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Profit Maximisation & Market Structure
Lecture Objectives:
1. Examine profit maximisation under perfect competition & oligopoly
2. Introduce game theory through an evaluation of oligopoly & duopoly
ALTERNATIVE MARKET STRUCTURES• Classifying markets by degree of competition
– number of firms– freedom of entry to industry– nature of product– nature of demand curve• Structure, Conduct & Performance (SCP)
PERFECT COMPETITION
• Assumptions– firms are price takers– freedom of entry– identical products– perfect knowledge
• Short-run equilibrium of the firm
O O
S
D
(a) (a) Industry Industry
P £
Pe
(b) (b) Firm Firm
ARD = AR= MR
Q (millions) Q (thousands)
Short-run equilibrium of industry and firm under perfect competition
O O
S
D
(a) (a) Industry Industry
P £
Q (millions)
Pe
(b) (b) Firm Firm
ARD = AR= MR
MC
Qe
Short-run equilibrium of industry and firm under perfect competition
Q (thousands)
O O
S
D
(a) (a) Industry Industry
P £
Q (millions)
Pe
(b) (b) Firm Firm
ARD = AR= MR
MC
Qe
AC
AC
Short-run equilibrium of industry and firm under perfect competition
Q (thousands)
O O
S
D
(a) (a) Industry Industry
P £
Q (millions)
Pe
(b) (b) Firm Firm
ARD = AR= MR
MC
Qe
AC
AC
Short-run equilibrium of industry and firm under perfect competition
Q (thousands)
S1
P1 AR1
Duopoly & Oligopoly
– barriers to entry (economic & strategic)
– interdependence of firms
– incentives to compete versus incentives to collude
Imperfect Competition
One – shot commercial game: UK Motor Industry
Ford UKPrice cut Aggressive Adverts
FIAT Price cut 60, 40 75, 25
Aggressive Adverts 50, 50 65, 35
Ford should cut price Rover should cut price Dominant strategy game Zero – sum game
Duopoly & Game Theory: Non-collusion
Iterated Commercial Game: Business Joint Venture
Co-operate Defect
Co - operate
Defect
UK
CHINA3 , 3
5 , 0
0 , 5
1, 1
Permanent co-operation = highest return ‘Tit – for – tat’ = return of 2.5 Range of other strategies = All D; Random; Tit – for –two –tats Axelrod (1984) found Tit-for-tat the winning strategy
Reading:Begg, D. et al, (2008), Economics, 9th Ed., Chpts. 8 & 9Cook, M. and Farquarson, C., (1998), Business Economics,Chpt. 9 Dixit, A. and Nalebuff, B., (1991), Thinking Strategically,(various chapters).Douma, S. and Schreuder, H., (2002) Economic Approaches to Organisations, 3nd Ed., Chpt. 5Griffiths, A. & Wall, S. (2005), Economics for Business &Management, Chapter 6
Film Reference:“A Beautiful Mind”, (2002), Dreamworks & Universal Pictures, featuring Russell Crowe