Kap 0-9

Industrial Organization
9. Market power
2021/22, 1st Semester
Margarida Catalão Lopes

Market power
• Market power = capacity to set (and
mantain) price above marginal cost, which is
the level that would prevail under
competition.
• Danger: abuse of dominant position
• Lack of competition opens the door to
beneficial public intervention.
2
How do you measure market power?
What is the Lerner index?
Market power
• The degree of market power depends on
– demand elasticity
– market concentration
– how collusive is firms’ behavior
• Market power is measured by the Lerner

index: L=(P-MC)/P Lerner index = (pris - MC) / pris
3
Market power
“When a firm has market power, how will it
behave? How does its behavior affect the
firm’s suppliers, customers, and
competitors?”
(Extracted from: Scientific Background on the Sveriges Riksbank Prize in
Economic Sciences in Memory of Alfred Nobel 2014, JEAN TIROLE:
MARKET POWER AND REGULATION)
4
Market power
• For a monopolist with a single good,
Lerner index
L=1/e
• A monopolist with n goods chooses pi (i=1,2,…n) to
maximize
where p is a price vector.

FOC:
If total cost can be split into n costs,

5
Market power
After some algebraic manipulation we get
𝑝𝑖 −𝑐𝑖 1 𝑝𝑗 −𝑐𝑗 𝐷𝑗 𝜀𝑖𝑗
Li= = + σ𝑗≠𝑖
𝑝𝑖 𝜀𝑖𝑖 𝑅𝑖 𝜀𝑖𝑖
where eii is the (absolute value of the) direct
price elasticity, eij is the cross-price elasticity, 𝑐𝑗
is the marginal cost of producing good j, and
Ri=piDi (revenue associated with good i)
Lender Index (L) = (pris- MC)*mengde*cross-price elasticity/(pris*mengde*priselastistitet)
cross-price elasticity: Q’(d)*pris/Q
priselastisitet:
(endring i mengde / snittmengde) / (endring i pris / snittpris) (med absolutttegn, så alltid positiv)
6
Market power
• Interpretation: cross-price elasticity er positiv for subsitutter
– if the monopolist is selling substitutes (eij>0), the

Lerner index for good i is above the value for the case
in which the monopolist is selling just one good,
because by raising the price of i’s product the
monopolist sells more in the other markets;
cross-price elasticity er negativ for complimenter
– if the monopolist is selling complements (eij <0), the
Lerner index for good i is below the value for the case
in which the monopolist is selling just one good,
because by raising the price of i’s product it sells less
also in the other markets.
• Now comment on the effect of 𝑅𝑖 , 𝑝𝑗 − 𝑐𝑗 and 𝐷𝑗
skjønte ikke helt dette..
7
Market power
• The Lerner index of market power (Cowling-
Waterson formula), valid for any market structure:
L=H(1+g)/e
• It is clear from the formula that the degree of

market power depends on demand elasticity, market
concentration, and how collusive is firms’ behavior.
• The conjectural variation g: expectation of the rivals’

response to a change in the firm’s strategic variable.
8
Market power
• Value of g under several models:
VIKTIG! De ulike
– Bertrand: g= -1, hence L=0 Lerner Indexene for de
ulike markedsformene
– Cournot: g= 0, hence L=H/e
– Collusion: g= N-1, hence L=NH/e
– Monopoly: H=1, g= 0, hence L=1/e
• Other values for g: as g decreases (increases),

competition is intensified (softened).
Under collusion, L = N*H/demand elasticity, der N =
• 0≤ L ≤1/e number of firms originally and H = Herfindahl index
orginally, & demand elasticity have to be calculated again,
putting MC = MR, and finding elasticity = Q’(p) * (pris/
mengde)
9
Market power
L=H(1+g)/e
• All other things equal (ceteris paribus), the

greater the concentration (as measured by H),
the greater the market power.
• Ceteris paribus, the higher the demand elasticity,

the lower the market power.
10
8. Product differentiation

Product differentiation
• As we have seen, pricing strategies are a way of
using market power. Differentiation is a way of
achieving it.
2
What kind of differentiation are u doing, if you offer another quality level tha your rivals?
What is Horizontal differentation?
• Vertical differentiation: through quality. It’s an
objective criterion. All consumers agree that more
of this characteristic is better.
• Horizontal differentiation: through preferences
and through consumer perception (the role of
advertising). It’s a subjective criterion.
• Through differentiation firms choose their
location in the product space.
8.1. Explain why some firms prefer to sell low quality products instead of approaching their
quality to the rivals’.
Solution: It is a way of vertical product differentiation, which eases price competition and
may render higher profits than if companies offer similar quality levels. If quality levels are
similar, the good becomes homogeneous and price competition is more intense. We are back
to the Bertrand model, with zero economic profits. 3
(Monopolistic competition)
• Main types of differentiation:
– Physical: size, design, color, shape, performance.
Example: consumer electronics
– Marketing: packaging, placing in the stores,
branding, … Example: breakfast cereals
– Human capital: differences through the skill of
employees, distinctive uniforms, … Example:
reputed cooker, Michelin stars
– Distribution: mail order, internet shopping...
• Product differentiation allows sellers to
increase price without the substantial sales
loss that would occur if the product was
homogeneous.
• Differentiation helps solving the Bertrand
paradox. Other solutions: switching costs;
search costs and uninformed consumers
(advertising prices increases price
competition); capacity restrictions.
• Differentiation grants market power.
Bertrand model: price competition with homegeneous good. The reason
price competition often doesnt drives firms’ profits down to zero even
if there are only two competitors in the market, like Bertrand theories
implies, is product differentation (& dynamaic competition & capacity constraints) 5
Vertical differentiation
through quality.It’san objective criterion. All consumers agree that
more of this characteristic is better.
• uinytte
=bvi-pi
The utility derived from consuming one unit of product i depends on i’s quality vi, on
its price pi, and on quality valuation given by b>0.
• All consumers agree that more quality is better than
less, but some consumers are willing to pay more for
quality than others. There’s a distribution function for
parameter b, possibly related with household income
and other consumer characteristics.
• Unlike in the Bertrand model, it is not enough to price
lower than the rival to gel all the demand.
• Consumers who value quality most are more sensitive
to quality changes than consumers who don’t value
quality as much.
6
Vertical differentiation
• Optimal quality level choice (product vertical
positioning): it is not certain that by increasing
quality a firm increases its profit, because
equilibrium price will also change.
• If a low-quality firm approaches its quality level
to the one of the high-quality supplier, price
competition will become more intense, and
profits may go down. When this happens,
vertical differentiation is softened and we
approach the Bertrand model, with lower profits.
7
Horizontal product differentiation and through preferences and through
Hotelling model consumer perception (the role of

