ECON1101 Chapter Notes - Chapter 3: Coase Theorem, Nash Equilibrium, Deadweight Loss
ECON1101
○ Collusion is much more likely in an oligopoly since there are
only a small number of firms
● This is done by controlling prices or preventing new competitors from
entering the market
● This is the purpose of competition laws - to ensure that firms do not
engage in cartel conduct and that consumers are charged the lowest
possible prices
The Coordination Game
● These are a type of game where the players benefit from coordinating
their decisions
● A strategy profile denote a set of strategies, one for each player.
● Nash Equilibrium - a strategy profile is a Nash Equilibrium if no
player can benefit from unilaterally
changing their strategy
Chapter 9: Imperfectly Competitive Markets (Externalities)
Positive Consumption Externality
● A positive consumption externality represents a benefit accrued to
someone who is not involved in the consumption of the given good
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● In the diagram above, the red curve represents the social demand
curve
● The marginal external benefit is $2 (see the horizontal red line at the
bottom)
○ As such, we get the red lines by shifting the blue line upwards
by $2 (vertical distance is marginal external benefit)
● Looking at the graph above, assume the market price is $8
● If you only considered your own marginal benefit, you would consume
4 units of the good (marginal benefit would be = $8 and this is equal
to the marginal cost)
● However, the socially optimal quantity is 6 units (the social demand
curve is $8 when you consume 6 units)
● By making consumption decisions without accounting for external
benefits, you are not maximising social surplus. This results in a
deadweight loss (see diagram below)
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● This highlights the limitations of the invisible hand principle where the
action which maximises personal satisfaction does not translate to
the optimal amount of consumption for society as a whole
● To solve this problem, parties can undergo a private negotiation
○ The person gaining the marginal external benefits can pay $2 to
get the consumer to consume 2 more units of the good
● Coase Theorem: this theorem states that if trade in an externality is
possible and there are no transaction costs, bargaining will lead to an
efficient outcome regardless of the initial allocation of property rights
○ This is also the idea that inefficiency arising from externalities
can be solved without government intervention
● Other examples of positive consumption externalities include:
○ Fitness activities - reduces health care for society
○ Vaccinations - by being vaccinated, an individual reduces the
likelihood that others get infected
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Document Summary
Collusion is much more likely in an oligopoly since there are only a small number of firms. This is done by controlling prices or preventing new competitors from entering the market. This is the purpose of competition laws - to ensure that firms do not engage in cartel conduct and that consumers are charged the lowest possible prices. These are a type of game where the players benefit from coordinating their decisions. A strategy profile denote a set of strategies, one for each player. Nash equilibrium - a strategy profile is a nash equilibrium if no player can benefit from unilaterally changing their strategy. A positive consumption externality represents a benefit accrued to someone who is not involved in the consumption of the given good. In the diagram above, the red curve represents the social demand curve. The marginal external benefit is (see the horizontal red line at the bottom)
