2 – Market Structure

"! Firm' s amount of sales

Market share: 𝑠! = #
= Total market sales
N-firm concentration ratio: 𝐶𝑅𝑛 = ∑𝑛𝑖=1 𝑠𝑖 (only sum of the largest 𝑛)
)
∑# "
!$% (! ∑#
!$% (! ,,- .
Variance of the market share: 𝜎() = +
−( +
) = +
− +"® If it is high: more concentrated.
.
Herfindahl-Hirschman index: 𝐻𝐻𝐼 = ∑+ ) )
!/. 𝑠! = 𝑁𝜎( + +® If it is high: uneven distribution, more concentrated, less competitive.
- 𝐻𝐻𝐼 = 1 ® monopoly.
- 𝐻𝐻𝐼 = 0 ® perfect competition.
.
- 𝐻𝐻𝐼 = ® identical market share of firms.
+
Concentration has positive relation with price; BUT it doesn’t have a necessarily positive relation with profitability (only if it is concentrated because of entry
barriers and not if because the market size is small); nor competition.

Price as optimization variable Quantity as optimization variable

1) Demand for firm 𝑖: 𝑞 = 𝐷(𝑝) 𝑝 = 𝑃(𝑞) (inverse)
2) Profit for firm 𝑖 (𝜋! ) 𝑝𝐷(𝑝) − 𝐶9𝐷(𝑝): 𝑃(𝑞)𝑞 − 𝐶(𝑞)
0 )𝑞 0
3) FOC ;𝑝0 − 𝐶 1 9𝐷(𝑝0 ):<𝐷1 (𝑝0 ) + 𝑃′(𝑞 + 𝑃(𝑞0 ) = 𝐶′(𝑞
>?????@?????A >?@? 0
A)
𝐷(𝑝0 ) = 0 23 24

5& 64 ' 78(5& ); . 5&

From FOC we get: 5&
= < (where 𝜂 = −𝐷′(𝑝0 ) 8(5& )
is the demand elasticity). A price increase (i) decreases the total number of units sold (∇net
revenue by 𝑝0 ), and (ii) increases the price charged on each of the units sold (∆net revenue by 𝐶 1 9𝐷(𝑝0 ):).
56=1 .
Lerner index (inverse relation between markup with elasticity): 5
=<
 3 – Oligopoly Static Competition
COURNOT (competition in quantities) = strategic substitutes (because of negative slope of the BR function: ∇𝑐. ⟹↑ 𝑞. ⟹↓ 𝑞) ). ® Model for Capacity constraints
𝑎 = intercept of demand function; 𝑏 = slope of demand function; 𝑐 = marginal costs; 𝑛 = number of firms; 𝑗 = all firm; 𝑖 = studied firm; −𝑖 = other firms
Linear COURNOT (𝑛 firms with Linear COURNOT duopoly (2 firms
Monopoly
constant/heterog. costs) with constant/heterog. costs) 𝒒𝟏 .
1) Demand for firm 𝑖: 𝑃(𝑞) = (𝑎 − 𝑏 ∑ 𝑞> ) (inv.) 𝑄 = 𝑎 − 𝑏𝑝. Consumer Surplus: 𝐶𝑆 = ) 𝑄∗ )
𝐴−𝑐
2) Profit for firm 𝑖 (𝜋! ) 𝜋! = 9𝑎 − 𝑏 ∑ 𝑞> − 𝑐! :𝑞! 𝜋. = (𝑎 − 𝑏(𝑞. + 𝑞) ) − 𝑐. )𝑞. Previous
?6@"(! 6=! ?6@"" 6=% chapter 𝒒∗𝟐 (𝒒𝟏)
3) Best response of 𝑞! (𝑞6! ) = 𝑞 (𝑞
. ) ) =
)@ )@
firm 𝑖 (FOC):
() () 𝐴−𝑐
DEEFE
?6B= EG
! C= DE
EFE EG
Individual production: 𝑞!∗ (𝑛) = (!
𝑞.∗ =
?6)=% C=" 2
@(BC.) H@ 𝐴−𝑐
∗ ?6= 𝒒𝟏∗ =
+) ")
𝑞0 = )@
3

