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b251 final

question
how do accountants measure a firm's profits?
answer
Accountants measure a firm's profit using Internal Revenue Service rules based on standards established by the Financial Accounting Standards Board
question
how do economists measure a firm's profits?
answer
Economists measure profit based on an opportunity cost measure of cost
question
what are explicit costs?
answer
Explicit costs are costs paid directly in money
question
what are implicit costs?
answer
Implicit costs are costs incurred when a firm...
Uses its own capital (economic depreciation or interest foregone)
Uses its owners' time or financial resources
question
difference between economic and normal profit
answer
Economic profit equals a firm's total revenue minus its total cost. (TR-TC)
A firm's total cost of production is the sum of the explicit costs and implicit costs
Normal profit is part of the firm's total costs, so economic profit is profit above and over normal profit
question
what three features of the environment are a firm's profit limited by?
answer
Technology constraints
Information constraints
Market constraints
question
what is a command system?
answer
a managerial hierarchy
Commands pass downward through the hierarchy and information (feedback) passes upward
Use when it's easy to monitor (perfect information)
question
what is an incentive system?
answer
market-like mechanisms to induce workers to perform in ways that maximize the firm's profit
Use when it's hard to monitor (imperfect information)
question
difference between symmetric and asymmetric information
answer
Symmetric information occurs when all individuals have the same information
Asymmetric information happens when individuals have different amounts of information available to them
question
what are the two types of asymmetric information and explain them with an example
answer
Adverse selection occurs when information is different (hidden) between buyers and sellers
ex- Health insurance

Moral hazard happens when individuals have more information about their actions than others an have an incentive to behave or act differently (increase risk) because they do not bear the full costs of their actions
ex- The principal agent problem
question
what is the principal agent problem
answer
The principal agent problem is the problem of devising compensation rules that induce an agent to act in the best interests of a principal
For example, person that has health insurance will be reckless because someone else is responsible for his injuries. Also with a person paying another person to write an essay for him; doesn't care what grade he gets
question
what are the three ways of coping with the principal agent problem
answer
Ownership
Incentive pay
Long-term contracts
question
what are the three types of business organizations
answer
proprietorship (largest number), partnership, corporation (largest revenue)
question
what is a proprietorship (advantages and disadvantages)
answer
Firm with a single owner

Advantages: the proprietor answers to no one else, and the owner receives all of the profits. Profits are taxed the same as the owner's other income

Disadvantage: the owner has unlimited liability, meaning that he or she has complete legal responsibility for all debts and damages- up to an amount equal to the entire wealth of the owner
question
what is a partnership (advantages and disadvantages)
answer
Firm with two or more owners

Advantages: more than one person is available for specialized management, partners can pool their financial capital in order to have a larger business base

Disadvantages: partners have unlimited liability for debts incurred while in business. Partners must agree on a management structure and how to divide up the profits (taxed as personal income). If one partner cannot pay his or her share of a debt, the other partners are responsible. When a partner decides to leave the partnership or dies, the partnership normally ends
question
what is a corporation (advantages and disadvantages)
answer
A corporation is owned by one or more stockholders

Advantage: By law, shareholders enjoy limited liability, which means the owners who have legal liability only for the initial value of their investment
The personal wealth of the stockholders is not at risk if the firm goes bankrupt

