

d. What happens to snitches

4. A Nash equilibrium is

a. The outcome that maximizes the payoff of all players

b. Never achieved without cooperation between players

c. The outcome in which no player can improve their payoff by changing his or her strategy, (given the strategy of the other player)

d. All of the above

goldbutterfly763

3. Breakdown of a cartel agreement

Consider a town in which only two residents, Gilberto and Juanita, own wells that produce water safe for drinking. Gilberto and Juanita can pump and sell as much water as they want at no cost. For them, total revenue equals profit. The following table shows the town's demand schedule for water.

Price	Quantity Demanded	Total Revenue
(Dollars per gallon)	(Gallons of water)	(Dollars)
5.40	0	0
4.95	25	$123.75
4.50	50	$225.00
4.05	75	$303.75
3.60	100	$360.00
3.15	125	$393.75
2.70	150	$405.00
2.25	175	$393.75
1.80	200	$360.00
1.35	225	$303.75
0.90	250	$225.00
0.45	275	$123.75
0	300	0

Suppose Gilberto and Juanita form a cartel and behave as a monopolist. The profit-maximizing price is (1) $______ per gallon, and the total output is (2) ___ gallons.

As part of their cartel agreement, Gilberto and Juanita agree to split production equally. Therefore, Gilberto's profit is (3) $____, and Juanita's profit is (4) $_____.

Suppose that Gilberto and Juanita have been successfully operating as a cartel. They each charge the monopoly price and sell half of the monopoly quantity. Then one night before going to sleep, Gilberto says to himself, "Juanita and I aren't the best of friends anyway. If I increase my production to 25 gallons more than the cartel amount, I can increase my profit even though her profit goes down. I will do that starting tomorrow."

After Gilberto implements his new plan, the price of water (5) (increases/decreases) to (6) $____per gallon. Given Gilberto and Juanita's production levels, Gilberto's profit becomes (7) $____ and Juanita's profit becomes (8) $______.

Because Gilberto has deviated from the cartel agreement and increased his output of water to 25 gallons more than the cartel amount, Juanita decides that she will also increase her production to 25 gallons more than the cartel amount.

After Juanita increases her production, Gilberto's profit becomes (9) $_____, Juanita's profit becomes (10) $_____ and total profit (the sum of the profits of Gilberto and Juanita) is now (11) $_____

(12) True or False: Based on the fact that both Gilberto and Juanita increased production from the initial cartel quantity, you know that the output effect was smaller than the price effect at that quantity.

Gilberto and Juanita have each cheated on their cartel agreement and increased production by 25 gallons more than the cartel amount. However, they both realize that if they continue to increase output beyond this amount, they'll each suffer a decrease in profit. (To see this for yourself, consider Gilberto's profit when he produces 50 gallons more than the cartel amount compared to his profit when he produces 25 gallons more than the cartel amount.)

Neither Gilberto nor Juanita has an incentive to further increase output, nor does either have an incentive to decrease output. This outcome is an example of

(13) (resale price maintenance/ predatory pricing/ tying/ a Nash equilibrium).

raspberrygnat142

ECON 1B03 Chapter Notes - Chapter 17: Strategic Dominance, Market Power, Invisible Hand

ECON 1B03 Full Course Notes

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