I D%EFEG 𝒒∗𝟏 (𝒒𝟐 )

Total production eq.: B?6∑ =* ∗ )?6(= C=")
∗
𝑄 (𝑛) = 𝑄 = H@ 𝒒𝟐
@(BC.)
𝐴−𝑐 𝐴−𝑐 𝐴−𝑐
+) ") 𝒒𝟐∗ =
3 2
I ?6=
Price eq.: ∗
𝑃 (𝑛) =
?C∑ =*
𝑃 =∗ ?C(=D%EFEG
C=") 𝑃0∗ = )
BC. H
"% ?6)= C=
Individual Profits eq. DEEFE
()
EG
"
DE
EFE
()
EG
"
(?6=)"
Firm 𝑖 market share: 𝑠 = " = )?6=% 6="
J?6B= ! C= (! K J?6)=% C="K ∗ % C"" % "
𝜋0 =
𝜋!∗ = 𝑞!∗ ) 𝜋!∗ (𝑛) = @(BC.)"
𝜋.∗ = L@
M@

* With constant costs 𝑐 you can impose symmetry in “3)”. ||. * With heterogeneous costs ® 𝑞!∗ is MORE decreasing in my 𝑐! than 𝑞!∗ is increasing in other 𝑐> .
NNO 56∑+ '
!$% (! 4! ("! ) NNO . P(#) . QQQQQQ
5642
Lerner index: FOC ® 𝑝 N1 − <
O = ∑B!/. 𝑠! 𝐶!1 (𝑞! ) ⟺ 5
= <
Demand price-elasticity: 𝜂 = − P' (#) #
. If 𝑁′ equal firms ® HHI = +1 = N ,
5
O𝜂
BERTRAND (competition in prices) = strategic complements (because of positive slope of BR function: ∇𝑐. ⟹↓ 𝑝. ⟹↓ 𝑝) ) 𝒑∗𝟐 (𝒑𝟏 )
𝒑𝟏
BERTRAND Linear BERTRAND with 2 firms.
𝐷(𝑝! ) if 𝑝! < min 𝑝"! 𝑎 − 𝑝. 𝑝. < 𝑝) 𝑃- 𝒑∗𝟏 (𝒑𝟐 )
#(% ) ?65%
1) Demand for firm 𝑖: 𝑄! = $ ' ! if 𝑝! = min 𝑝"! and 𝑛 − 𝑙 firms have 𝑝( > 𝑝! 𝑄. (𝑝. ) = S ) 𝑝. = 𝑝)
0 otherwise (if 𝑝! = min 𝑝"! ) 0 𝑝. > 𝑝)
2) Profit for firm 𝑖: 𝜋! = 𝑄! (𝑝! )(𝑝! − 𝑀𝐶)
min 𝑝6! − 𝜀 if min 𝑝6! > 𝑐 min 𝑝) − 𝜀 if min 𝑝) > 𝑐
3) Reaction f. of firm 𝑖: 𝑝! (𝑝6! ) W 𝑝. (𝑝) ) W
𝑐 otherwise 𝑐 otherwise 𝑀𝐶
Unique Price eq.: 𝑝.∗ = ⋯ = 𝑝B∗ = 𝑐 ∗ ∗
𝑝. = 𝑝) = 𝑐 → 𝝅𝟏 = 𝝅∗𝟐 = 𝟎
∗