advertising). It’s a subjective
criterion.
• Spatial location model, which can also be seen as
location in the varieties space. This is horizontal
product differentiation
• See location as product characteristics: color, acidity,
schedule, …
• Consumers have different preferences as to these
characteristics
(American mathematical statistician

and economic theorist, 1895-1973)
8
Horizontal product differentiation and
Hotelling model
• The original model is of spatial location: firms
compete along a straight line (suppose a street or
a beach with homogeneous ice-cream vendors,
differentiated through location). Consumers
choose based on price and location.
• Generalizing, consumer’s location corresponds to
his/her valuation of the product’s characteristics
and paying “transportation costs” corresponds to
buying a variety that does not exactly match the
consumer’s preferences.
9
Hotelling model
• Two important results:
– if prices are fixed and firms compete in location,
they will locate quite close, and close to the center
in order to maximize the number of clients (low
differentiation)
– if firms compete in prices after choosing their
location (i.e., their product characteristics), they
choose location in order to differentiate the most
(that is, they locate at the extremes of the street or
of the beach) “When prices cannot be adjusted, firms will tend to offer products with similar
characteristics”. True or false?
True. Differentiation is minimum in order to capture more demand (in the Hoteling
model’s terminology, firms would all locate in the middle of the straight line). Since
there is no other competing variable (price) to compensate for the loss of customers
10
that prefer the rival’s product characeristics, firm prefer to share the rival’s product
characteristics.
Hotelling model
• Unlike in the Bertrand model it is not enough
to price lower than the rival to capture all
market demand (as in vertical differentiation).
• The greater the degree of product
differentiation, the greater the market power
(as in vertical differentiation).
11
Hotelling model
• Product positioning:
– the closer firm 1 is to firm 2, the greater its
demand: direct effect of product positioning
– however, the closer firms are, the more intense is
price competition: the strategic effect of product
positioning makes firms locate far apart (high
differentiation)
• Locating close (low differentiation) or far
apart (high differentiation) thus depends on
the intensity of price competition: if price
competition is intense (weak), differentiate
much (don’t differentiate much)
12
Switching costs
• Introducing switching costs is an artificial way
of differentiating.
• Suppose a market composed by L consumers
with unitary demand, which value the good at
most U. Changing supplier implies a switching
cost equal to v. There are n firms, with unitary
and marginal production cost equal to c.
• Each consumer is willing to pay at most U, or
U-v in case he changes supplier.
13
Switching costs
• Suppose each i firm is charging Pi=U (collusive
equilibrium), so it is making profit=(U-c)L/n.
• If a firm decreases its price, its profits increase to
(U-v-c)L, so it is worth to decrease price if and only
if (U-v-c)L>(U-c)L/n, which is equivalent to
𝑛−1
𝑣 < (𝑈 − 𝑐)
𝑛
• Firms have an incentive to decrease the switching
cost for their own product and increase the
switching cost for the rivals’ products. Examples?
14
Switching costs
• Hence, the collusive equilibrium subsists for
sufficiently high switching costs (lack of
competition).
• Note also: the collusive equilibrium (with no
price differentiation) is also easier to sustain the
lower U, the higher c and the lower n. Intuition?
• Setting a switching cost different from the rivals’

is a way of differentiating.
15
Switching costs or search costs?
Switching costs are often pointed out as a reason for

brand loyalty.
Another possible explanation is that consumers possess
incomplete information about their alternatives and
are faced with search costs.
16
Imperfect information and search costs
• Consider a setup similar to the one shown for

switching costs, but now applied to search costs.
• Suppose a market composed by L consumers with
unitary demand, which value a given
homogeneous good at most U. Consumers don’t
know which store is charging the lowest price.
Acquiring that information costs v. There are n
firms, with unitary and marginal production cost
equal to c.
17
• It can be shown that it is worth for a firm to
decrease price (non collusive equilibrium) if
and only if costs for consumers associated
with getting information about the selling
conditions of the existing firms are
sufficiently low. If they are higher than that,
the collusive equilibrium subsists.
• Note also: the collusive equilibrium (with no
price differentiation) is easier to sustain the
lower U, the higher c and the lower n, like in
the switching costs case.
18
Hidding information may help sustain high
prices, whereas public information may decrease
prices (ex: flight tickets acquired online).
However, hidding information about prices

also creates uncertainty on whether a decrease in
demand directed towards a given firm was simply
driven by a general demand contraction or by a
price cut by rivals, eventually originating a
subsequent “price war”.
19
20
21
22
Advertising
• Different categories of goods:
– search goods: their quality can be ascertained before purchase
(Ex: pc)
– experience goods: their quality can be ascertained upon
consumption (Ex: meal)
– credence goods: their quality cannot be ascertained, even after
purchase (Ex: in some cases, car repair services)
• Informative advertising (describe the product; fitted especially for

search goods)
versus
persuasive advertising (change consumers’
perceptions about the product’s value; fitted for
experience and credence goods)
23
Advertising
• Advertising as a signal of product quality.
Information spillovers when firms are
multiproduct.
• Advertising as an investment in brand equity.

• The value of a brand may explain the strategy
of umbrella branding (sell several products
under the same name)
24
Advertising intensity
• The Dorfman-Steiner condition (how a profit-maximizing
monopolist chooses its advertising level) explains why we
observe a higher advertising intensity in some industries (ex:
cars) than in others (ex: salt):
a/R=x/e
where x=demand elasticity to advertising, e =demand price
elasticity and a/R=ratio of advertising (a) to total sales (revenue
R).
The lower e, the larger the gain per additional unit sold
(because the larger the price-cost margin – recall formula). The
higher x, the more demand responds to increased advertising.
• Higher concentration implies that the firm benefits more from

each additional unit sold (higher price-cost margin) and from
the demand expansion effect of advertising.
advertising campaign price / total sales or revenue
= Demand Elasticity to advertising / demand price elasticity
Demand price elasticity = 25
(den deriverte av mengde funksjonen mhp pris * pris / mengde)
Advertising
• Advertising has a prisoners’ dilemma
nature: it would be better to cooperate in a
no-advertising solution, but then each one
has an incentive to break the agreement,
and all end up advertising.
26
Different pricing strategies:
- Non – linear pricing
- price discrimination (?, 1. Or 2. Or 3.)
selling more than on product that are complements/substitutes:
-Bundling
If the company should not ignore the interdependencies between prices in different moments of time:
-Penetration pricing (also if the firms sells complements, to prevent entry, the firm inteds to initially produce large quantities
in order to accumulate experience, which is relevant when there are strong experience economies or network economies)
-Price skimming
- Intertemporally price discriminate, “ lowest-price guarantee” (rent instead of selling)
- Prices with learning economies
- Cyclical demand fluctuations
7. Pricing strategies

