H1
Industrial organization is concerned with the workings of markets & industries, in particular, the way
firms compete with each other
H4
Game: model that depicts a situation of strategic behavior
Games may be presented in normal form (matrix) of in extensive form( game tree)
Simultaneous strategy: players choose at same time
Nash-Equilibrium: a situation such that no player would unilaterally find it optimal to change strategy
Sequential game: solved backwards
Committing to take future action which is ex-post suboptimal may have an ex-ante strategic value
H5
Degree of monopoly power inversely related to the demand elasticity faced by the firm
High-power regulation mechanism provides strong incentives for cost reduction but few incentives
for quality provision
Natural monopoly: 1 firm producing cheaper than multiple
−δDD
p−mc 1 ∗p
Elasticity rule: = δDp
p ∈ ∈=
q
H6
Perfect competition assumptions:
- Atomicity
- Product homogeneity
- Perfect information
- Equal access
- Free entry
Perfect competition: implies maximum efficiency in a static sense, for a given set of available
technology
Equilibrium under competitive selection is efficient
Equilibrium profits under monopolistic competition are zero, but firms don’t produce at minimum of
average cost
H7
, Bertrand model: firms compete with prices
Best response function (reaction function) is a function p i*(pj) that gives, for each pj, I’s optimal price
In Bertrand both firms have p=mc
In Bertrand, there is no product differentiation
In Bertrand, there is no dynamic competition
In Bertrand, there are no capacity constraints
If total industry capacity is low in relation to market demand then equilibrium price > marginal costs
Cournot model: firms compete in quantities
Residual demand: Gives all possible combinations of firm 1’s quantity & price for given value q 2
Perfect competition output > duopoly output > monopoly output
Monopoly price > duopoly price > perfect competition price
If capacity & output can easily be adjusted, then the Bertrand model is a better approximation of
duopoly competition. If, by contrast, output & capacity are difficult to adjust, then the Cournot
model is a good approximation
An increase in marginal costs implies a downward shift of the reaction curve
a−c q2
q 1∗( q 2 )= −
2b 2
a+2 c
P N =a−b Q N =
3
N a−2c 1 +c 2
q1 =
3b
N N N 2 a−c 1−c 2
Q =q1 +q 2 =
3b
q1 a−2 c1 +c 2
s1= = Market share
q 1+ q2 2a−c 1−c2
N N a+c 1+ c 2
P =a−b Q =
3
H8
1 m 1 m 21 m
π +δD π +δD π No deviation from collusion
2 2 2
1 1
V = πm V ' =π m Payoff optimal deviation
2 1−δD
δ> ½ : collusion possible
Industrial organization is concerned with the workings of markets & industries, in particular, the way
firms compete with each other
H4
Game: model that depicts a situation of strategic behavior
Games may be presented in normal form (matrix) of in extensive form( game tree)
Simultaneous strategy: players choose at same time
Nash-Equilibrium: a situation such that no player would unilaterally find it optimal to change strategy
Sequential game: solved backwards
Committing to take future action which is ex-post suboptimal may have an ex-ante strategic value
H5
Degree of monopoly power inversely related to the demand elasticity faced by the firm
High-power regulation mechanism provides strong incentives for cost reduction but few incentives
for quality provision
Natural monopoly: 1 firm producing cheaper than multiple
−δDD
p−mc 1 ∗p
Elasticity rule: = δDp
p ∈ ∈=
q
H6
Perfect competition assumptions:
- Atomicity
- Product homogeneity
- Perfect information
- Equal access
- Free entry
Perfect competition: implies maximum efficiency in a static sense, for a given set of available
technology
Equilibrium under competitive selection is efficient
Equilibrium profits under monopolistic competition are zero, but firms don’t produce at minimum of
average cost
H7
, Bertrand model: firms compete with prices
Best response function (reaction function) is a function p i*(pj) that gives, for each pj, I’s optimal price
In Bertrand both firms have p=mc
In Bertrand, there is no product differentiation
In Bertrand, there is no dynamic competition
In Bertrand, there are no capacity constraints
If total industry capacity is low in relation to market demand then equilibrium price > marginal costs
Cournot model: firms compete in quantities
Residual demand: Gives all possible combinations of firm 1’s quantity & price for given value q 2
Perfect competition output > duopoly output > monopoly output
Monopoly price > duopoly price > perfect competition price
If capacity & output can easily be adjusted, then the Bertrand model is a better approximation of
duopoly competition. If, by contrast, output & capacity are difficult to adjust, then the Cournot
model is a good approximation
An increase in marginal costs implies a downward shift of the reaction curve
a−c q2
q 1∗( q 2 )= −
2b 2
a+2 c
P N =a−b Q N =
3
N a−2c 1 +c 2
q1 =
3b
N N N 2 a−c 1−c 2
Q =q1 +q 2 =
3b
q1 a−2 c1 +c 2
s1= = Market share
q 1+ q2 2a−c 1−c2
N N a+c 1+ c 2
P =a−b Q =
3
H8
1 m 1 m 21 m
π +δD π +δD π No deviation from collusion
2 2 2
1 1
V = πm V ' =π m Payoff optimal deviation
2 1−δD
δ> ½ : collusion possible
