ch13_Solutions - Chapter 13 Market Structure and...

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Chapter 13 Market Structure and Competition Solutions to Review Questions 1. In a Cournot setting, each firm chooses a level of output that maximizes its own profit given the output choice of the other firm. In equilibrium each firm is choosing the profit-maximizing level of output given the other firm’s output choice. Thus, neither firm will have any regret since it is doing the best it can given the other firm’s choice. 2. A reaction function represents a firm’s best response to each possible choice of another firm. For example, in a Cournot model a reaction function represents the firm’s profit-maximizing level of output given another firm’s choice of output. At the point where the reaction functions intersect, both firms are choosing a level of output that maximizes its profit given the output choice of the other firm. Thus, neither firm would choose to deviate from this point since doing so would reduce its profit. This point, therefore, represents an equilibrium since neither firm would choose to change what it is doing given the other firm’s choice. 3. The Cournot equilibrium price is less than the monopoly price because the firms in the Cournot oligopoly are not trying to maximize industry profits. By acting in their own self-interest the firms will expand their output to achieve greater profits. By expanding output, market price falls. The Cournot equilibrium price is greater than the perfectly competitive price because the firms in the Cournot oligopoly exhibit market power. This market power allows the firms to set a price above the perfectly competitive price. 4. In the Cournot model of oligopoly, firms choose a level of output given the output choices of rival firms. In the Bertrand model of oligopoly, firms choose a price given the prices set by rival firms. In the Bertrand model it is assumed that the firm with the lowest price will achieve 100% market share. Therefore, firms will undercut the prices of rival firms until price is driven down to the firm’s marginal cost. In a homogenous products oligopoly, Cournot firms exhibit market power and set a price above the perfectly competitive price and provide a level of output below the perfectly competitive level. Bertrand firms, by undercutting prices of rival firms, drive the price down to the level of marginal cost, achieving the perfectly competitive solution. Thus, in the Cournot model price is above the perfectly Page 13 - 1
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competitive price and in the Bertrand model price is equal to the perfectly competitive price. 5. In a dominant firm market, one dominant firm splits the market with a competitive fringe. This competitive fringe is some number of producers that act as perfect competitors: each chooses a quantity of output taking the market price as given. The market price is set by the dominant firm who chooses a price to maximize its own profit.
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ch13_Solutions - Chapter 13 Market Structure and...

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