Disadvantage: double taxation of corporate income
question
what are the four market types
answer
perfect competition, monopolistic competition, oligopoly, monopoly
question
describe perfect competition
answer
Many firms
Many buyers
Each sells an identical product
No restrictions on entry of new firms to the industry
Both firms and buyers are well informed about the prices and products of all firms in the industry
question
describe monopolistic competition
answer
Many firms
Each firm produces similar but slightly different products - called product differentiation
Each firm possesses an element of market power
No restrictions on entry of new firms to the industry
question
describe oligopoly
answer
A small number of firms compete
The firms might produce almost identical products or differentiated products
Barriers to entry limit entry into the market
question
describe monopoly
answer
One firm produces the entire output of the industry
There are no close substitutes for the product
There are barriers to entry that protect the firm from competition by entering firms
question
what is the four-firm concentration ratio
answer
The percentage of the total industry sales accounted for by the four largest firms in the industry
question
what is The Herfindahl-Hirschman index (HHI)
answer
The square of percentage market share of each firm summed over the largest 50 firms in the industry
question
what is a sunk cost for a firm
answer
A sunk cost is a cost incurred by the firm and cannot be changed
If a firm's plant has no resale value, the amount paid for it is a sunk cost
Sunk costs are irrelevant to a firm's decisions
question
what is the relationship between AVC, ATC, and MC on a graph?
answer
When marginal cost (MC) is less than average variable cost (AVC), then average variable cost will decline
When marginal cost (MC) exceeds average variable cost, then average variable cost will increase
It is also true for average total cost (ATC) and marginal cost (MC)
The marginal cost curve will always intersect the average variable and average total cost curves at their minimum points
question
what is the relationship between the production function, AVC, ATC, and MC
answer
As long as marginal physical product (MP) rises, marginal cost (MC) will fall as output increases
When marginal physical product starts to fall (after reaching the point of diminishing marginal returns), marginal cost will begin to rise as output increases
question
what is economies of scale and the reasons for it
answer
Features of a firm's technology that lead to falling long run average cost as output increases

Specialization
Dimensional factor
Improved productive equipment
question
what are diseconomies of scale
answer
Features of a firm's technology that lead to rising long run average cost as output increases

Limits to the efficient functioning of management (greater increase in management)
Coordination and communication is more of a challenge as firm size increases
question
what are constant returns to scale
answer
Features of a firm's technology that lead to constant long run average cost as output increases
question
Sue quit her $40,000 per year job and opened a coffee shop that she calls Top Brew. In the first year, Top Brew earned $200,000 in revenue. For the same year, Top Brew paid $80,000 to employees in wages, spent $45,000 on ingredients such as coffee beans, $15,000 rent for the building to house Top Brew. Sue also used $50,000 of her personal savings to purchase equipment for Top Brew, which she was earning $5,000 in interest each year. Assuming no depreciation in the value of the equipment, Sue's economic profit from Top Brew for the year is $
answer
$15k
question
The short run is a period of time in which...
answer
the quantity used of at least one factor of production is fixed.
question
When a firm is producing a given output at the least possible​ cost, it is producing on
answer
its long run average cost curve
question
what is a price taker in perfect competition
answer
take the price of its product as given because the firm cannot influence its price
A firm can sell as much as it wants at the going market price
There is no incentive to sell for a lower price
Attempts to charge a higher price will result in no sales
No single firm can influence the price- it must "take" the equilibrium market price
Each firm's output is a perfect substitute for the output of the other firms, so the demand for each firm's output is perfectly elastic
question
what is the profit maximizing rate of production for a firm in perfect competition
answer
where marginal revenue equals marginal cost
For a perfectly competitive firm, this is at the intersection of the firm's demand curve (price) and its marginal cost curve
question
what is the profit box on a graph for perfect competition
answer
Profit box is intersection of mc and mr down to atc
question
what is the shut down price for a firm in perfect competition
answer
The price that just covers average variable costs
It occurs just below the intersection of the marginal cost curve and the average variable cost curve
question
what are the three outcomes in the profit maximizing short run for a firm in perfect competition
answer
Positive economic profits
-Price is greater than average total cost (P>ATC)

Negative economic profits (still produce)
-Average total cost is greater than price, but price is greater than average variable cost (ATC>P>AVC)

Negative economic profits (Shut Down: Q=0)
-Average variable cost is greater than price (AVC>P)
question
what does the supply curve for the individual firm look like in perfect competition
answer
The firm's supply curve is the marginal cost curve at or above the short run shutdown point
Thus, the competitive firm's short run supply curve is its marginal cost curve equal to and above the point of intersection with the average variable cost curve
question
summary of what happens and outcomes in perfect competition
answer
Economic profits (#1: P>ATC)
-Signal firms (resources) to enter the market and the price falls to the break-even price (due to increase in supply)

Economic losses (#2 or #3: P<ATC)
-Signal firms (resources) to exit the market and the price increases to the break-even level (due to decrease in supply)