EKSAMENSOPPGAVE:
*case*
Recommend a price strategy for this company
Pricing strategies
• Differentiation (to be addressed in the next chapter)
is a way of achieving market power. Pricing
strategies are a way of using market power.
• In a perfectly competitive market, the law of one

price prevails. If we observe different prices for the
same product, the market is not perfectly
competitive.
• Non-linear pricing: the average price paid per unit

delivered depends on the total size of the purchase.
avslag hvis du kjøper 3 glass istedenfor1
2
What is Nonlinear pricing, & what conditions must be fulfilled to do it?
Nonlinear pricing
• Nonlinear pricing may be a useful strategy for
competition (ex: offering quantity discounts)
• Nonlinear pricing can be used by a firm with
monopoly power to increase its profits.
• Preconditions for implementing nonlinear pricing:
– Have some monopoly power
– Limited or absent resale markets
– Seller can monitor customers’ purchases and has
disaggregated demand data
Disaggregated Data Disaggregated data is data that has been extrapolated (taken) from
aggregated data and divided and broken down into smaller information units.
Disaggregating data is another critical step to gaining increased knowledge from
collective or aggregated information. 3
Pricing strategies - Context
• There are many cases where companies do not sell all
units of the product at the same price (i.e., they don’t
practice uniform pricing).
Examples:
– Scientific journals: libraries and private
– Conferences: students/academics/professionals
– Cinemas : discounts for youth card holders; discounts on
Mondays; different prices for families
– Photocopies: discounts for students; discounts for a large
number of units
4
• Software: new customers and upgrades, academic versus
nonacademic
• Trains and buses: special discounts for seniors, under 23,
families, or on certain days of the week
• Airlines: significant discounts to travelers spending the night
from Saturday to Sunday at the destination; miles cards
(loyalty programs)
• Petrol stations: points cards
• Water: different unitary prices for different levels of
consumption
5
• Restaurants: menus, lunch / dinner
• Take-away: several discounts, depending on the food
combination; meals accumulation cards (ex: receive
one for free after purchasing 10)
• Cars: same brand and model, but different prices in
different countries
• Mobile phones: various packages
• Cable tv+net+phone (triple play)
• Clothes’ stores: sales
• Hypermarkets: cards and promotions
6
Price Discrimination
• Sometimes companies charge different prices for the same
product to different customers: this is price discrimination.
To be able to do this the firm must have some market
power.
• However, if a company charges different prices for the
same product to different customers, arbitrage is expected
to occur unless the company makes the products slightly
differentiated or sets some conditions that prevent
arbitrage. Arbitrage=possibility of resale
• Let us consider the simplest case of constant MC=AC
• Remember that in order to maximize profit the company
should choose the amount for which marginal revenue and
marginal cost equate.
7
• When it practices a single price, the company with market power
enjoys profit p, consumers have surplus CS and there is a welfare
loss area (WL) corresponding to the subsequent units that should
be traded because consumers value them more than it costs to
produce them.
• The company may try to increase its profits at the expense of CS
(selling the units that it already sells at a higher price) and of the
WL area (by selling more units).
CS
P1
P2
p WL
MC=AC
D
MR
Q1 Q2
8
• After selling Q1 there is a residual demand. If it is possible to
separate consumers who bought Q1 from those in the
residual demand, the company can additionally sell QT-Q1= Q2
at price P2 and get additional profit equal to area C. The total
profit is p = A + B + C > A + B.
• The idea is practicing lower prices for customers with lower
willingness to pay to be able to sell them and charging higher
prices to those who are most willing to pay.
P1
P2 A
B C
MC=AC
MR
D
MR R
Q1 QT
Q2 9
It is possible to increase p even more (at the expense of
CS) if P1 is set taking into account P2 (that is, maximizing
the sum of profits in each demand segment instead of in
each one separately). The sum of areas A, B and C is larger
than before. QT is lower and P1 and P2 are higher. (One can
show that the optimal P2 lies at 1/3 of the distance between
MC and the vertical demand intercept and the optimal P1
lies at 2/3).
P1
A
P2
B C
MC
Q1 QT
Q2
10
• The company may extend this reasoning to more than two
segments of D. In the limit, when each unit is sold at a different
price profit is maximum (it corresponds to the entire area
between the D curve and the cost) - this is perfect
discrimination (or 1st degree). Each customer pays its entire
valuation, so CS=0 (a different price for each consumer). Sales
terms are tailored to each individual customer.
p MC=AC
QT
11
• Price discrimination allows the seller to create
additional consumer surplus and to capture
existing consumer surplus.
• Testing for the existence of price discrimination:

compare the ratio of prices across markets with
the ratio of marginal costs. Ex: the same book in
hardback and paperback version - it’s not exactly
the same product, so should be priced differently,
but how differently?
12
• For the company to segment the market, it is necessary:
– that consumers with higher valuations can not buy at the
lowest prices (by pretending to have low valuation)
– that those who buy at the lowest prices can not resell to
those with higher valuations (arbitrage).
– identify buyers who value the product differently

(require presentation of student card, identity card to
prove age, etc., or supply different versions leading to
self-selection) and offer the good to each at the price
corresponding to his willingness to pay (price discrimination
by indicators vs price discrimination by self-selection)
13
• In short, to implement price discrimination it is
necessary:
– to identify buyers who value the product differently
(demand the student card or identity card to prove
age, etc.) and offer the good to each at a price
corresponding to his willingness to pay
– separate different groups of buyers, i.e., prevent
resale
• Price discrimination is commonly seen as unfair (although the

creation of new CS benefits consumers). This may prevent
firms that meet the above conditions from doing it (it hurts
reputation and brand image).
14
• It is easier to prevent services resale than goods resale
(services are not immediately consumed and some are
not marketable - exs: meal, haircut, show). Physical
impossibility of resale makes price discrimination more
frequent in services than in products. Ex: physical
impossibility of electricity resale for those who buy it at
lower prices (e.g., low-income consumers).
• The existence of transport costs also makes it difficult to

resell. The same for imperfect information about selling
conditions.
• Until now we have seen discrimination along the curve.

