The regulation of industry
The problem of natural monopoly.
The technology of production is subject to increasing returns to scale.
For production eciency, there should be just one firm undertaking
the entire production of the market.
An unregulated m
Introduction to dynamic oligopoly theory
Fixed beliefs and strategic behaviours
Firms, when deciding what strategy to adopt
the price to charge in Bertrand oligopoly,
the output level in Cournot oligopoly,
hold a fixed belief as to what others would
Problem set 4
1. The demand curve is P = 300 Q and MC is constant at 10. What is the eciency
loss according to Richard Posners theory of rent-seeking when the industry falls to the
hand of a monopoly?
2. Country Utopias president i
Product bundling to price discriminate
Suppose there are no dierences in consumers valuations of a particular good.
There are n consumers, each of whom is willing to pay up to p for a
unit of the good.
The demand curve is perfectly inelastic at prices
Problem set 5
1. We argued in class the reason for the ineciency in equilibrium entry
in Cournot oligopoly is a pecuniary externality firms impose on one
another in their entry decisions. How come then any such externalities
Problem set 1
1. We have studied two explanations for why the industry supply curve can be upward
sloping even after allowing for entry and exit. In fact the two explanations are based
on a common theme. Discuss.
2. We argued that
Problem set 3
1. There are 30,000 consumers in the market, each of whom has demand curve P = 302q.
The MC is equal to 10.
(a) What is the reservation price; i.e., the highest price that a consumer will pay?
(b) What is the monopoly
problem set 8
1. What is the NE in locations of the Hotelling model with 4 firms?
2. Suppose the campus of HKU is best described as the interval [0,1].
Two fast-food restaurants serving identical food are located at the edges of
Industrial Organization ECON0402/2216
Problem set 2
1. An important lesson in Principe Microeconomics is that decisions should NOT be
aected by sunk costs. But then here last week, we saw how sunk costs played a role
in determining an interval of price wi
Problem set 7
1. Consider an infinitely repeated Bertrand oligopoly. There are two
firms in the market. Suppose the cooperative price Pe = (P m + c) /2,
where P m is the monopoly price and c is the marginal cost. There is a
Problem set 6
1. Name two industries in which Bertrand oligopoly is a more appropriate model than
Cournot oligopoly and two industries in which Cournot oligopoly is a more appropriate
model than Bertrand oligopoly. Explain your cho
Long run supply curve with sunk cost
The industry is perfectly competitive with the following features:
a. infinite supply of potential entrants
b. all entrants the same cost curves
c. shape of cost curves independent of industry output
d. free entry and
Stackelberg model of oligopoly
In the Stackelberg model of oligopoly,
there are two firms competing using output levels as strategies,
just as in Cournot oligopoly.
Firms are assumed to set output levels one after another, instead of
Why cartels form?
Firms in an oligopoly would be better o to cooperate than to compete.
Cournot oligopoly with n 2 firms: Qn > Qm, P n < P m.
Profits in monopoly and oligopoly
The maximum profit that can be earned in the industry is when outpu
Third degree price discrimination
Third degree price discrimination refers to the situation where the firm
charges dierent groups of consumer dierent prices.
For example, the franchise bus companies charge elderly and schoolage passengers l
Number of brands
Our previous analysis on product dierentiation assumes two firms.
Then we ask
1. what forces would drive firms to locate their brands close together
2. what forces would drive firms to locate their brands apar
Limit pricing the advantage of
An incumbent monopolist faces the threat of entry.
It can protect its monopoly position by pricing at a low level at all
times to make entry not profitable.
Such a pricing policy is called limit pricing.
Product dierentiation and price
Our analysis has restricted attention to industries selling a homogenous
Outside agriculture, very few industries sell truly homogeneous products.
Principle of minimal dierentiation
Harold Hotelling proposed a model to study the locational choices of
It has subsequently been applied to study the extent to which firms
choose to dierentiate their products from each other
Durable good monopoly and the Coase
The monopoly faces a downward sloping demand curve D1 (p).
The marginal cost is c.
The monopoly maximizes profit,
= max (p c) D1 (p) .
The condition for profit maximization : marginal re
Predation and entry deterrence
Entry deterrence and predation are a firms (usually the industrys
incumbent) business practices
to reduce the level of expected profits that the firms rivals, actual
and potential, could hope to earn.
2 firms competing for market shares, using prices as strategies.
Demand curve : P = G gQ.
Each firm has constant marginal cost : c.
If the competition goes on for just one period, NE : P1 = P2 = c.
The firms ear
Nobel prize winner George Stigler of the Chicago school argues that
cartel is not the only means for firms to collude to restrict output and
Collusion to restrict output and raise price could be a natural outcome
of market int
Capacity expansion to deter entry
For some time, the SAR government has considered opening up the
electricity (power supply) market.
The change would pose serious threats to the two monopoly incumbents
HK Electric for HK Island
China Light and Power f
Quantity discount and quality choice
Second degree of price discrimination
The monopoly is able to identify the willingness to pay of each consumer.
It can first degree price discriminate, charging each consumer her maximum willingness to pay.
First-degree price discrimination
When a monopolist raises output,
MR = P + Q
When the firm raises output from q1 to q2, MR is equal to
the increase in revenue due to the increase in quantity (P )
the decrease in the
The ineciency of monopoly
Elasticity of demand and deadweight loss
How important is the economic ineciency caused by monopoly? This is a
question of great practical importance.
For if the ineciency turns out to be small, then there is no great need
Upward-sloping market supply curve
Market price completely independent of demand in the long run a
strong and extreme result.
Not a necessary implication of PC.
A market can satisfy conditions (a)-(f ) of perfect competition, yet the
long run market su
Equilibrium with costly search and price
A more systematic look at the tourist trap model
1. homogenous good
2. a large number of firms (n) and a large number of consumers (m)
3. consumers are ignorant as to prices charged in
In Cournot oligopoly, firmss strategies are output levels.
A common criticism is that it is hard to see how prices are set if firms
do not employ prices as strategies.
The defining dierence between perfect and imperfe