chapter summary

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chapter summary

Section 1 Monopolistic Competition

10.1 A monopolistically competitive industry has the following characteristics:

  • Large number of firms, each with insignificant market share.

  • Little to no barriers to entry and exit.

  • Products sold by firms are similar but differentiated (has a brand name).

  • Limited market power and ability to set prices.

10.2 Short-run profit maximization for a firm in a monopolistically competitive industry looks identical to a monopoly. In the long run, however, the demand curve is tangent to the average total cost curve, signaling zero economic profit.

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Because of product differentiation, a firm’s demand curve is downward sloping. However, it is highly elastic due to the competitive nature of the industry.

Types of Product Differentiation

Location

Quality

Style, Design, and Features

Advertising

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A shopping mall offers dozens of stores at which to buy clothing, each of which is differentiated.
Eric Chiang

Section 2 Oligopoly

10.3 Oligopoly industries are controlled by a few large firms. Barriers to entry are significant, products are less differentiated than in monopolistically competitive industries, and pricing decisions by one firm directly impact other firms (mutual interdependence). Oligopoly firms possess market power, but not as much as a monopoly.

10.4 Cartels are agreements to restrict output to push prices higher, but are inherently unstable because cheating is profitable.

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A kinked demand curve occurs because firms are reluctant to match price increases but not price decreases. The kink creates a discontinuity in the marginal revenue curve, allowing marginal cost to vary (from MC0 to MC1) while prices remain stable.
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Kevork Djansezian/Getty Images
Nearby competing gas stations keep their prices similar.

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Section 3 Game Theory

10.5 Game theory is the study of strategic decision making when multiple players each act in their own interests.

Components of a Game

Players Information Strategy Choices Outcomes Payoffs

Sequential-move games: Games in which players move one at a time, and are analyzed using game trees.

Simultaneous-move games: Games in which players move at the same time, and are analyzed using game tables.

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Eric Chiang
Golf is a sequential-move game, in which players take their shots one at a time.

Nash equilibrium is an outcome that results from all players responding optimally to all other players’ actions to maximize their expected payoffs. In a Nash equilibrium, no player wishes to deviate unilaterally from that outcome.

10.6 Solving for a Nash equilibrium requires analyzing a game table for best responses to the other player’s possible actions.

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Player 1’s best response to “Left” is “Top” = 8.

Player 1’s best response to “Right” is “Down” = 7.

Player 2’s best response to “Top” is “Right” = 6.

Player 2’s best response to “Down” is “Right” = 5.

One Nash equilibrium is “Down,” “Right” = (7, 5).

Section 4 Applications of Game Theory

10.7 A Prisoner’s Dilemma occurs when optimal noncooperative play results in an outcome that is inferior to another outcome for both players.

10.8 Ways to Overcome the Prisoner’s Dilemma

Collusion: This is illegal in most cases, although international cartels exist, such as the OPEC oil cartel and various drug cartels. Also, free trade agreements are a legal form of cooperation between countries.

Repeated games: Games that are repeated by the same players, and often results in one player taking the lead on a cooperate strategy, and others follow. The possibility of retaliation in a repeated game increases the likelihood of cooperation.

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Eric Chiang
American Airlines was the first major airline to charge for checked baggage. Almost all other airlines followed, allowing the airlines to achieve a mutually beneficial outcome.

Trigger Strategies Used in Repeated Games

Grim trigger: When one player defects, the other refuses to cooperate again (no forgiveness).

Trembling hand trigger: Players forgive certain instances of defection as “mistakes” before retaliation is taken.

Tit-for-tat trigger: Essentially an eye for an eye: If one player defects, the other player punishes this player until cooperation resumes.

Leadership games: Describes situations that occur when a small firm competes against a large firm, and where the market share captured by the small firm is not large enough to warrant a reaction by the large firm.

Chicken games: Describes situations that occur when opposing players have an incentive to maintain a tough stance; however, if neither player refuses to back down, the worst outcome for both players occurs.