Transcript Lecture 1
The Economic Framework • For our purposes two basic sets of agents: – Consumers – Firms • Interact through markets • Faced with some economic environment or market structure, each agent makes decisions Market Structure • What is a market? -Set of firms and consumers whose interactions establish the price of products that are viewed as close substitutes by consumers (firms produce different brands) • When are brands ‘close substitutes’? • Cross Price Elasticity -Measures how responsive quantity demanded is to changes in price of other goods. -% change in quantity demanded of X / % change in price of Y. Market Power • Ability to raise price above marginal cost • Interested in strategies that can be used to obtain and/or preserve market power -pricing strategies -product positioning strategies -choice of quality -advertising strategies -R&D strategies • Market power depends on: i) Demand Elasticity ii) Market concentration iii) Collusive behaviour Market Structure Perfect Competition vs Monopoly Perfect Competition • Perfectly competitive environment -large number of small producers -identical product -perfect information -free entry into and exit from market - price takers • Firms choose output level to maximize profits: Max Profits=Revenue-Costs Max PxQ-C(Q) Q What Q should the firm choose? The one that makes MR=MC P,C Ph MC AC At Ph: eco profits Pl At Pl : eco losses Q • In the long run 2 things can happen: -firms in industry can adjust their fixed factors to maximize profits -new firms can enter, old firms can leave As a result, all firms break even in the long run Monopoly • A single firm serves an entire market for a good that has no close substitutes • Why are some markets monopolized? - Cost advantages over other firms - Government created Monopolists are price makers • Amount of output they sell responds continuously as a function of the price they charge • In fact, they can charge a price above MC—they have market power • Operate where MR=MC • What is MR? -MR= ∆R /∆Q= ∆(PxQ)/∆Q =P[1+1/E] -So, P[1+1/E]=MC Price is marked-up over marginal cost What is a Game? • A game describes any situation: – involving the interaction of two or more individuals – in which the individuals can make choices that affect the “outcome” of the interaction How Do We Describe a Game? • A game is described by: – number of players/agents – the “strategies” available to each player – each player’s preferences over outcomes of the game • For any game, a strategy choice by each one of the players results in a unique outcome of the game What is a Strategy? • A strategy is an action plan for a player. It specifies: – what action the player takes – when the player takes the action – the way that the action choice depends on the information the player has when taking the action • Two action plans that specify different actions represent two different strategies • Dominant Strategy -yields at least as high a payoff as any other strategy available to agent regardless of strategy choices of other agents Predicting Behavior in Games • If games are to help us understand observables, we need a way of predicting how agents behave in game settings; i.e., we need a notion of equilibrium for games • Some equlibrium notions: • Dominant strategy equilibrium • Nash equilibrium Dominant Strategy Equilibrium Roughly speaking a Dominant strategy equilibrium has the feature that each player’s strategy choice is best for that player regardless of other players’ strategy choices Nash Equilibrium Roughly speaking a Nash equilibrium has the feature that each player’s strategy choice is best for that player given other players’ strategies – each player acts in a purely self-interested way and seeks to be as “well off” as possible – in making a strategy choice, each player forms beliefs about what strategies the other players are choosing – These beliefs are correct in equilibrium