Imperfect Competition and Strategic Behaviour

Imperfect Competition and Strategic Behaviour
Imperfect Competition and Strategic Behaviour
Question 2
a) The (domestic) four-firm concentration ratio is equal to the sales of the four largest
firms expressed as a fraction of the total industry sales. The concentration ratios are:
Forestry products: (185 167 98 47)/550 = 497/550 = 90.3%
Chemicals: (27 24 9 4)/172 = 64/172 = 37.2%
Women’s clothing: (6 5 4 2)/94 = 17/94 = 18.1%
Pharmaceuticals: (44 37 22 19)/297 = 122/297 = 41.1%
b) The most concentrated industry is Forestry products, and then Pharmaceuticals,
followed by Chemicals and then Women’s clothing.
c) If Canada trades with the world in these industries, then the relevant market must be
taken to be the world market. In this case, the concentration ratios will be lower than in
part (a). The modified concentration ratios are:
Forestry products: 497/1368 = 36.3%
Chemicals: 64/2452 = 2.6%
Women’s clothing: 17/3688 = 0.5%
Pharmaceuticals: 122/2135 = 5.7%
Question 4
In both the short run and the long run, the firm is profit maximizing by choosing output
where marginal revenue equals marginal cost. In the short run, the firm is shown to have
positive profits (since at Q* price exceeds ATC). These profits attract new firms to enter
the industry. As new firms enter, the demand curve shifts to the left and becomes flatter,
because total industry output must now be divided among a larger number of firms. Entry
occurs until firms have zero profit in the long-run equilibrium, shown as a tangency
between ATC and the demand curve.
© 2005 Pearson Education Canada Inc.
Question 6
a) Free entry and exit implies that firms will enter if existing firms are making positive
profits, and this entry will dissipate those profits. Conversely, firms will exit if they are
making negative profits (losses), and the exit will increase the profits (reduce the losses)
of the remaining firms. Thus, firms in the long-run equilibrium of a monopolistically
competitive industry will have zero profits. At point A, price is equal to average total
costs, and so profits are zero.
Imperfect Competition and Strategic Behaviour
c) This firm’s long-run equilibrium price, pA, is greater than the price that minimizes its
average costs, and in this sense there is an inefficiency compared to perfect competition.
But as we argued in the text, the higher unit cost is the price we pay for greater product
diversity, and it may well be the case that consumers benefit more from the diversity than
they lose from the higher prices, in which case we could not say that monopolistic
competition is unambiguously worse than perfect competition.
Question 8
a) There are two Nash equilibria in this game. One is that both firms bid $10 000. The
other is that both bid $5000. In both cases, neither firm would want to change its
behaviour given the behaviour of the other firm.
b) See above.
c) If the two firms could cooperate, they would clearly both prefer the high-bid
equilibrium to the low-bid equilibrium, for the simple reason that they both get a higher
payoff in the high-bid case. So we would predict cooperation (collusion) to lead to the
outcome that both firms bid $10 000 and end up sharing the contract.
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