Transcript
7th Tutorial
Monopolistic Competition and Oligopoly
Solutions
True or False
1. A key difference between oligopoly and other types of market structure is a consideration of strategic interdependence. True. See section 6.1 of Begg and Ward True/False
2.. Economies of scale can be an important reason for the existence of oligopolies. True. See section 6.3 of Begg and Ward and the importance of minimum efficient scale as a determinant of the number of players in a market place. True/False
3. A contestable market will generate supernormal profits. False. See section 6.4 of Begg and Ward. A contestable market has freedom of entry and exit. This threat of competition leads to the generation of normal profits in the long run. True/False
4. Under Nash equilibrium, each firm makes decisions based on the expected behaviour of its rivals. True. See section 6.6 of Begg and Ward and the definition of a Nash equilibrium. True/False
5. A key characteristic of monopolistic competition is product differentiation. True/False
Question 1
Which of the following are characteristics of a monopolistic competition?
There are a large number of small firms in the industry. Yes/No
There are many barriers to entry and exit. Yes/No
The firms produce a homogeneous product. Yes/No
The firms face downward sloping demand curves. Yes/No
There are few opportunities for economies of scale. Yes/No
Question 2
Which of the following are characteristics of an oligopoly?
a. There are a large number of small firms in the industry...........................................Yes/No
b. There are many barriers to entry and exit................................................................Yes/No
c. The firms produce either a homogeneous or a differentiated product.....................Yes/No
d. The firms face downward sloping demand curves...................................................Yes/No
e. There is little point in advertising because there are so few firms...........................Yes/No
Question 3
List four industries that you think can be reasonably characterised as oligopolies.
Any industry with a small number of large players, e.g. banks, supermarkets, soft drinks, computers and mobile telecommunications, can be reasonably characterised as oligopolies.
Question 4
Why does the perfectly elastic demand curve, for a perfectly competitive firm, not illustrate strategic interdependence?
A perfectly elastic demand curve, for a perfectly competitive firm, reflects the idea that the firm is a price taker, it can sell as much as it likes at the existing price. Its decisions do not impact on its rivals. Therefore, there is no strategic interdependence.
Question 5
Consider the following game. Find the Nash equilibrium.
i) If A decides to Cooperate, the best choice for B is to start Price War.
ii) If A decides to start Price War, the best choice for B is to start Price War.
iii) If B decides to Cooperate, the best choice for A is to start Price War.
iv) If B decides to start Price War, the best choice for A is to start Price War.
So, the Nash Equilibrium is the (60,60) outcome where both firm start a price war.
Question 6
Consider the following game. Find the Nash equilibrium.
i) If A decides to Cooperate, the best choice for B is to Cooperate.
ii) If A decides to start Price War, the best choice for B is to Cooperate.
iii) If B decides to Cooperate, the best choice for A is to start Price War.
iv) If B decides to start Price War, the best choice for A is to start Price War.
So, the Nash Equilibrium is the (40,120) outcome where firm B cooperates and firm A starts a price war.
HINT: Use the +/- trick to find the equilibrium and always explain briefly the way of thinking.
Question 7
Under what circumstances would you expect an industry to move from the game in question 5 to question 6?
Firm B in question 6 no longer views a price war as preferable to cooperation. This is likely to occur in the real world if firm B is weakened in some way. A reasonable example would be a rising cost base for firm B, which did not impact firm A. Firm B may source its raw materials from overseas, where prices have increased, while firm A sources its raw materials in the domestic market where prices are stable.
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