But there may also be discrimination between curves
(third-degree price discrimination).
15
• When there are different demands, it is easier to price
discriminate. Ex: when the company sells to different
countries.
• When markets have different demand elasticities, the
company sells at a higher price in the market with lower
elasticity (2) and affords there a greater margin. In this case
the company knows the aggregate demand for different
consumer groups and identifies to which group each
consumer belongs.
Market 1 Market 2
MC=AC MC=AC
D1
MR1
D2
MR2
16
Two-part tariff (second degree
discrimination)
• The implementation of price discrimination
may be difficult (select segments, prevent
resale) or even illegal.
• Another way for the company with market

power to appropriate consumer surplus and
the loss of social welfare is by setting a two-
part tariff.
17
• Two-part tariff = fixed part, independent
from the consumption level + variable part,
proportional to the amount consumed.
Price = fixed amount + amount that
varies with the quantity purchased
• Exs : electricity, water, gas, taxis, sports

clubs, some amusement parks , ...
18
• At the uniform price P1 the firm sells Q1, consumers pay B + C and
enjoy a surplus equal to A. The firm’s profit is area B.
P1
A
B
MC=AC
C D
MR
Q1
• But to buy Q1 consumers would be willing to pay A + B + C, so the

company can increase its profit by A if it charges a membership fee
(fixed part of the tariff ) equal to A and then sells the Q 1 units at price
P1. The company earns p = A + B.
19
• The firm can still increase profit if it is able to sell Q2 (quantity
for which P=MC). For Q2 consumers would be willing to pay
areas A+B+C+P+E and the company would profit = A+B+P.
P1
A
B P MC=AC
C E D
MR
Q1 Q2
• To accomplish this, the firm should set a two-part tariff with a fixed
part=A+B+P and variable part=MC. Customers will buy Q2.
20
• A two-part tariff consists of a positive fee plus a
variable fee that is lower than the monopoly
price.
• A two-part tariff allows the company to
appropriate the entire consumer surplus, but
implies some risks:
– if D is overestimated, the company does not sell
anything. Therefore, the company should be
more conservative in estimating demand;
– if D is heterogeneous (some above average,
some below), the company sells only to those
above.
21
• If the company is able to identify and separate different
consumer types, it may set multiple two-part tariffs.
• The company may choose to offer a price menu and then

let consumers choose the one that suits best
(versioning). This practice is similar to offering different
levels of quality for the same product, with different
prices. Ex: gym tariffs that allow every day every hour
use, versus tariffs that only allow restricted use at some
hours.
• This practice is useful in situations of asymmetric

information regarding the type of consumer the company
faces, because it leads to consumer self-selection. It is
useful when the company knows individual demands of
each consumers group but is not able to identify the
group to which each consumer belongs (price discrimination
by indicators vs price discrimination by self-selection).
22
• Company's profits grow, as it is
approaching perfect price discrimination.
• This menu pricing may be implemented in

the two-part tariff by creating multiple
combinations of fixed and variable
components.
23
• Mathematically, participation constraints (that
groups want to buy) and incentive compatibility
constraints (that each group does not want to
pretend to be another one, buying a basket that
is not intended for him) are established.
• Low-valuation consumers get zero surplus, high-

valuation consumers get positive surplus, so
they don't pretend to be low-valuation (those
who have a lower price). Quantity offered to
low-valuation consumers is distorted
downwards so that it does not compensate for
high-valuation consumers.
24
More on nonlinear pricing- Quantity
discounts
Ex: “pay 2, take 3”
• Quantity discounts may arise
– for cost-related reasons: scale economies/fixed
costs (ex: in order processing or simply in the
production process. The average cost is reduced,
which can compensate for the price reduction
associated with the quantity discount)
– for price discrimination and profit increasing
purposes
25
Quantity discounts - Heterogenous clients
There are different demands, but the firm is not able

to distinguish or separate them. So, offers a
quantity discount to price discriminate.
P1 and P2 are the optimal prices for

each demand. But the firm does not
know the type of client she is facing.
So, charge P1 and offer a discount to
P2 if the client buys at least Q2. Only
consumers belonging to demand 2
want to benefit from this quantity
MC discount, so the company is now able
to implement price discrimination.
26
Quantity discounts - Homogeneous clients
P1 is the optimal price. Decrease it
to P2 if the client buys at least Q2.
Consumers accept if B + adjacent
triangle>E (CS increases). Profit
increases if C+E>B.
This profit expansion is due to
consumers’ options being
restricted, that is, they are forced
to buy Q2 when for a price of P2
MC they would prefer a quantity
between Q1 and Q2 (but this would
decrease the firm’s profit).
27
Setting prices for substitutes or
complements
• If the company sells more than one product
and they are complements or substitutes, the
price of one affects the other’s consumption
and therefore the profit that the company
obtains in that other market. The company
must take this effect into account when
setting the price of each product. Demands
are interdependent.
28
• Bundling: combining several products or services
into one package for an all-inclusive reduced price
– Ex: cable TV; Microsoft Office
– Pure bundling: buy the entire bundle or nothing
– Bundling: consumers have the choice to purchase the
bundle or separate parts of it
• This practice is related with asymmetric valuations

of the different goods included in the bundle. It
can also be used as a self-selection mechanism
• Although the items are sold for discounted prices,
bundling can increase profits because it promotes
the purchase of more items
29
• Set the bundle price equal to the lowest sum of
individual valuations. All types will buy (for the high
valuation consumers the bundle will be cheaper than
purchasing the components separately).
Ex of valuations:
consumer A consumer B
pizza 10 8
beverage 6 9
The bundle (or basket) price should be=16. The firm earns 16x2=32.
Selling separately the pizza at price 10 and the beverage at price 9, the
company only sells one pizza and one beverage and earns 19<32.
If the company sets the pizza at price 8 and the beverage at price 6, it
sells two pizzas and two beverages and earns 16+12=28<32.
30
• Usually, complementarity leads to a lower
price than what would maximize the profit on
the product (1) whose consumption increases
the other’s consumption (2).
• The stronger the impact of P1 over market 2

and the smaller the dimension of market 1
(less important for the firm’s total profits), the
lower the margin in market 1 will be. The firm
may even opt for a negative margin (P<MC) in
market 1. Ex: free drinks in buying a pizza
31
• When goods are substitutes, the analysis is similar
to the complements case, but the effect has the
opposite sign: dQi/dPj>0
• Exs: cars of the same brand but in a different range;
cars of the same model (3, 4, 5 door and van)
• Now the reciprocity of the effect can not be
ignored.
• Since by increasing the price of its goods the
company causes an increase in quantity demanded
of other goods which it also sells, the optimal price
for each will be higher than it would be if there
were no interdependence (that is, if demand would
move to other companies, or if consumers would
simply stop purchasing this good).
32
Prices over time
• In many cases the company should not