∗ ∗ 𝒑𝟐
⚠ BERTRAND trap: 𝑝. = 𝑝) = 𝑐 ® Solutions: (1) Product differentiation; (2) Limit capacity; (3) Collusion; (4) Cost leader
𝑀𝐶 𝑃-
(with heterogeneous costs: If 𝑝0 (𝑐) ) > 𝑐) > 𝑐. , firm 1 sets 𝑝.∗ = 𝑐. and BR of firm 1 is undercut 𝑝.∗ = 𝑐) − 𝜀 [ ] to get 𝜋.∗ > 0).
 4 – Sequential competition
Subgame perfect Nash equilibrium (SPNE) if strategy induces a Nash equilibrium in every subgame. ® Solved by backward induction if finite number of actions
at each node and perfect information.
® Commitment theory:
(1) Strategic commitment (firm’s actions that are irreversible or very costly to reverse): if (A) sequential moves; (B) communication (C) credible threat.
It has 2 effects (or change in present value of the firm’s profits) because of:
1) Direct effect ® Change assuming that the rival’s tactics are unaffected by the commitment) Program of R+D reduces my marginal costs independently.
2) Strategic effect ® Change due to rival adjusting its tactics. The sign depends on (1) Stage 1 commitment type and (2) Stage two type of competition:
Firm 1’s Commitment Second Stage Competition Strategic Effect on Firm 1
Soft (good for rival) ↙ COURNOT (substitutes) Negative
Soft (good for rival) ↘ BERTRAND (complements) Positive
Tough (bad for rival) ↗ COURNOT (substitutes) Positive
Tough (bad for rival) ↖ BERTRAND (complements) Negative
(2) Model Leader-Follower
STACKELBERG (leader takes a decision and the follower reacts to it). ® BACKWARD INDUCTION
I. In the second stage, firm 2 (Follower) chooses its quantity as a function of Firm 1 choice ® 𝑞) (𝑞. ).
(1) Firm 2 maximizes profits choosing 𝑞) :
𝑚𝑎𝑥 (𝑎 − 𝑏(𝑞. + 𝑞) ) − 𝑐)𝑞)
""
(2) Best response of 𝟐
?6@" 6=
𝑞) (𝑞. ) = )@%
II. In the first stage, firm 1 (Leader) chooses its quantity ® 𝑞. .
(3) Firm 1 plugs in the BR of Firm 2 into its objective function and derive =0:
?6@" 6=
𝑚𝑎𝑥 (𝑎 − 𝑏(𝑞. + )@% ) − 𝑐)𝑞.
"%
(4) We get equilibrium quantity for Leader:
𝑎−𝑐
𝒒∗𝟏 = > Cournot
2𝑏
-()
?6@T U6=
𝑞.∗
(5) ® When Firm 2 plays its BR, we must substitute into its BR function: 𝑞) (𝑞. ) = )@
and we get:
".

𝑎−𝑐
𝒒∗𝟐 = < Cournot
4𝑏
𝑄∗ 𝜋.∗ 𝜋)∗ 𝑃 Total Π
3 𝑎−𝑐 (𝑎 − 𝑐) ) (𝑎 − 𝑐) )
N O > Cournot > Cournot < Cournot 𝑃(𝑆) < Cournot Π(𝑆) < Cournot
4 𝑏 8𝑏 16𝑏
DIXIT-SPENCE (excess of capacity): reduce MC at the expense of a greater fixed cost, so firm can credibly commit to greater production. BACKWARD IND:
I. In the second stage, firm 2 observes 𝐾. (capacity) and firms compete á la COURNOT simultaneously with linear demand functions.
Linear COURNOT (firm 1) Linear COURNOT (firm 1)
1) Demand: 𝑃 = 𝑎 − 𝑏𝑄
𝑐 if 𝑞. ≤ 𝐾.
MC (differs across firms) 𝑐. (𝑞. , 𝐾. ) = q 𝑐) (𝑞) ) = 𝑐 + 𝑟
𝑐 + 𝑟 if 𝑞. > 𝐾.
max(𝑎 − 𝑏(𝑞. + 𝑞) ) − (𝑐 + 𝑟))𝑞. if 𝑞. ≥ 𝐾.
"
2) Profit (max.) t % max9𝑎 − 𝑏(𝑞. + 𝑞) ) − (𝑐 + 𝑟):𝑞)
max(𝑎 − 𝑏(𝑞. + 𝑞) ) − 𝑐)𝑞. − 𝑟𝐾. if 𝑞. < 𝐾. ""
"%
?6"" 6=
)@
if 𝑞. < 𝐾. ?6"% 6(=CW)
3) Best response (FOC): 𝑞. (𝑞) ) = t?6"" 6(=CW) 𝑞) (𝑞. ) = )@
)@
if 𝑞. ≥ 𝐾.
II. In the first stage, firm 1 chooses 𝐾. depending on the equilibria that expects to be played in the second stage, 𝑞) (𝐾. ) and 𝑞. (𝐾. ).
𝒂6(𝒄C𝒓)
𝑲𝟏 < 𝑞.∗ ≡ 𝟑

