Question

ECN 100B

2 Short answers

2.1 What is backward induction?

2.2 What are the three ways in which markets can differ?

2.3 What are the three models of oligopoly we discussed in class? Please summarize each model.

2.4 Assume two identical firms with M C= 5 are competing following a Bertrand Oligopoly model. Inverse market demandisp= 720−96Q. What is the Nash-Bertrand Equilibrium?

2.5 In what two ways is a Nash-Bertrand equilibrium without differentiated products inconsistent with real oligopoly markets?

2.6 Can the same factory impose both positive and negative externalities on the same person living nearby?

2.7 What are the two most straightforward way to regulate externalities? What is one challenge with these ways of regulation?

2.8 Does a profit-maximizing oligopoly with a negative externality choose produce too little, too much, or the right amount of the externality?

2.9 What is the Coase Theorem?

2.10 What are three reasons the Coase Theorem may not hold in real life?

Answer 1

2.1.

This is a process where, the starting point is with the potential conclusions. From this the path to the conclusion is chalked out after which the paths are evaluated. This involves a lot of work as one goal can achieved using many paths. It is usually a method used in artificial intelligence.

2.2.

Markets can differ in the following ways:

A. Number of Firm/ sellers and buyers : based on the number of firms the markets can be differentiated. If there are infinite number of firms then it is perfect competition , if there is only one it is monopoly etc. With regards to buyer if there is only one buyer then it is monopsony market.

B. Nature of the product :

Depending on the nature of the product the market can differ, If the products are the same in all manner then a perfect competition exists, if the products are similar but differentiated then it is monopolistic competition and if it is a unique product then it is monopoly

C. Implication and shape of Demand Curve :

Shape of the demand curve of each market is different and each shape implies something. For instance, in perfect competition the demand curve is horizontal which means it is highly elastic and the firms are price takers.

For a monopoly , the demand curve is downward sloping and very less elastic as the firm has full control over the price of the product.

D. Freedom of Entry :

Depending on how easy or difficult it is for a new firm to enter a market is one criteria to differentiate the markets.

In perfect competition there are no barriers so free entry and exit and in monopoly the entry is restricted or blocked. These are extreme cases. In monopolistic competition there are few barriers.

2.3

1. Cournot Duopoly Model :

This is the simplest and a traditional model of duopoly developed by french economist Cournot. To explain the model , Cournot used the example of a mineral water business.

Assumptions of this model :

a) few firms but many buyers b) product produced is homogeneous c) firms are profit maximizers

d) strategy of the firms  is to determine is to determine the output levels assuming the rivals outputs are given.

e) barriers to entry exist.

2. Bertrand Model

This model is suggested by Bertrand and is suitable to analyze oligopoly or duopoly situations when the products are differentiated. The competition in this model is in the form of price differences meaning that each firm determines its product price with estimated constant prices of other firms. Each firm believes that its own strategy pricing strategy does not affect the pricing strategies of other firms.

Assumptions are each firm maximizes its own profit and assumes other firms also do the same. Barriers to entry exist and firms do not face capacity constraints in production.

3. Stackelberg Model

This model was developed as a non-game one. However, now game theorists have adopted it as an example of dynamic games with continuous strategy.

Assumptions:

1. Few firms and many buyers

2. Output is either homogeneous or differentiated

3. A single firm is the leader who chooses the output level before all other firms make their choice of output level.

4. Barriers to firm exist and no capacity constraints.

3.4

In bertrand competition there is marginal cost pricing.

So, the MC=price.

Here, MC=Price=5

Putting the value of 5 in the demand function:

5 = 720 - 96Q

96Q = 720 - 5

Q = 715 / 96

Q = 7.44 units

So, nash equilibrium is at price = $5 and Quantity is 7.44 units.