At break-even (P= minimum ATC)
-Resources will not enter or exit because the market is yielding a normal rate of return

In the long run, the perfectly competitive firm will make zero economic profits (a normal rate of return)
question
what signifies an efficient use of resources?
answer
Resources are used efficiently when no one can be made better off without making someone else worse off
This situation arises when marginal social benefit equals marginal social cost *important
question
The profit maximizing level of output for the perfectly competitive firm occurs where
answer
price = marginal cost
question
At the profit maximizing level of output, firms shutdown when
answer
price < average variable cost
question
what are the sources of a monopoly
answer
Ownership of resources without close substitutes
Problems in raising adequate capital
Economies of scale
Legal or governmental restrictions
Natural
question
what are legal barriers to entry for a monopoly
answer
Legal barriers to entry create a legal monopoly, a market in which competition and entry are restricted by the granting of an ownership of resources without close substitutes
-Public franchise (like the U.S. Postal service, a public franchise to deliver first-class mail)
-Government license (like a license to practice law or medicine)
-Patent and copyright
question
what is a natural monopoly
answer
A monopoly that arises from the peculiar production characteristics in an industry
It usually arises when there are large economies of scale
One firm can supply the entire market at a lower price than two or more firms can
question
what is a cartel
answer
An association of producers in an industry that agree to set common prices and output quotas to prevent competition
question
why is a monopolist's demand also the market demand?
answer
Monopolist is the industry
A monopoly is a price setter, not a price taker like a firm in price competition
The reason is the demand for the monopoly's output is the market demand
To sell a larger output, a monopoly must set a lower price
question
what is a price searcher
answer
A firm that must determine the price-output combination that maximizes profit because it faces a downward-sloping demand curve
question
what is price discrimination and what are the two kinds
answer
Selling a given product at more than one price, with the difference being unrelated to differences in cost

-Among units of a good. Quantity discounts are an example. (but quantity discounts that reflect lower costs at higher volumes are not price discrimination
-Among groups of buyers (airline tickets)

Price differences that arise from cost differences are not price discrimination
question
what is price differentiation
answer
Establishing different prices for similar products to reflect differences in marginal cost in providing those commodities to different groups of buyers
question
what are the necessary conditions for price discrimination
answer
The firm must face a downward-sloping demand curve
The firm must be able to separate markets at a reasonable cost
The buyers in the various markets must have different price elasticities of demand
The firm must be able to prevent the resale of the product or service
question
The profit maximizing single price monopolist produces along the ______ portion of its demand curve.
answer
elastic
question
Joe, a hair dresser, offers students a discount price on haircuts. This form of pricing is an example of
answer
price discrimination
question
The more perfectly a monopoly can price discriminate, the _____ its output and the ______ its profit.
answer
larger, larger
question
what is strategic dependence for an oligpoly
answer
A situation in which one firm's actions with respect to price, quality, advertising, and related changes may be strategically countered by the reactions of one or more other firms in the industry
question
what does it mean that oligopolistic firms have some degree of market power?
answer
Oligopolistic firms have some degree of market power, which means each one can affect the market price
This creates some inefficiency in resource allocation
But to the extent that US oligopolies must compete with firms from other countries, their market power is limited
question
what is a reaction function
answer
The manner in which one oligopolist reacts to a change in price, output, or quality made by another oligopolist in the industry
question
what is game theory and what are the four components
answer
A way of describing the various possible outcomes in any situation involving two or more interacting individuals when those individuals are aware of the interactive nature of their situation and plan accordingly
Four components of Game theory
1. Players (decision makers)
2. Strategies (choices or possible actions)
3. Information
4. Payoffs (outcomes)
question
what is a cooperative game
answer
A game in which the players explicitly cooperate to make themselves better off
question
what is a noncooperative game
answer
A game in which the players neither negotiate nor cooperate in any way
question
what is a simultaneous game
answer
A game in which the players move at the same time or are not aware of the other's actions
question
what is a sequential game
answer
A game in which the players move in different order and are aware of the other's prior actions
question
what is a zero-sum game
answer
A game in which any gains within the group are exactly offset by equal losses by the end of the game
question
what is a negative-sum game
answer
A game in which players as a group lose at the end of the game
question
what is a positive-sum game
answer
A game in which players as a group are better off at the end of the game
question
what is opportunistic behavior
answer
Actions that ignore the possible long-run benefits of cooperation and focus solely on short-run gains
Implies a noncooperative game
Not realistic
We make repeat transactions
question
what is tit-for-tat strategic behavior
answer
In game theory, cooperation that continues so long as the other players continue to cooperate
question
what is price leadership
answer
A practice in many oligopolistic industries in which the largest firm publishes its price list ahead of its competitors, who then match those announced prices
question
what is a price war and examples
answer
A pricing campaign designed to drive competing firms out of a market by repeatedly cutting prices