𝑎 − (𝑐 + 𝑟) 𝑎 − (𝑐 + 𝑟)
𝑞. (𝐾. ) = 𝑞) (𝐾. ) =
3 3

(Little capacity)
𝒂6(𝒄C𝒓) 𝒂6𝒄C𝒓
𝟑
≤ 𝑲𝟏 ≤ 𝟑

𝑎 − 𝐾. − (𝑐 + 𝑟)
𝑞. (𝐾. ) = 𝐾. 𝑞) (𝐾. ) =
2

𝒂6𝒄C𝒓
𝑲𝟏 > 𝟑

𝑎−𝑐+𝑟 𝑎 − 𝑐 − 2𝑟
𝑞. (𝐾. ) = 𝑞) (𝐾. ) =
3 3

(Huge capacity)
 Assumptions:
- Linear transportation costs
- Same costs for firms
5 – Product differentiation
- Consumers uniformly distributed
Horizontal differentiation (Spatial): Consumers have different preferences about one attribute of the product.
HOTELLING (Linear City): reduce MC at the expense of a greater fixed cost, so firm can credibly commit to greater production. BACKWARD INDUCTION:
𝑣. − 𝑡𝑥 ) − 𝑝. if buys to 1
𝑢(𝑥) = q )
𝑣) − 𝑡(1 − 𝑥) − 𝑝) if buys to 2
I. SECOND STAGE (solving price equilibria once firms have chosen location: take as given that Firm 1 is located at 𝑎 and Firm 2 at 1 − 𝑏):
We assume 𝒂 ≤ 𝟏 − 𝒃 (Firm 1 always on the left of Firm 2). 0 1

