Industrial Organization Mid-term

I.  Monopoly

A.  Monopoly Behavior

1.  Demand Curve & Marginal Revenue Curve

a)  Proof that MR lies half-way below the DC.

2.  max Profits ==>  choose Q such that MR = MC  (diagram)

3.  Monopolist’s Supply Curve?

4.  Elasticity of Demand  (formulas)

a)  Monopolist will not operate on inelastic portion of demand curve.

5.  Lerner Index = measure of monopoly power (ability to set P > MC)

B.  Creating and Maintaining a Monopoly

1.  Special knowledge that allows production of a new or better product.

2.  Special knowledge that allows production of same product at lower cost.

3.  Patent

4.  Other government protection

5.  Strategic behavior.

C.  Costs and Benefits

1.  Costs

a)  DWL

b)  Rent-seeking behavior

2.  Benefits

a)  Technological advance, innovation, new & better products

b)  Reduction in output when an externality is present.

c)  Production of goods that might not otherwise be produced.

II.  Price Discrimination

A.  1st Degree or Perfect Price Discrimination

1.  Charge each consumer their “willingness to pay”

2.  No DWL

B.  Quantity Discount

1.  Charge p1 for q1 units sold, then a lower p2 for the remainder

2.  Graphical analysis

C.  Market Segmentation

1.  Identify two types of consumers (and their demand curves)

2.  Graphical analysis

3.  Numerical problem

4.  Can determine relative elasticities by observing which has higher price

III.  Cartels = association of firms that explicitly agrees to coordinate its activities

(cooperative oligopolies)

A.  Why cartels form

B.  Creating and Enforcing a Cartel

1.  Why join?

2.  Once in………..  (graphical analysis)

3.  Things that facilitate cartels

i)  ability to increase industry price

ii)  low expectation of severe punishment

iii) low organizational costs

few firms involved

highly concentrated industry

nearly identical product

existence of trade association

4.  Enforcing a cartel

i)  detecting cheating

ii)  preventing cheating

fix more than just price

divide the market

fix market shares

most-favored nation clause

meeting-competition clause

trigger prices

IV.  Dominant Firm with a Competitive Fringe

A.  Dominant Firm=one firm, price-setter, faces smaller, price-taking firms.

Has large market share.

B.  Fringe Firms=smaller, price-taking firms each with small market share.

C.  Key Points:

1. Not in the dominant firm’s best interest to set price so low that it drives all other

firms out.

2. Presence of competitive fringe (or threat of) keeps dominant firm’s price below

monopoly price.

D.  Why are some firms dominant?

1.  Lower Costs

a)  Technological advantage

b)  Early entry affords “learning by doing”

c). Economies of Scale

2.  Superior Product (Good will, reputation, etc)

3.  Group of firms act like a dominant firm.

Ex:  Philippine coconut-oil producing firms

E.  Model with No Entry

1.  Assumptions

a)  single, large dominant firm with lower costs

b)  all other firms are price-takers.  Set MC=P

c)  “n”, the number of fringe firms is set

d)  dominant firm knows market demand curve

e)  dominant firm knows fringe supply curve

2.  2 Steps to Profit Maximization

a)  Determine the residual demand curve

b)  Act like a monopolist (set MR=MC)

3.  Graphical analysis

V. Non-cooperative Games  (Game Theory)

A.  Terminology

Players, games, pay-offs, rules of the game (simultaneous, sequential), strategies

(strictly vs. weakly dominant), pay-off tables (normal-form representation), zero-sum game, symmetric game, Nash equilibrium, Prisoners’ Dilemma, 1st Mover Advantage,

single-period vs. repeated games, signaling, credible threats, subgames, backwards


B.  Pay-Off Tables:  Examples

1.  Paul Revere and the Redcoats

2.  2 Truckers

3.  Firm 1, Firm 2 Output

4.  Monopoly/Potential Entrant

5.  3 by 3 table:  Firm A and Firm b levels of output

6.  Prisoners’ Dilemma  (Cadets’ Dilemma in the case of Mr. Okuley and Mr. Martin!)

C.  Repeated Games

1.  Collusion more likely

2.  Firm can influence rival’s strategy through


Threatening to Punish

D.  Effectiveness of Threat depends on

1.  the interest rate (present values)

2.  length of the game

3.  credibility

  1. Extensive Form Representation of Subgames

1.  Game Tree and Backwards Induction



File: Introduction[test]


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