examples:
Cell phone companies
PC hardware and software
question
what is nash equilibrium
answer
Each player is making the best decision that he or she can, taking into account the decisions of the others. (confess)
Nash equilibrium does not necessarily mean the best cumulative payoff for all the players involved. (Pareto optimal: both don't confess)
In many cases all the players might improve their payoffs if they could somehow agree (cooperate) on strategies different from the nash equilibrium
question
How could we achieve the Pareto outcome of higher profits?
answer
Since the game is played more than once, we could collude through price leadership and tit-for-tat strategy
Still may not work
Offer a price match guarantee (ex. 10%)
The payoffs and strategies change
question
what are extensive form games
answer
Also, known as tree games, represents a strategic game specifying the order of play, the actions (decisions) represented by nodes connected by branches, and payoffs resulting from different strategies shown as the final nodes
These games are primarily used to illustrate sequential games
Backwards induction is used to determine the dominant strategy. Start at the end of the game and move to the beginning
It is best used in full information games
question
hhi index <100
answer
highly competitive, perfect competition
question
hhi index 100-1500
answer
moderately competitive, monopolistic competition
question
hhi index 1500-2500
answer
moderate market concentration
question
hhi index 2500+
answer
oligopoly, high market concentration
question
hhi index 10,000+
answer
monopoly
1 of 77
question
how do accountants measure a firm's profits?
answer
Accountants measure a firm's profit using Internal Revenue Service rules based on standards established by the Financial Accounting Standards Board
question
how do economists measure a firm's profits?
answer
Economists measure profit based on an opportunity cost measure of cost
question
what are explicit costs?
answer
Explicit costs are costs paid directly in money
question
what are implicit costs?
answer
Implicit costs are costs incurred when a firm...
Uses its own capital (economic depreciation or interest foregone)
Uses its owners' time or financial resources
question
difference between economic and normal profit
answer
Economic profit equals a firm's total revenue minus its total cost. (TR-TC)
A firm's total cost of production is the sum of the explicit costs and implicit costs
Normal profit is part of the firm's total costs, so economic profit is profit above and over normal profit
question
what three features of the environment are a firm's profit limited by?
answer
Technology constraints
Information constraints
Market constraints
question
what is a command system?
answer
a managerial hierarchy
Commands pass downward through the hierarchy and information (feedback) passes upward
Use when it's easy to monitor (perfect information)
question
what is an incentive system?
answer
market-like mechanisms to induce workers to perform in ways that maximize the firm's profit
Use when it's hard to monitor (imperfect information)
question
difference between symmetric and asymmetric information
answer
Symmetric information occurs when all individuals have the same information
Asymmetric information happens when individuals have different amounts of information available to them
question
what are the two types of asymmetric information and explain them with an example
answer
Adverse selection occurs when information is different (hidden) between buyers and sellers
ex- Health insurance

Moral hazard happens when individuals have more information about their actions than others an have an incentive to behave or act differently (increase risk) because they do not bear the full costs of their actions
ex- The principal agent problem
question
what is the principal agent problem
answer
The principal agent problem is the problem of devising compensation rules that induce an agent to act in the best interests of a principal
For example, person that has health insurance will be reckless because someone else is responsible for his injuries. Also with a person paying another person to write an essay for him; doesn't care what grade he gets
question
what are the three ways of coping with the principal agent problem
answer
Ownership
Incentive pay
Long-term contracts
question
what are the three types of business organizations
answer
proprietorship (largest number), partnership, corporation (largest revenue)
question
what is a proprietorship (advantages and disadvantages)
answer
Firm with a single owner