ignore the interdependencies between
prices in different moments in time.
33
When should penetration pricing be used?
• Penetration pricing: start with a low price when launching the

product (or even give samples, which corresponds to zero
price) to induce consumers to try the product (this is relevant
for experience goods, for ex.); then gradually increase price.
This type of pricing is important for instance when there are
network economies. The intention is to rapidly reach a wide
fraction of the market and initiate word of mouth.
• Other reasons:
– the firm sells complements
– prevent entry
– the firm intends to initially produce large quantities in order to
accumulate experience, which is relevant when there are strong
experience economies or network economies
34
When should Price skimming be used? What are the problem that can occur, & the price strategy that can solve this problem?
• Price skimming: start with a high price and sell

initially only to customers who value the product
most; then reduce price to cover more market. It
allows to extract more surplus from consumers
with high valuations (the impatient). E.g.,
launching prices for mobile phones and other
technologies (iPhone, ...)
– Problem: in the case of durable goods, consumers may
decide to wait (strategic purchase delay) and hence it may
be better for the company to commit not to
intertemporally price discriminate (this is known as the
“Coase conjecture” or the “durable goods curse” - the
monopolist becomes his own worst enemy). Solutions:
offer a “lowest-price guarantee”; rent the good instead of
selling it; introduce some differentiation characteristic
across time
35
Nondurable goods: a demand flow is needed (ex:
groceries, bus travels, …);
Durable goods: purchase can be delayed (ex: car, pc,
fridge, …)
• Prices with learning economies: price goes down

as the company acquires experience in
producing the good (and AC decreases).
36
• Cyclical demand fluctuations: there are products
whose consumption is seasonal, but whose
production can not be accumulated in the low
season to meet the demand of the high season.
Mainly services.
Exs: hotels, electricity consumption throughout the day,
water consumption on vacation in summer places, public
transport at rush hour.
The decision of the capacity to be installed has to do

with high season demand.
37
• Limits of price discrimination: why not always
perfectly price discriminate or segment the
market more and more?
– it may be too expensive to gather data about each
submarket (in the limit each client is a submarket), as
compared with the gain expected
– submarkets may have very similar market elasticities,
so it’s not worth to set different prices
– if submarkets are geographically close, arbitrage may
be easy
38
• Big data processing facilitates perfect price
discrimination (ex: use of cookies). In the pre-
internet era market segmentation was mainly
based on geographic or demographic indicators;
in the digital era, sellers gather much more
information about individual customers that
allows them to know consumers’ preferences and
valuations and hence price discriminate.
Transform data into valuable information.
• Worries about data protection.
39
Price discrimination and efficiency
• Price discrimination may increase efficiency
because more units are traded. It may even be a
Pareto improvement if consumers and firms are
both made better off.
• But it may also decrease efficiency if the costs
associated exceed the global net gains for firms
and consumers.
• Some studies show that consumers dislike more
paying a higher price than the other purchasers,
than they like paying a lower price (so price
discrimination may hurt the firm’s reputation).
40
Price discrimination and law
• Public policy towards price discrimination does not
take into account efficiency considerations.
• The concern has been mainly about competition and
the possibility that price discrimination represents an
abuse of dominant position (Article 102 of the Treaty
of Rome).
Such abuse may consist in:
(a) directly or indirectly imposing unfair purchase or selling prices or
other unfair trading conditions
(b) …
(c) applying dissimilar conditions to equivalent transactions with other
trading parties, thereby placing them at a competitive
disadvantage
(d) …
41
42
https://www.concorrencia.pt/en/articles/call-information-digital-ecosystems-big-data-and-algorithms
43
4. Dominant firm and monopolistic

competition

What is the difference between Dominant firm and Monopoly?
Dominant firm
• Market composed by a dominant firm, which
is price-maker, plus a fringe of competitive
firms, which are price-takers and follow the
price set by the dominant
så forskjellen på dominant firma & monopoly er at selv om det dominante firmaet sitter på en stor del av markedet
og bestemmer markedprisen, finnes det fortsatt mindre firmaer som må forholde seg til denne satte prisen.
I monopoly er det fravær av andre konkurransedrevede firmaer
2
Dominant firm
What are possible reasons for emergence of dominant firms?
- lavere produksjonskostnader for store volum
- vanskelig å entre markedet (barrierer)
- nettverksøkonomi (bedre for brukerne å være på samme plattform enn ulike, slik som IG :( )
• Pure monopolies are hard to find. But markets

with dominant companies are not so hard to find.
• Some possible reasons for the emergence of a
dominant firm: When more units of a good or service can be produced on a larger scale, yet
with (on average) fewer input costs, economies of scale are said to be
– scale economies achieved
– barriers to entry
– network economies (the benefit for each user is
increasing in the number of users)
altså at produktet eller prisen blir bedre når mange bruker samme produkt!
Eks facebook og instagram
3
Dominant firm
Examples:
Google
Microsoft (Windows)
4
Dominant firm
• Solve backwards.
• First step: solve the problem of the competitive
fringe (2nd stage of the game). Each firm
produces up to the point where P=MC, and then
we aggregate to obtain the supply of the
competitite fringe, Q=F(P) mengde = funksjon av prisen
• Second step (1st stage of the game): incorporate
the response of the fringe into the maximization
problem of the dominant firm and optimize
5
Dominant firm
• Max Profit=(P-MC)[D(p)-F(P)]-FC
FOC: [D(P)-F(P)]+(P-MC)[D’(P)-F’(P)]=0
which yields
(P-MC)/P=(1-sf)/(e+hsf)
mengde solgt for fringde
where sf=market share of the fringe q_cf / totalt mengde Q
e=elasticity of market demand mhp pris * pris ) / mengde = (…)*p / Q
= (den deriverte av mengdefunksjonen
h=elasticity of the supply of the fringe

= (den deriverte av mengdefunksjonen til cf * pris ) / mengde cf = (…) * p / q_cf
FOC=first order conditions