Firm 1 = 𝒂 5 Firm 2 = 𝟏 − 𝒃
∗
(1) INDIFFERENT CONSUMER 𝒙 will be indifferent between buying to Firm 1 or 2 ® Equate transportation costs:
𝑣 − 𝑡(𝑎 − 𝑥 ∗ )) + 𝑝. = 𝑣 − 𝑡(1 − 𝑏 − 𝑥 ∗ )) + 𝑝)
(2) If we isolate 𝒙∗ we get the DEMAND FUNCTION for both firms:
1 − 𝑎 − 𝑏 𝑝) − 𝑝. + 𝑣. − 𝑣) 1 − 𝑎 − 𝑏 𝑝. − 𝑝) − 𝑣. + 𝑣)
𝐷. (𝑝. , 𝑝) ) = 𝒙∗ = 𝑎 + + , 𝐷) (𝑝. , 𝑝) ) = 1 − 𝑥 ∗ = 𝑏 + +
2 2𝑡(1 − 𝑎 − 𝑏) 2 2𝑡(1 − 𝑎 − 𝑏)
(3) Build the PROFIT FUNCTION (objective function) of both firms:
1 − 𝑎 − 𝑏 𝑝) − 𝑝. + 𝑣. − 𝑣) 1 − 𝑎 − 𝑏 𝑝. − 𝑝) − 𝑣. + 𝑣)
max (𝑎 + + ) (𝑝. − 𝑐. ) , max (𝑏 + + ) (𝑝) − 𝑐) )
5% 2 2𝑡(1 − 𝑎 − 𝑏) 5" 2 2𝑡(1 − 𝑎 − 𝑏)
\]
(4) Derive \5 % = 0 to get BEST RESPONSE functions by deriving [the professor skipped this step].
% If firms choose a symmetric
(5) Find the EQUILIBRIA PRICE and EQUILIBRIA PROFITS. .
strategy (𝑎 = 𝑏) ® 𝑥 ∗ = )
𝒂−𝒃 𝒃−𝒂
𝒑∗𝟏 = 𝒄𝟏 + 𝒕(𝟏 − 𝒂 − 𝒃) (𝟏 + ), 𝒑∗𝟐 = 𝒄𝟐 + 𝒕(𝟏 − 𝒂 − 𝒃) (𝟏 + ) If also have equal MC (𝑐. = 𝑐) )
𝟑 𝟑 ^
® 𝑝∗ = 𝑐 + 𝑡 and Π. = Π) = )
II. FIRST STAGE. Knowing the future equilibrium prices for an arbitrary location we look for the location:
(6) We must plug prices into the PROFIT FUNCTIONS, and everything will depend on the location.
1−𝑎−𝑏 1−𝑎−𝑏
Π. (𝑎, 𝑏) = 𝑡(𝑎 + 3 − 𝑏)) , Π) (𝑎, 𝑏) = 𝑡(𝑎 − 3 − 𝑏))
18 18
(7) Derive to get BEST RESPONSE fucntions:
max Π. (𝑎, 𝑏) = max Π. (𝑎, 𝑏; 𝑝.∗ (𝑎, 𝑏), 𝑝)∗ (𝑎, 𝑏))
? ?
(8) Find two LOCATIONS which are Nash equilibria (optimal taking as given what the other firm is doing).
Effects on derivation (maximum differentiation)
\_
If assumptions are fulfilled (linear transportation costs, linear problem…), we observe effects of ∆𝑎 with derivative \?% by applying the Chain rule:
𝝏𝚷𝟏 𝜕Π. 𝜕𝑝.∗ 𝜕Π. 𝝏𝒑∗𝟐 𝜕Π.
= + +
𝝏𝒂 𝜕𝑝. 𝜕𝑎
>?@?A 𝜕𝑝) 𝝏𝒂
>?@?A ‰
𝜕𝑎
Ignore Strategic effect Demand effect
(C)
>???????@??????
(–) ?A
Global effect
(–)
\_%
Derivation global effect < 0: effect of moving location closer to rival (∆𝑎) is negative ® Maximum differentiation: corner solution (we want 𝑎 = 0)
\?
\_ \5"∗
• Strategic effect N \5 % \?
O < 0: (negative because of more competition)
"
\_%
-
\5"
> 0 ® The higher the price of my rival, the higher my profits. (positive)
\5"∗
-
\?
< 0 ® If I increase 𝑎 ® Closer to rival ® Easier substitution ® More competition ® Lower prices ® Lower profit. (negative)
\_
• Direct / Demand effect N \?%O > 0 ® Closer to rival ® Indifferent consumer moves right too ® steal additional costumers from my rival. (positive)
Vertical differentiation (Quality): Consumers have the same ordinal preferences (of attributes), but not the same cardinal preferences (willingness to pay).
GABSZEWICZ & THISSE:
(1) A consumer buys from the second firm (high quality) if 𝜃𝑠. − 𝑝. ≤ 𝜃𝑠) − 𝑝)
Indifferent consumer: equate both cardinal preferences and isolate 𝜽∗ : 𝜃 ∗ 𝑠. − 𝑝. = 𝜃 ∗ 𝑠) − 𝑝)
𝒑𝟐 − 𝒑𝟏
𝜽∗ =
𝒔𝟐 − 𝒔𝟏
5" 65%
(2) Demand is the of marginal consumer 𝐹 N ( 6( O, since 𝑫𝟏 is those who have a lower willingness to pay (𝜃;) than cutoff 𝜃 ∗ (and 𝑫𝟐 : 𝜃̅ is higher than 𝜃 ∗ )
" %
1 𝑝) − 𝑝. 1 𝑝) − 𝑝.
𝑫𝟏 (𝒑𝟏 , 𝒑𝟐 ) = N − 𝜃O , 𝑫𝟐 (𝒑𝟏 , 𝒑𝟐 ) = N𝜃̅ − O
𝜃̅ − 𝜃 ∆𝑠 𝜃̅ − 𝜃 ∆𝑠
.
𝜃̅ − 𝜃 is length of the interval ® st6s can be simplified because the length is 1. || Since 𝑠! are exogenous parameters ® ∆𝑠: Premium of quality.
(3) We add the markup and get profits maximization problems:
1 𝑝) − 𝑝. 1 𝑝) − 𝑝.
max N − 𝜃O (𝑝. − 𝑐), max N𝜃̅ − O (𝑝) − 𝑐)
5% 𝜃̅ − 𝜃 ∆𝑠 5" 𝜃̅ − 𝜃 ∆𝑠