Advantages: the proprietor answers to no one else, and the owner receives all of the profits. Profits are taxed the same as the owner's other income

Disadvantage: the owner has unlimited liability, meaning that he or she has complete legal responsibility for all debts and damages- up to an amount equal to the entire wealth of the owner
question
what is a partnership (advantages and disadvantages)
answer
Firm with two or more owners

Advantages: more than one person is available for specialized management, partners can pool their financial capital in order to have a larger business base

Disadvantages: partners have unlimited liability for debts incurred while in business. Partners must agree on a management structure and how to divide up the profits (taxed as personal income). If one partner cannot pay his or her share of a debt, the other partners are responsible. When a partner decides to leave the partnership or dies, the partnership normally ends
question
what is a corporation (advantages and disadvantages)
answer
A corporation is owned by one or more stockholders

Advantage: By law, shareholders enjoy limited liability, which means the owners who have legal liability only for the initial value of their investment
The personal wealth of the stockholders is not at risk if the firm goes bankrupt

Disadvantage: double taxation of corporate income
question
what are the four market types
answer
perfect competition, monopolistic competition, oligopoly, monopoly
question
describe perfect competition
answer
Many firms
Many buyers
Each sells an identical product
No restrictions on entry of new firms to the industry
Both firms and buyers are well informed about the prices and products of all firms in the industry
question
describe monopolistic competition
answer
Many firms
Each firm produces similar but slightly different products - called product differentiation
Each firm possesses an element of market power
No restrictions on entry of new firms to the industry
question
describe oligopoly
answer
A small number of firms compete
The firms might produce almost identical products or differentiated products
Barriers to entry limit entry into the market
question
describe monopoly
answer
One firm produces the entire output of the industry
There are no close substitutes for the product
There are barriers to entry that protect the firm from competition by entering firms
question
what is the four-firm concentration ratio
answer
The percentage of the total industry sales accounted for by the four largest firms in the industry
question
what is The Herfindahl-Hirschman index (HHI)
answer
The square of percentage market share of each firm summed over the largest 50 firms in the industry
question
what is a sunk cost for a firm
answer
A sunk cost is a cost incurred by the firm and cannot be changed
If a firm's plant has no resale value, the amount paid for it is a sunk cost
Sunk costs are irrelevant to a firm's decisions
question
what is the relationship between AVC, ATC, and MC on a graph?
answer
When marginal cost (MC) is less than average variable cost (AVC), then average variable cost will decline
When marginal cost (MC) exceeds average variable cost, then average variable cost will increase
It is also true for average total cost (ATC) and marginal cost (MC)
The marginal cost curve will always intersect the average variable and average total cost curves at their minimum points
question
what is the relationship between the production function, AVC, ATC, and MC
answer
As long as marginal physical product (MP) rises, marginal cost (MC) will fall as output increases
When marginal physical product starts to fall (after reaching the point of diminishing marginal returns), marginal cost will begin to rise as output increases
question
what is economies of scale and the reasons for it
answer
Features of a firm's technology that lead to falling long run average cost as output increases

Specialization
Dimensional factor
Improved productive equipment
question
what are diseconomies of scale
answer
Features of a firm's technology that lead to rising long run average cost as output increases

