Rules of thumb models.

a. Average cost pricing (AC) Price = AC + mark up.

b. Price benchmarks. Tradition for sellers to charge the prices according to trademarks.

b. Non – collusion models. No agreement.

i. Kinked D-curve. Assumptions:

1. there is a certain market price.

2. if a firm increases its price and sets it above the market level, the rival will not follow suit.

3. if a firm decreases its price, the rivals will follow suit.

a. There will be 2 different D curves which correspond to assumptions 2 and 3.

b. The final D-curve consists of parts of 2 curves.

c. D-curve makes a kink. Different Elast in different parts of the curve. Each point has MR-curve of its own. There is a gap between MR-curves.

d. The idea of the model is to show that in oligopolistic markets there is certain price stability because price competition is very costly and not efficient.

e. Price stability is not absolute, to a certain extent stability if MC intersects MR in [a;b] à Pe;Qe will not change. If outside [a;b] à will change.

ii. Game theory. 1944 Veumann, Morgenstern. Assumes that we and the firms are players. There are rules and players can not collude. Outcome depends on the matrix of pay-offs: penalties and prices.

B choices
A choices		Not confess	confess
Not confess	A: 1 year B: 1 year	A: 10 years B: free
confess	A: free B: 10 years	A: 5 years B: 5 years

1. A maximin strategy (pessimistic approach). Assumes that the expectation will do the worst thing for the person in question. EX:

a. person A analyses the strategy to confess and sees that if B confesses A will get either 10 or 5 years.

b. If he expects B not to confess A will have 1 year or be free.

c. Of 2 bad outcomes A chooses the best – 5 years – to confess

d. The same for B – the least bad – 5 years.

e. They are in lower right corner.

2. Maximax strategy (optimistic approach). EX:

a. A expects that B will do the best possible thing for A.

b. They meet once more in the same corner.

c. Given the behavior of the rival the person can do no better.

d. Hash equilibrium (low-right corner).

Cournot model / duopoly (2 firms in industry) 1830s.

We assume that 2 firms are identical and can’t collude.

Initially there is only 1 firm in the market and a new one enters. The new one decreases the price => it sells a certain output.

The existing firm takes these price and output as given and the only thing it can do is to ↓ price and output. The new firm in turn ↓ price again and ↑ output. The old firm again takes it as given and ↓ output.

New firm à aggressive style, old one retreats. Equilibrium à when both firms have equal market share – Cournot equilibrium.

§ Reaction function – the set of tangent (optimal) points.

§ Isoprofit curve – shows all the combinations of the 2 firms that yield the same level of profit to one of the firms.

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