4240_update_Notes

4240_update_Notes - TO: everyone in AEM 4240 FR: Garrick...

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TO: everyone in AEM 4240 FR: Garrick Blalock RE: where we stand in this class, how to solve Cournot problems DT: October 1, 2008 As we approach the middle of the semester, I’d like to discuss two things with you. First, I want to update you on where we stand on the syllabus and tie together the topics we have covered. Second, I want to give you a written explanation of Cournot problems in the hope that it will remove any remaining confusion. The class so far: what game theory tells us about price and quantity strategies We started by contrasting Bertrand markets, in which firms are most concerned with price, with Cournot markets, in which firms are most concerned with quantity. We started with the most basic case in which firms produce homogenous goods in a single period. In a Bertrand market with two or more firms, we saw that the only equilibrium outcome was that all firms price at marginal cost. Economic profits are zero and consumers capture the entire surplus. We termed this the “Bertrand Trap” or the “Bertrand Paradox” because it’s something firms wish to avoid and because it’s counter to our experience as consumers. In a Cournot market, we saw that the situation is better for firms. As the number of firms increases, prices gradually fall, quantity gradually rises, and surplus slowly shifts from producers to consumers. We next added some complexity to our simple view of the world. We discussed four conditions that allow firms to escape the Bertrand trap. (1) heterogeneity in cost structures, (2) heterogeneity in goods’ perceived quality, e.g., the linear city, (3) capacity constraints, and (4) more sophisticated pricing strategies like “we won’t be undersold.” We also added some complexity to the timing of our models. We concluded that there was no “first mover’s advantage” in Bertrand markets. In contrast, we found a first mover’s advantage in Cournot markets. If decisions are made sequentially, rather than simultaneously, then the first firm will grab the majority of market share, and leave the second firm with only the smaller residual demand (more on this below). The finding of a first mover’s advantage in Cournot markets led to a follow-up question:
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This note was uploaded on 02/20/2009 for the course AEM 4240 taught by Professor Blalock,g. during the Fall '07 term at Cornell.

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4240_update_Notes - TO: everyone in AEM 4240 FR: Garrick...

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