F(P)=supply of the competitive fringe
6
Dominant firm
• Under monopoly, the optimality condition is
(P-MC)/P=1/e
• Note that (1-sf)/(e+hsf)<1/e
• So we conclude that the existence of a competitive

fringe reduces the margin of the dominant firm.
This reduction is stronger the higher the market
share of the fringe, and the higher its supply
elasticity.
• The monopoly model is a good but not precise
approximation to the behaviour of dominant firms.
7
Price leadership (chapter 5)
Homogeneous good
Price
Market Demand, D(p)
Follower’s supply, S(p)
P1
Residual demand curve facing leader, R(p)
MR facing leader
P*
MC1 of Leader
q f * qD* qT* Quantity
8
Monopolistic competition
• Besides pure monopoly and dominant firm,
other market structures may give rise to
market power (that is, to P>MC):
- monopolistic competition
- and oligopoly
9
What characterises monopolistic competition?
• Characteristics: many firms, ease of entry and
exit, differentiated product
• Answers one of the main critiques to the
perfect competition model: product
homogeneity.
Joan Edward
Robinson Chamberlin
10
• Each firm produces a product that has unique
characteristics, and so attracts her own clientele.
Degree of market power of each firm depends on
her success in differentiating her product from
those of other firms.
• Because of product differentiation,
Hva
each firm is a
price maker and not a price taker, so the demand
she faces is not horizontal.
• Most industries are neither monopolies, nor
perfectly competitive. This model is a response to
this observation.
11
What are the 4 main ways for firms to differentiate themselves?
huskeregle: there ones was a very PHYSICAL person that trough MARKETING & DISTRIBUTION
of workout powders was seen as having big HUMAN CAPITAL
• Main types of differentiation:
– Physical: size, design, color, shape, performance.
Example: consumer electronics
– Marketing: packaging,Tekst
placing in the stores,
branding, … Example: breakfast cereals
– Human capital: differences through the skill of
employees, distinctive uniforms, … Example:
reputed cooker, Michelin stars
– Distribution: mail order, internet shopping...
12
• Common examples of monopolistic
competition (mainly retailing industries):
– Restaurants
IF economies of scales are showing (marginal cost (=the cost
– Hotels of producing one additional unit) descreased as the volume
of output increases. They have high fixed cost and low
– Hairdressing marginal cost, and the strong scale economies in book
publishing imply that the gap between price & marginal cost
– Doctors is particularly high.
– … bookstores
• Monopolistic competition partly explains the
survival of small firms.
13
• Admit each firm’s technology is described by a U-
shaped average cost curve (given, for example, by a
fixed cost, plus increasing MC)
• Each firm faces a downward sloping demand curve
(given the prices charged by the other firms). (Facing
a downward sloping demand curve means having
some market power.)
AC
The model shows that price-making, profit-maximizing behaviour is consistent with a zero-profit long-run equilibrium.
14
• Then in equilibrium each firm makes zero profits
(because of free entry and exit), i.e., just breaks-
even.
• The equilibrium quantity is lower than the efficient
scale. There is excess capacity.
• The difference between the equilibrium quantity
and the efficient scale is higher, the more
differentiation there is. Why?
• Inefficient production, but variety. Impact on
welfare?
15
• As product heterogeneity decreases, demand
faced by each firm becomes flatter (more
elastic) and we tend to the point where price
equals marginal cost.
16
5. Oligopoly

In which market form does it occur interaction/competition between the firms in, and what characterises this market form?
Oligopoly
In perfectly competitive markets firms do not interact
because each one is too small to exert any influence
on the market equilibrium. Firms can only take price
as given and then choose the production level.
• Neither does the monopolist firm interact: it sets

MC=MR and finds price and quantity.
• There exists interaction among firms when they are

few and of approximately the same size (that is, none
is dominant): oligopoly.
2
What is the outcome of competition in Oglipoly, & what does the outcome depend upon?
Oligopoly
• In oligopoly markets firms do compete. Equilibrium price and
quantity are the outcome of this interaction. When choosing
price or quantity each firm must take into account the impact
upon the rivals and how they are expected to react (a
strategic choice). The market equilibrium will depend on the
prevailing type of strategic interaction (more or less
cooperative) and so will profits and market power.
• Game Theory: a tool employed to analyze strategic

interaction and forecast the outcome. Players choose the
best available alternative, given the expectation they have
about what their rivals are doing (or will do).
3
Example – market for video
conferencing
“Zoom has had a tough few months as competitors such as Microsoft Teams and Google Meet have
tried to steal its crown in the video conferencing space. But now, Zoom is fighting back with a
bunch of game-changing features—one of which is rare in large scale video conferencing.
The first and possibly the biggest new feature is the availability of end-to-end encryption in Zoom.
This will be available as a technical preview from next week, allowing free and paying users to host
up to 200 people on an end-to-end encrypted video call.” (14 Oct 2020)
(https://www.forbes.com/sites/kateoflahertyuk/2020/10/14/zoom-beats-microsoft-teams-google-
meet-with-game-changing-new-features/#367394086cba)
4
Example – market for video
conferencing
Zoom is copying several features of Microsoft Teams
“Zoom today made several new announcements to make its video conferencing
platform more attractive among enterprise customers and consumers…. most of the
features announced by Zoom were recently released on Microsoft Teams.
… Most of the new features of Zoom seem to be inspired by Microsoft Teams
announcements in the past 6 months. It will be interesting to see how Microsoft
reacts to Zoom’s announcements.” (14 Oct 2020) (https://mspoweruser.com/zoom-
is-copying-microsoft-teams/)
5
6
7
Here u see different models to play with in Oglipoly, depening on your capacity
Which one do u chose if u have no capacity constrains & strong capacity lack?
Oligopoly
• The most common oligopoly models: - firms compete in providing quantity
- homogeneous products
Choose this one over Bertrand if you have strong capacity lack(cant adjust quantity or services / have production capacity)
– simultaneous choice of quantities – the Cournot model
- firms compete in giving best price
chose this if you easily can adjust quantity of services provided (No capacity constrains)
- homegeneous products
– simultaneous choice of prices – the Bertrand model
P = MC
– quantity leadership – Stackelberg model

choose this one if one company becomes the leader
– price leadership
– collusion
–…
8
Oligopoly
Find the equilibrium for your model de ulike modellene er beskrevet på forrige slide
• Equilibrium: point at which neither firm in the pursuit of

maximal profits wishes to change its own actions, given the
(re)actions that it supposes others will take if it changes its
own actions.
9
Choose this one over Bertrand if you have strong capacity lack
Cournot model
• Assumptions: firms compete in quantities
(capacities) in a market for a homogeneous
product. They make their choices
“simultaneously”. One-shot.
Strategies: quantities
Payoffs: profits
2 CRITICS AND ANSWERS FOR THEM
(1) firms normally choose prices, not quantities;
(1) If firms are capacity constrained, then price
competition “looks like" quantity competition. Antoine Augustin Cournot (1801-1877)
(2) firms don’t normally take their decisions French philosopher and mathematician
simultaneously.
(2) If there are significant information lags, then 10
sequential decisions “look like" simultaneous decisions.
Cournot model
• Let us start with duopoly.
• Consider two firms producing a

