Microeconomics ii

Please choose a company and explain how this company has been dealing with the coronavirus pandemic and economic crisis. You must focus on the company's production costs and mention in three sentences how the production structure and the costs have been changing recently. An example from me: Airplane manufacturing has been hit hard by the coronavirus pandemic due to different restrictions on international travel. Airbus cut sharply the production of its three main models (about 30%). The aerospace sector is a key consumer of aluminum, so the global demand for it dropped by about 8% in the first half of the year . (Source: https://www.fastmarkets.com/article/3927455/airbus-to-cut- aircraft-production-by-30-on-covid-19-aviation-headwinds)

Deadline: 16th of July 2021 at 17:00 CET

Discussion Forum W5: Changing production costs

Four types of market structure Monopoly Monopolistic competition Oligopoly Introduction to Game Theory The Prisoner s Dilemma

Class content

Types of market competitions

Perfect competition: a market structure where there are many firms, none of which is large; where there is freedom of entry into the industry; where all firms produce an identical product; and where all firms are price takers. Monopoly: a market structure where there is only one firm in the industry, and its unique product has no close substitute. Monopolistic competition: a market structure where there are many firms and freedom of entry into the industry, but where each firm produces a differentiated product and thus has some control over its price. Oligopoly: A market structure where there are few enough firms to enable barriers to be erected against the entry of new firms.

Four market types

Quiz: Which type of market for the following companies?

A monopoly is a price maker on a non-competitive market It is the sole seller of its product The product does not have a close substitute

How do monopolies arise? There are barriers for others firms to enter the market Barriers to entry has 3 main sources:

1. a key resource is owned by a single firm (water, power plant, mobile cable network) 2. the government gives a single firm the exclusive right to produce some good or service (patents,

copyrights, exclusive business licenses) 3. the costs of production make a single producer more efficient than a large number of producers =

natural monopoly Economies of scale: the average total cost declines as the production of output increases

Monopoly

The monopoly faces a downward sloping demand curve (= average revenue) Average revenue:

AR = TR/Q = P equals the price of good!

Marginal revenue: MR = TR/ Q always less than the price of the good

Monopol re en e

A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost (point A) It then uses the demand curve to find the price that will induce consumers to buy that quantity (point B) The price exceeds the marginal cost

P > MR = MC

Profit maximization of a monopoly

The monopoly sets its price above the marginal cost The monopoly produces less than the socially efficient quantity of output Deadweight loss is created Monopoly receives more profit than in a competitive market

The inefficiency of monopoly

Advantages: economies of scale profits can be used for

investment

Disadvantages: high prices / low output both

in the short and long run lack of incentive to innovate inefficiency

Advantages and disadvantages of monopoly

Government responds to monopolies in four ways:

1. Making monopolized industries more competitive (competition laws, ban on mergers)

2. Regulating the behavior of monopolies (price regulations) 3. Turning some private monopolies into public enterprises 4. Doing nothing at all

Public policy toward monopolies

A form of industry (market) structure characterized by a few dominant firms Products may be homogenous or differentiated Market entry in difficult The behavior of any one firm in an oligopoly depends to a great extent on the behavior of others

Oligopoly

Oligopolistic market if the market share of

four largest companies are more than 80%

Many different types of oligopoly models have been developed All kinds of oligopoly have one thing in common:

The behavior of any given oligopolistic firm depends on the behavior of the other firms in the industry comprising the oligopoly mutual interdependence

1. Collusion model: production determined by MC = MR, and price is set above MC

2. Duopoly/Cournot model: a model of a two-firm industry in which a series of output adjustment decisions leads to a final level of output between the output that would prevail if the market were organized competitively and the output that would be set by a monopoly

3. Price leadership model: one dominant firm sets prices and all the smaller firms in the industry follow its pricing strategy

Oligopoly models

Game theory is used by economists to examine strategic interaction of markets, and is especially useful in analyzing oligopoly markets

A game involves players making strategic decisions Players are the decision-making units, independent from each other

Payoff matrix: a table that describes the outcome for each player and for each set of strategic choices Dominant strategy (DS): a strategy that produces the optimal outcome regardless of what the other players do Dominant strategy equilibrium (DSE): occurs if each player in a game chooses its dominant strategy Nash equilibrium: occurs if e er pla er s strateg is optimal gi en its competitors strategies

Game theory

The Pri oner dilemma Prisoner s dilemma: a game bet een t o captured criminals that illustrates why cooperation is difficult even when it is mutually beneficial

Dominant strategy of both prisoners: to confess Outcome: Ginger and Rocky both confess, each gets 5 years in prison Both would have been better off if both remained silent But even if Ginger and Rocky had agreed before being caught to remain silent, the logic of self-interest takes over and leads them to confess

When oligopolies form a cartel in hopes of reaching the monopoly outcome, the become pla ers in a prisoners dilemma!

Pri oner dilemma o come

The players: American Airlines and United Airlines

The choice: cut fares by 50% or leave fares alone If both airlines cut fares, each airline s profit = $400 million If neither airline cuts fares, each airline s profit = $600 million If only one airline cuts its fares, its profit = $800 million, the other airline s profit ithout cut = $200 million

a) Draw the payoff matrix. b) Find the dominant strategy equilibrium. c) Find the Nash equilibrium.

Exercise 1.

Exercise 1 solution

American/ United

United

Cut No cut

American Cut 400/400 800/200

No cut 200/800 600/600

a) The payoff matrix:

b) DS: to cut fares c) Nash equilibrium: highest profit equally

Dominant strategy

equilibrium

Nash equilibrium

Monopoly: a market structure where there is only one firm in the industry, and its unique product has no close substitute. Monopolistic competition: a market structure where there are many firms and freedom of entry into the industry, but where each firm produces a differentiated product and thus has some control over its price. Oligopoly: A market structure where there are few enough firms to enable barriers to be erected against the entry of new firms. Game theory is used by economists to examine strategic interaction of markets, and is especially useful in analyzing oligopoly markets Prisoner s dilemma: a game bet een t o captured criminals that illustrates why cooperation is difficult even when it is mutually beneficial

Summary