\u
(4) FOC ® best reaction function (deriving \5% = 0):
%
𝑝) + 𝑐 − 𝜃∆𝑠 𝑝. + 𝑐 + 𝜃̅∆𝑠
𝑝. (𝑝) ) = , 𝑝) (𝑝. ) =
2 2
® They are strategic complements because they have a positive slope (the higher the price of my rival, the higher my price).
® The higher the Premium of quality (∆𝑠), the higher the price of the first firm, and the lower the price of the second firm.
(5) Nash Equilibrium (equilibrium prices) by plugging 𝑝. into 𝑝) ® Assumption (𝑝.∗ > 𝑐) to guarantee Firm 1 participation is fulfilled since markup is positive.
𝜃̅ − 2𝜃 𝜃̅ − 2𝜃
𝑝.∗ = 𝑐 + ∆𝑠 , 𝑝)∗ = 𝑐 + ∆𝑠
>??@?
3 ?A >??@?
3 ?A
0?Wvw5 0?Wvw5
(6) Demands:
𝜃̅ − 2𝜃 2𝜃̅ − 𝜃
𝐷.= = , < 𝐷)= =
3(𝜃̅ − 𝜃) 3(𝜃̅ − 𝜃)
(7) Profits functions
𝜃̅ − 2𝜃 2𝜃̅ − 𝜃
𝜋.= = ∆𝑠, < 𝜋)= = ∆𝑠
9 9
® Premium of quality ∆𝑠: the more differentiated the firms are, the better profit for both (strategic complements: both increase prices)
 6 – Entry STRUCTURAL barriers to entry:
DIXIT (excess of capacity): ® 𝑞) is equivalent to 𝐾) if 𝑐 = 0. BACKWARD INDUCTION: - Incumbent’s control of essential resources.
I. In THIRD STAGE, Firm 2 (Entrant) chooses 𝑞) (or equivalently 𝐾) if 𝑐 is 0). ® Solution of STACKELBERG - Economies of scale and scope.
(1) Inverse demand: 𝑃 = 𝑎 − 𝑏𝑄 - Marketing advantage of incumbency
(2) Profits of entrant (maximization) ® 𝑚𝑎𝑥 (𝑎 − 𝑏(𝑞. + 𝑞) ) − 𝑐)𝑞) − 𝑬 = 0 - Trade restrictions
""
Entry Deterring STRATEGIES
(3) Best response of entrant: - Limit Pricing (BESANKO)
?6@" 6=
𝑞) (𝑞. ) = )@% - Predatory Pricing
(4) We get STACKELBERG equilibrium solutions: - Excess of Capacity (DIXIT)
𝑎−𝑐 (𝑎 − 𝑐)) ∗ 𝑎−𝑐 (𝑎 − 𝑐)) - Product Proliferation (cereals)
𝒒∗𝟐 = , 𝜋)∗ = − 𝑬, 𝒒𝒎
𝟏 = 𝑞 = , 𝜋.
∗
= - Contracts and bundling (aspartame)
4𝑏 16𝑏 . 2𝑏 8𝑏
II. In SECOND STAGE, Firm 2 (Entrant) chooses whether to enter or not (and incurring in this entry cost 𝑬):
?6@"%0 6=
(5) Calculate critical level of production of Incumbent (𝑞.y ) that makes profit of entrant equal to 0 by replacing BR2 𝑞)∗ (𝑞.y ) = ’ )@
“ we get:
𝑎− 𝑏𝑞.y −𝑐 𝑎− 𝑏𝑞.y −𝑐
”𝑎 − 𝑏 ”𝑞.y + • –— − 𝑐— • –− 𝑬=0
2𝑏 2𝑏
𝒒𝟏
𝒂 − 𝒄 − 𝟐√𝒃𝑬
𝑞.y =
𝒃 𝒒𝒅𝟏 (𝐸)
III. In FIRST STAGE, for Firm 1 (Incumbent) to deter the entry will be optimal if: 𝜋.0 9𝑞.y : > 𝜋.∗
𝒂 − 𝒄 − 𝟐√𝒃𝑬 𝒂 − 𝒄 − 𝟐√𝒃𝑬 (𝑎 − 𝑐)) 𝒎
𝒒𝟏 =
𝑎−𝑐
”𝑎 − 𝑏 • – − 𝑐— • –> 2𝑏
𝒃 𝒃 8𝑏
2√𝑬𝒅 9𝑎 − 𝑐 − 2√𝒃𝑬𝒅 : (𝑎 − 𝑐))
− = 0 → isolate 𝑬𝒅
√𝑏 8𝑏
Accomodated Deterred Blockaded
Type of entry: 𝒅 (𝑎 − 𝑐)%
𝑬
𝑬 𝜋%∗ =
𝒅
• ACCOMODATED if 𝑬 < 𝑬 16𝑏