homogeneous product with output q1, q2,
respectively, so that aggregate output is
q1+ q2 = Q. Inverse demand is p(Q). Costs
are c1(q1) and c2(q2), respectively.
11
Cournot model
• Firm 1 maximizes p1 = p(q1 + q2).q1 - c1(q1)
Her quantity choice depends on the conjecture she makes about
what firm 2 will produce.
free of charge
• Given q2e, firm 1's F.O.C. is

p1/ q1= p(q1*+ q2e) + p’(q1*+ q2e).q1*- c1’(q1*) = 0
Solving this equation, one obtains firm 1’s best response to firm
2’s expected production: q1*(q2e). This is firm 1’s “reaction
function”.
12
Cournot model
• Similarly, one obtains firm 2’s reaction function: q2*(q1e).
• Each firm takes the quantity set by its competitors as a given,

evaluates its residual demand, and then behaves as a
monopoly.
• The equilibrium is a set of outputs (q1*, q2*) such that each

firm is maximizing her profit, and behaviors are consistent
with beliefs, so q1*=q1e and q2*=q2e.
13
Cournot model
• Example:
p = 52-2(q1 + q2) and constant AC=4 for each
firm.
p1 = [52 - 2(q1+ q2e)] q1 - 4q1
So F.O.C. is
p1/ q1= 52- 4q1- 2q2e - 4 = 0
and the reaction function is q1*=12-q2e/2
14
Cournot model
• Similarly, q2*=12-q1e/2
Let qi* = qie (i=1,2).

Then q1* = 12 - (12-q1*/2)/2, so q1*=8.
Hence, q2*=8
p=52-2(8+8)=20
p1=p2=20*8-4*8=128
15
Cournot model
Reaction functions will typically be downward sloping
when firms choose quantities (strategic substitutes): if one
firm increases output, the other finds it profitable to
decrease output, so that price is forced up.
16
Cournot model
q2 p=a-b(q1+q2), MC=c
(a-c)/b reaction curve of firm 1
stable Cournot
(a-c)/2b =QM
equilibrium and
convergence
(a-c)/3b=q2*
reaction curve of firm 2
QM q1
q1*
17
Cournot model
For the previous numerical example:
q2
Suppose marginal cost of firm 1
f1(q2) increases. Its reaction function
moves down. In the new
equilibrium 1 produces less and
2 produces more, total quantity
decreases and price increases.
12
8
f2(q1)
12 q1
8
18
Cournot
model
19
Cournot model
• Let us now try with n firms.
pi = p(Q). qi – ci(qi), i=1,2,…,n
FOC: p(Q)+p’(Q). qi* = c’i(qi*)
• Rearrange: 𝑝(𝑄) 1 +
𝑑𝑝 𝑞𝑖 ∗
= 𝑐𝑖 ′(𝑞𝑖 ∗)
𝑑𝑄 𝑝
𝑑𝑝 𝑄
si=qi/Q= firm i’s market share ⇔ 𝑝(𝑄) 1 + 𝑠𝑖 = 𝑐𝑖 ′(𝑞𝑖 ∗)
𝑑𝑄 𝑝
e=market demand elasticity 𝑠𝑖
⇔ 𝑝(𝑄) 1 − = 𝑐𝑖 ′(𝑞𝑖 ∗)
𝜀
20
Cournot model
• si = 1: monopoly.
• si close to zero: we obtain something close to perfect

competition. So, as n increases, the Cournot solution
approaches the perfect competition outcome.
• Unless si close to zero, price will be above marginal cost, so a

Cournot industry produces an inefficiently low level of output.
Social welfare lies in between the competitive industry’s and
the monopoly’s, approaching the first as n increases.
21
How do you compute which market has the greatest market power, given their demand, MC and
number of firms? Kap 9. oppgv 9.1
Cournot model
• For a market with n asymmetric firms and a generic
linear demand P=a-bQ, it can be shown that
a = fixed price bit
𝑎 − 𝑛𝑐𝑖 + σ𝑗≠𝑖 𝑐𝑗 b = variable price bit
𝑞𝑖 = n = numbers of firms
𝑛+1 𝑏
c = MC
• Hence, 𝑎+σ𝑗 𝑐𝑗
𝑛𝑎−σ𝑗 𝑐𝑗
Q= P=
𝑛+1 𝑏 𝑛+1
• Each firm’s equilibrium quantity is a decreasing function

of own marginal cost and an increasing function of
rivals’ marginal costs. når det står c_i betyr det PER firma
når det står j =/ i betyr det også PER firma
når det står c_j betyr det SUM for alle firma
22
Bertrand model
• This model is based on price competition.
Homogeneous good. Simultaneous choices. One shot.
• Look at the following discrete game, in which two
firms chose their price. What’s the equilibrium?
Firm 2
5 4 3
Each firm has an
5 7.5 12 7 incentive to
7.5 0 0 undercut the price
set by the rival
Firm 1 4 0 6 7
12 6 0
3 0 0 3.5
7 7 3.5
23
Bertrand model
In a continuous version:
• Firm 1 gets the entire market if p1 < p2, splits the

market if p1 = p2 and sells 0 if p1 > p2.
• Then, for example, if each firm has constant cost,

with c2 > c1, firm 1 sets price to p1 = c2 and takes
the whole market. This is the equilibrium.
Joseph Louis François Bertrand

(1822-1900)
French mathematician
24
Bertrand model
• Reaction functions in the Bertrand model
are typically upward sloping: if one firm
increases its price, the other firm finds it
profitable to increase its too (strategic
complements).
25
Bertrand model
• Example. Same as in the Cournot model. Then
p = 4, p1=p2= 0.
• We get zero economic profits in a two-firm

industry. Reason: one-shot game. The reason we dont observe serzo
profit between two competitors
very often:
3 possible explanations:
(a) product differentiation
(b) dynamic competition
• Kind of a “prisoners’ dilemma”. (c) capacity constraints
26
Bertrand model
• Kind of a “prisoners’ dilemma”.
27
Bertrand model
• Bertrand paradox (or Bertrand trap): just two competing firms,
but they find themselves with zero economic profits
(accounting profits can be negative if there are sunk costs).
• Solutions:
– product differentiation and branding moderates the impact
of price competition and allows charging a higher price
(would someone travel twice as far to save 1% on the price
of vegetables?)
– capacity constraints: if a firm undercuts a rival and gets full
market share, she must supply the whole market; but many
firms would not have the capacity to. In general, the
greater the overall capacity constraints in relation to
market demand, the higher the price is compared to
marginal cost.
– being a cost leader (more efficient than rivals)
– dynamic competition and set up implicit or explicit
agreements on price (avoid retaliations and price wars)
28
Price competition with heterogeneous
goods
• As a solution to the Bertrand paradox, it has been suggested
that each firm produces a somewhat differentiated product,
and consequently faces a demand curve that is downward-
sloping for all levels of the firm's price.
• There are as many prices as varieties.
• An increase in a competitor's price is represented as an

