Profit Maximisation & Market Structure

Lecture Objectives:

1. Examine profit maximisation under perfect competition & oligopoly

2. Introduce game theory through an evaluation of oligopoly & duopoly

ALTERNATIVE MARKET STRUCTURES• Classifying markets by degree of competition

– number of firms– freedom of entry to industry– nature of product– nature of demand curve• Structure, Conduct & Performance (SCP)

PERFECT COMPETITION

• Assumptions– firms are price takers– freedom of entry– identical products– perfect knowledge

• Short-run equilibrium of the firm

O O

S

D

(a) (a) Industry Industry

P £

Pe

(b) (b) Firm Firm

ARD = AR= MR

Q (millions) Q (thousands)

Short-run equilibrium of industry and firm under perfect competition

O O

S

D

(a) (a) Industry Industry

P £

Q (millions)

Pe

(b) (b) Firm Firm

ARD = AR= MR

MC

Qe

Short-run equilibrium of industry and firm under perfect competition

Q (thousands)

O O

S

D

(a) (a) Industry Industry

P £

Q (millions)

Pe

(b) (b) Firm Firm

ARD = AR= MR

MC

Qe

AC

AC

Short-run equilibrium of industry and firm under perfect competition

Q (thousands)

O O

S

D

(a) (a) Industry Industry

P £

Q (millions)

Pe

(b) (b) Firm Firm

ARD = AR= MR

MC

Qe

AC

AC

Short-run equilibrium of industry and firm under perfect competition

Q (thousands)

S1

P1 AR1

Duopoly & Oligopoly

– barriers to entry (economic & strategic)

– interdependence of firms

– incentives to compete versus incentives to collude

Imperfect Competition

One – shot commercial game: UK Motor Industry

Ford UKPrice cut Aggressive Adverts

FIAT Price cut 60, 40 75, 25

Aggressive Adverts 50, 50 65, 35

Ford should cut price Rover should cut price Dominant strategy game Zero – sum game

Duopoly & Game Theory: Non-collusion

Iterated Commercial Game: Business Joint Venture

Co-operate Defect

Co - operate

Defect

UK

CHINA3 , 3

5 , 0

0 , 5

1, 1

Permanent co-operation = highest return ‘Tit – for – tat’ = return of 2.5 Range of other strategies = All D; Random; Tit – for –two –tats Axelrod (1984) found Tit-for-tat the winning strategy

Reading:Begg, D. et al, (2008), Economics, 9th Ed., Chpts. 8 & 9Cook, M. and Farquarson, C., (1998), Business Economics,Chpt. 9 Dixit, A. and Nalebuff, B., (1991), Thinking Strategically,(various chapters).Douma, S. and Schreuder, H., (2002) Economic Approaches to Organisations, 3nd Ed., Chpt. 5Griffiths, A. & Wall, S. (2005), Economics for Business &Management, Chapter 6

Film Reference:“A Beautiful Mind”, (2002), Dreamworks & Universal Pictures, featuring Russell Crowe