Limits to the efficient functioning of management (greater increase in management)
Coordination and communication is more of a challenge as firm size increases
question
what are constant returns to scale
answer
Features of a firm's technology that lead to constant long run average cost as output increases
question
Sue quit her $40,000 per year job and opened a coffee shop that she calls Top Brew. In the first year, Top Brew earned $200,000 in revenue. For the same year, Top Brew paid $80,000 to employees in wages, spent $45,000 on ingredients such as coffee beans, $15,000 rent for the building to house Top Brew. Sue also used $50,000 of her personal savings to purchase equipment for Top Brew, which she was earning $5,000 in interest each year. Assuming no depreciation in the value of the equipment, Sue's economic profit from Top Brew for the year is $
answer
$15k
question
The short run is a period of time in which...
answer
the quantity used of at least one factor of production is fixed.
question
When a firm is producing a given output at the least possible​ cost, it is producing on
answer
its long run average cost curve
question
what is a price taker in perfect competition
answer
take the price of its product as given because the firm cannot influence its price
A firm can sell as much as it wants at the going market price
There is no incentive to sell for a lower price
Attempts to charge a higher price will result in no sales
No single firm can influence the price- it must "take" the equilibrium market price
Each firm's output is a perfect substitute for the output of the other firms, so the demand for each firm's output is perfectly elastic
question
what is the profit maximizing rate of production for a firm in perfect competition
answer
where marginal revenue equals marginal cost
For a perfectly competitive firm, this is at the intersection of the firm's demand curve (price) and its marginal cost curve
question
what is the profit box on a graph for perfect competition
answer
Profit box is intersection of mc and mr down to atc
question
what is the shut down price for a firm in perfect competition
answer
The price that just covers average variable costs
It occurs just below the intersection of the marginal cost curve and the average variable cost curve
question
what are the three outcomes in the profit maximizing short run for a firm in perfect competition
answer
Positive economic profits
-Price is greater than average total cost (P>ATC)

Negative economic profits (still produce)
-Average total cost is greater than price, but price is greater than average variable cost (ATC>P>AVC)

Negative economic profits (Shut Down: Q=0)
-Average variable cost is greater than price (AVC>P)
question
what does the supply curve for the individual firm look like in perfect competition
answer
The firm's supply curve is the marginal cost curve at or above the short run shutdown point
Thus, the competitive firm's short run supply curve is its marginal cost curve equal to and above the point of intersection with the average variable cost curve
question
summary of what happens and outcomes in perfect competition
answer
Economic profits (#1: P>ATC)
-Signal firms (resources) to enter the market and the price falls to the break-even price (due to increase in supply)

Economic losses (#2 or #3: P<ATC)
-Signal firms (resources) to exit the market and the price increases to the break-even level (due to decrease in supply)

At break-even (P= minimum ATC)
-Resources will not enter or exit because the market is yielding a normal rate of return

In the long run, the perfectly competitive firm will make zero economic profits (a normal rate of return)
question
what signifies an efficient use of resources?
answer
Resources are used efficiently when no one can be made better off without making someone else worse off
This situation arises when marginal social benefit equals marginal social cost *important
question
The profit maximizing level of output for the perfectly competitive firm occurs where
answer
price = marginal cost
question
At the profit maximizing level of output, firms shutdown when
answer
price < average variable cost
question
what are the sources of a monopoly
answer
Ownership of resources without close substitutes
Problems in raising adequate capital
Economies of scale
Legal or governmental restrictions
Natural
question
what are legal barriers to entry for a monopoly
answer
Legal barriers to entry create a legal monopoly, a market in which competition and entry are restricted by the granting of an ownership of resources without close substitutes
-Public franchise (like the U.S. Postal service, a public franchise to deliver first-class mail)
-Government license (like a license to practice law or medicine)
-Patent and copyright
question
what is a natural monopoly
answer
A monopoly that arises from the peculiar production characteristics in an industry
It usually arises when there are large economies of scale
One firm can supply the entire market at a lower price than two or more firms can
question
what is a cartel
answer
An association of producers in an industry that agree to set common prices and output quotas to prevent competition
question
why is a monopolist's demand also the market demand?
answer
Monopolist is the industry
A monopoly is a price setter, not a price taker like a firm in price competition
The reason is the demand for the monopoly's output is the market demand
To sell a larger output, a monopoly must set a lower price
question
what is a price searcher
answer
A firm that must determine the price-output combination that maximizes profit because it faces a downward-sloping demand curve
question
what is price discrimination and what are the two kinds
answer
Selling a given product at more than one price, with the difference being unrelated to differences in cost

-Among units of a good. Quantity discounts are an example. (but quantity discounts that reflect lower costs at higher volumes are not price discrimination
-Among groups of buyers (airline tickets)

