MICRO reference

4. getting extra consumers at existing price (or close to it) is always profitable: room for promotions and other tools of price discrimination

Oligopoly

few large firms occupy a large share of the market

differentiated (or homogeneous) product

entry barriers

Game Theory

Analysis of interdependent decisions: actions of one decision maker affect payoffs of another decision maker.

Games with simultaneous moves

Each player makes a decision independently (not knowing what the other decides), and then the payoffs are realized. Players have complete information or common knowledge of all rules and factors of the game

Prisoner’s Dilemma

o each player has a dominant strategy

dominant strategy guarantees the highest payoff whatever other players do

opayoff to each player would be higher if all players chose their dominated strategies

excessive spending on advertising

cartel instability

coordination game

no dominant strategies

Nash Equilibrium is a set of strategies such that no player has an incentive to deviate from his strategy, if all other players stick to their strategies (such that every strategy is a best response to other strategies)

cartel is a coalition with a common goal of increasing profit

omany players–harder to reach an agreement, harder to find the cheater

obecause of uncertainty firms may not care enough about future profits

Cournot duopoly

Bertrand “price wars”

oproducts are heterogeneous

o oligopolistsseldom have capacity to serve the whole market

Sequential games decision tree

F2 is currently the only supplier in the market. F1, a competitor, thinks of entering this market. F2 may either respond with a price war (“fight”), or a more friendly strategy which will, however, bring lower profit.

F1 “if you enter-I’ll fight”

F1 invested in extra production capacity – unnecessary for his current level of production, but available at any moment in the case of entry.

A threat (or a promise) is called credible if, when the time comes, it is in the threatener’s (promiser’s) own interest to carry it out

Commitment problem: often, players can’t achieve their goals because they have an incentive to back out on their threat/promise and their opponents know it

entry deterrence

Investment in advertising

Product proliferation

Factor Markets

Labor

SR

Other factors of production (such as capital or land) are often fixed: Q = f(L,

we can only vary our output by hiring more labor or less labor your choice of Q determines your choice of L

LR

All factors can be varied, so we decide:

1)What input mix will be the least costly for each possible level of output?

2)Which of the possible output levels to pick?

Consider a perfectly competitive firm, that produces output q using the services of capital

(K) and labor (L). Profit-maximizing choice:

Step 1: Choosing the cost-minimizing input mix for each possible output Step 2: Choosing the level of output that maximizes profit

f(K, L) = Q0 C = rK + wL min

a set of input combinations (k, l) costing the same are called an isocost

at the cost-minimizing input mix:

slope of the isoquant=slope of the isocost

dL MPL + dK MPK = 0

The LR total cost function LTC(Q) is exactly the result of minimizing cost for every possible Q.

Substitution effect:

When wage increases, pure substitution effect: use relatively more capital Output effect:

Should the firm return to the same cost value under new input prices

A firm hires labor until marginal revenue product of the last worker equals the marginal cost of hiring him p*MPL = w

∆TR MRPL = ∆L

MRPL = p MPL if the firm takes output price as given

MRPL = MR MPL < p MPL if the firm has monopsony power W(L) = p MPL = MVPL

1.Perfectly competitive firm in both output and labor markets

2.Firm is perfectly competitive in the output market, but has monopsony power in the labor market

3.Firm is imperfectly competitive in the output market, but faces perfect competition in the labor market

4.Imperfectly competitive firm in both output and labor markets;

perfect competetion in the output market, monopsony power in the labor market

wage rate positively depends on employment.

marginal cost of labor lies above the wage curve and is steeper. market power in the labor market reduces employment (L2< L1)

imperfect competition in the output market, perfect competition in the labor market

market power in the output market

MRPL (=MPL*MR) lies to the left of MVPL (=MPL*P)

MRPL is the demand for labor curve of an imperfectly competitive

imperfect competition in the output market, monopsony power in the labor market

MRPL = MCL determines employment

perfect competition in both product market and labor market

MVPL0 is the horizontal sum of the MVPL curves of individual firms when W=W0 and P=P0.

E0 is the equilibrium point when W=W0, hire L0. Consider different (lower) wage W1.

Extra employment and output of the whole industry leads to excess supply at the original price P0.

To clear the output market the output price falls (lower MVPL). The new sum of the MVPL curves is MVPL1.

Do this for each wage: get industry demand for labor curve DL.

Individual Labor Supply

Suppose an individual consumes leisure and “non-leisure”–all goods and services that are purchased with money.

to get money, and hence non-leisure, he needs to work and earn wages.

the budget constraint in terms of time: leisure + nl/w= 24, where w is the real wage and nl is non-leisure (consumption of goods)

individual gets some consumption of non-leisure even if he does not work.

Two decisions: 1) whether to work and 2) if so, how much?

(AB) is the consumption of goods that you get if you do not work

There is a fixed cost to working (AC)

(ACD) is budget constraints: depends on wage rate.

Wage rate increase: budget constraint is ACF.

Thus, model shows: Workers are more likely to work if:

a)tastes are favorable to working;

b)real wage is higher;

c)fixed costs of working are lower;

d)income from not working is lower.

Individual supply of labor may be upward sloping (SS1), or backward-bending (SS2).

Increase in wage: Positive substitution effect on hours worked (non-leisure)

Negative income effect– consume more leisure. Empirical evidence: wage increases have very small positive effect on hours worked.