?6= (?6=)" ?6= (?6=)"

- Play STACKELBERG: Incumbent will set 𝒒∗𝟏 = )@
(and get 𝜋.∗ = {@
), and Entrant will set 𝑞)∗ = M@
(and get 𝜋)∗ = .|@
).
(?6=)"
• DETERRED if 𝑬𝒅 < 𝑬 ≤ 𝜋)∗ ≡ .|@
𝒂6𝒄6𝟐√𝒃𝑬 )€𝑬𝒅 T?6=6)€@𝑬𝒅 U
- Incumbent will choose minimum critical level of production to deter the entry: 𝑞.y (𝐸) = 𝒃
(and get 𝜋.0 (𝐸) = .
√@
(?6=)" (?6=)"
• BLOCKED if 𝜋)∗ ≡ .|@
< 𝑬 ® The entry cost for which the entry is blockaded is 𝜋)∗ = .|@
.
?6= (?6=)"
- Incumbent doesn’t need to change the STACKELBERG monopoly strategy 𝒒𝒎
𝟏 = )@
(and get 𝜋.∗ = {@
).
BESANKO (Limit pricing):
 7 – Collusion
BERTRAND collusion
_2 _3
+
≈ Π4•‚‚w(!•B (Half of monopoly profit) 𝜋,2 Π8 ≈ Π8ƒ„!?^!•B (All the competitive profit) 𝜋8 +
≈ ΠP•(^6yƒ„!?^!•B (Half of competitive profit) 𝜋4

Present value of Collusion / Cooperate (following the Grim strategy):

Π4 1 Π4 𝛿 𝟏 1 1
𝑃𝑉4•‚‚w(!•B/4••5ƒW?^!•B = + = Π4 + Π4 = 𝚷𝑪 = Π4•‚‚w(!•B + Π4•‚‚w(!•B = Π
𝑁 𝑟 𝑁 1−𝛿 𝟏−𝜹 𝑟 1 − 𝛿 4•‚‚w(!•B
Present value of Deviation / Defeat:

1 Π8 𝜹 𝚷𝑫 1 𝛿
𝑃𝑉8ƒ‡ƒ?^/8ƒ„!?^!•B = Π8 + = 𝚷𝑫 + = Π8ƒ„!?^!•B + ΠP•(^6yƒ„!?^!•B = Π8ƒ„!?^!•B + Π
𝑟 𝑁 𝟏−𝜹 𝑵 𝑟 1 − 𝛿 P•(^6yƒ„!?^!•B
𝟏 𝜹 𝚷
In Nash equilibrium, firms collude (cooperate) if 𝟏−𝜹 𝚷𝑪 ≥ 𝚷𝑫 + 𝟏−𝜹 𝑵𝑫
EFFECTS on collusion:
𝟏 𝜹 𝚷𝑫
𝚷 > 𝚷𝑫 + - More Concentration® more collusion.
𝟏−𝜹 𝑪 𝟏−𝜹 𝑵
- More time between periods ® Less Reaction speed ® more collusion
- Less Asymmetries ® more collusion
Infinitely repeated COURNOT duopoly:
. ?6= -
• When both firms produce 𝑞,2 = ) )@ (each the half of the monopoly quantities) each firm’s profits are the half of monopoly:
1 (𝑎 − 𝑐)) (𝑎 − 𝑐))
𝜋,2 ≔ =
2 4𝑏 8𝑏
?6=
• When both firms produce 𝑞4 = H@ each firm’s profits are COURNOT profits:
(𝑎 − 𝑐))
𝜋4 ≔
9𝑏
-()
?6@• Ž6= H(?6=)
• Optimal Deviation: When one firm produces 𝑞,2 (half of monopoly quantity) ® best response of other is produce 𝑞8 = )@
5.
= {
with profit:
9(𝑎 − 𝑐))
𝜋8 ≔
64𝑏
(𝑎 − 𝑐 )) )
(𝑎 − 𝑐 ))
8𝑏 9(𝑎 − 𝑐) 9𝑏 𝟗
≥ +𝛿 → 𝜹∗ =
1−𝛿 64𝑏 1−𝛿 𝟏𝟕
L
If 𝛿 > .• ® Strategy is SPNE, so there is collusion
L L6•‘
If 𝛿 < .• ® The mínimum production level that can be sustained in a grim-trigger SPNE is 𝑞∗ = 𝑞∗ (𝛿) = H(L6‘) (𝑎 − 𝑐) . Lower profitability as second best.
MOTTA & POLO (Leniency) The lower 𝑓 (reduced penalty for “xivatos”) ® the more likely is collusion (since anticipate the reduced penalty if they go to anti-trust).
 8 – Mergers
Horizontal mergers (effects)
MERGING PARTIES
1 OUTSIDERS (RIVALS) CONSUMERS
𝜋)&H − (𝜋) + 𝜋H ) ) )
) ?C= ' 6)= ?6= ) ?C= ' 6)= ?6= )
?C=6)= ' ?6= ) 𝜋.1 − 𝜋. = N O −N O 𝜋.1 − 𝜋. = N O −N O
= 2𝐹 − 𝐹 1 + N H
O − 2N M
O H M H M

𝒂 − 𝒄 < 𝒂 + 𝒄 − 𝟐𝒄1 𝒂 − 𝒄 > 𝒂 + 𝒄1 − 𝟐𝒄 𝟏

𝒂 − 𝒄 > 𝒂 − 𝒄1 + 𝒄
Positive: Lower costs (if synergies) More efficient merging party 𝟐
Marginal cost savings Lower cost ® lower prices (if synergies)
® Lower cost for merging
Neutral effect if NO synergies ® Lower profits for outsider (“+𝑐 1 ”). NO reduction on prices if NO synergies
𝒏1 𝒏
Higher Market power 𝒏 > 𝒏1 𝒏 > 𝒏1 1
<
𝒏 +𝟏 𝒏+𝟏
Fixed cost savings 𝟐𝑭 > 𝑭1
2>1
Exit
Less incentives to produce profit 𝜋

Effects without cost

synergies (𝑐 1 = 𝑐; 𝑛𝑜 𝐹) Profits of merging parties DECREASE Profits of outsiders INCREASE Profits of consumers DECREASE
Only considering Market (because of exit: 2 quantities ® 1) (because higher individual quantity)
power and Exit
TOTAL quantity DECREASES