Price differences that arise from cost differences are not price discrimination
question
what is price differentiation
answer
Establishing different prices for similar products to reflect differences in marginal cost in providing those commodities to different groups of buyers
question
what are the necessary conditions for price discrimination
answer
The firm must face a downward-sloping demand curve
The firm must be able to separate markets at a reasonable cost
The buyers in the various markets must have different price elasticities of demand
The firm must be able to prevent the resale of the product or service
question
The profit maximizing single price monopolist produces along the ______ portion of its demand curve.
answer
elastic
question
Joe, a hair dresser, offers students a discount price on haircuts. This form of pricing is an example of
answer
price discrimination
question
The more perfectly a monopoly can price discriminate, the _____ its output and the ______ its profit.
answer
larger, larger
question
what is strategic dependence for an oligpoly
answer
A situation in which one firm's actions with respect to price, quality, advertising, and related changes may be strategically countered by the reactions of one or more other firms in the industry
question
what does it mean that oligopolistic firms have some degree of market power?
answer
Oligopolistic firms have some degree of market power, which means each one can affect the market price
This creates some inefficiency in resource allocation
But to the extent that US oligopolies must compete with firms from other countries, their market power is limited
question
what is a reaction function
answer
The manner in which one oligopolist reacts to a change in price, output, or quality made by another oligopolist in the industry
question
what is game theory and what are the four components
answer
A way of describing the various possible outcomes in any situation involving two or more interacting individuals when those individuals are aware of the interactive nature of their situation and plan accordingly
Four components of Game theory
1. Players (decision makers)
2. Strategies (choices or possible actions)
3. Information
4. Payoffs (outcomes)
question
what is a cooperative game
answer
A game in which the players explicitly cooperate to make themselves better off
question
what is a noncooperative game
answer
A game in which the players neither negotiate nor cooperate in any way
question
what is a simultaneous game
answer
A game in which the players move at the same time or are not aware of the other's actions
question
what is a sequential game
answer
A game in which the players move in different order and are aware of the other's prior actions
question
what is a zero-sum game
answer
A game in which any gains within the group are exactly offset by equal losses by the end of the game
question
what is a negative-sum game
answer
A game in which players as a group lose at the end of the game
question
what is a positive-sum game
answer
A game in which players as a group are better off at the end of the game
question
what is opportunistic behavior
answer
Actions that ignore the possible long-run benefits of cooperation and focus solely on short-run gains
Implies a noncooperative game
Not realistic
We make repeat transactions
question
what is tit-for-tat strategic behavior
answer
In game theory, cooperation that continues so long as the other players continue to cooperate
question
what is price leadership
answer
A practice in many oligopolistic industries in which the largest firm publishes its price list ahead of its competitors, who then match those announced prices
question
what is a price war and examples
answer
A pricing campaign designed to drive competing firms out of a market by repeatedly cutting prices

examples:
Cell phone companies
PC hardware and software
question
what is nash equilibrium
answer
Each player is making the best decision that he or she can, taking into account the decisions of the others. (confess)
Nash equilibrium does not necessarily mean the best cumulative payoff for all the players involved. (Pareto optimal: both don't confess)
In many cases all the players might improve their payoffs if they could somehow agree (cooperate) on strategies different from the nash equilibrium
question
How could we achieve the Pareto outcome of higher profits?
answer
Since the game is played more than once, we could collude through price leadership and tit-for-tat strategy
Still may not work
Offer a price match guarantee (ex. 10%)
The payoffs and strategies change
question
what are extensive form games
answer
Also, known as tree games, represents a strategic game specifying the order of play, the actions (decisions) represented by nodes connected by branches, and payoffs resulting from different strategies shown as the final nodes
These games are primarily used to illustrate sequential games
Backwards induction is used to determine the dominant strategy. Start at the end of the game and move to the beginning
It is best used in full information games
question
hhi index <100
answer
highly competitive, perfect competition
question
hhi index 100-1500
answer
moderately competitive, monopolistic competition
question
hhi index 1500-2500
answer
moderate market concentration
question
hhi index 2500+
answer
oligopoly, high market concentration
question
hhi index 10,000+
answer
monopoly
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