increase (for example, an upward shift) of the firm's demand
curve.
• As a result, when a competitor raises price, generally a firm

can also raise its own price and increase its profits.
29
goods (good is differentiated)
• Two firms, linear demands:
p1=a1-b1.q1-g. q2
p2=a2-b2. q2-g. q1
g2/b1b2 is a measure of product differentiation: 0
means markets are independent; 1 means goods are
perfect substitutes (b1=b2=g).
• Corresponding direct demand functions:

q1=a1-b1.p1+c.p2
q2=a2-b2.p2+c.p1
a1, b1, a2, b2, g, a1, b1, a2, b2, c >0
30
goods
• If both firms set their prices at the same time, we proceed
similarly to the Cournot model to determine the Nash
equilibrium, with the difference that now we are optimizing
on price instead of quantity: each firm chooses own price
taking the competitor’s price as fixed.
• Reaction functions are upward sloping:
p1*(p2)
p2
p2*(p1)
equilibrium 3 possible explanations for why firms profits
never are down to zro based on the price competition:
(a) product differentiation
(b) dynamic competition
(c) capacity constraints.
p1 31
Stackelberg model
• This is a “quantity leadership” situation.
Homogeneous product.
Sequential two-stage game.
One-shot.
Heinrich Freiherr von Stackelberg

(1905-1946)
German economist
32
Stackelberg model
• Suppose firm 1 is the leader and firm 2 is the
follower. Firm 2 observes firm 1’s choice.
• Which firm is the leader often depends on historical

circumstances (ex: incumbent and entrant).
33
Stackelberg model
• We solve the problem “backwards”. Firm 2
simply solves as in the Cournot model. FOC
are:
p(q1+ q2*) + p’(q1+ q2*).q2* = c’2(q2*)
• Her reaction function is q2*=f2(q1).
34
Stackelberg model
• The leader, firm 1, incorporates this reaction
function into her objective function and
maximizes p1 = p(q1 + f2(q1)).q1 - c1(q1)
FOC are:
p(Q) + p’(Q) (1+f2’ (q1)).q1 = c’1(q1)
35
Stackelberg model
q2
Isoprofit lines: output
combinations that yield the f1(y2)
same level of profit.
Isoprofit lines – Firm 1
Lower isoprofit lines: higher Cournot Equilibrium
profits (the follower
produces less and the Stackelberg Equilibrium
q*2
leader is closer to the
monopoly solution).
f2(q1)
q*1 q1
q1*=(a-c)/2b, q2*=(a-c)/4b, with
p=a-b(q1+q2) and MC=c
36
Stackelberg model
• Leader:
The leader must know ex-ante that the
follower observes his action. And the leader
must have commitment power.
Moving observably first is a means of

commitment: once the leader has made its
move, it cannot undo it. For example, holding
excess capacity is a means of commitment.
37
Stackelberg model
• Follower:
The follower must have no means of committing to a
future non-Stackelberg follower action and the
leader must know this. Indeed, if the follower could
commit to a Stackelberg leader action and the leader
knew this, the leader's best response would be to
play a Stackelberg follower action.
38
Stackelberg model
• Example. Same as in the Cournot model.
Recall that firm 2’s reaction function is q2=12-q1/2.
So firm 1 will maximize

p1 = [52-2(q1 + (12-q1/2))].q1 - 4q1
This yields q1*=12, q2*= 6, p*=16, p1*=144, p2*=72

(the profit of firm 1 is higher as compared with the Cournot solution – first-
mover advantage, but the profit of firm 2 is lower. Total profits are lower)
(consumers are better in Stackelberg than in Cournot: price is lower and

total quantity is higher)
39
Price leadership
Heterogeneous product:
• Demand for firm i’s product depends on own price and
on rivals’ prices. Sequential two-stage game. One-shot.
• Suppose firm 1 is the leader (dominant firm) and firm 2 is

the follower. Firm 2 observes firm 1’s choice.
• First derive the behavior of the follower, then of the

leader.
40
Price leadership
• Given p1, the follower chooses p2 to maximize
p2 = p2. q2(p1,p2) – c2(q2(p1,p2))
From this optimization, one obtains the
reaction function p2=g2(p1), which the leader
incorporates to maximize in p1
p1 = p1. q1(p1,g2(p1)) – c1(q1(p1,g2(p1)))
41
Price leadership
Homogeneous good: (recall dominant firm from chapter 4)
Price
Market Demand, D(p)
Follower’s supply, S(p)
P1
Residual demand curve facing leader, R(p)
MR facing leader
P*
MC1 of Leader
q2 q1 * qT* Quantity
42
Why are models useful?
• Once we have derived the equilibrium, we can run
comparative statics
– let one variable change and compare two equilibria: the
former one and the one after the change
– predict how a shift in one variable influences the other
variables
– Ex: suppose a change in input prices; how does
equilibrium price react?
43
Comparative statics
• In order to find out the impact of a change in
a variable in the market equilibrium (price,
market shares, etc), solve the model before
and after the change and compare.
• Exs: new technology which allows a cost
reduction; demand expansion; Government
subsidy to production; tax increase; entry of a
new competitor
44
Which model?
• Neither model is necessarily better. Depends on the
industry being analyzed.
• The one-shot approach may make sense if we think

of strategic variables that can not be adjusted very
rapidly. Short term moves are made given the long-
term choices.
• The simultaneous or sequential game choice has to

do with the level of observability of the rival’s moves.
45
Cournot vs Bertrand
• These two models yield different results: in the
Cournot model price lies between perfect
competition and monopoly, whereas in the
Bertrand model two firms are enough to drive price
down to marginal cost.
46
Cournot vs Bertrand
• The choice between Cournot and Bertrand models depends
largely on determining what is long term, what is short
term.
Players choose Players choose

the level of the level of their
their long-term short-term
variable variable
• If capacity and output can be easily changed, Bertrand is a

better model of duopoly competition (firms choose prices
and let quantities adjust). If output and capacity are
difficult to adjust, then Cournot is generally a better model
(firms choose quantities and let price adjust).
47
The Bell Journal of Economics
Vol. 14, No. 2 (Autumn, 1983), pp. 326-337
48
Which model?
• Although most of the Industrial Organization
literature assumes that firms compete either by
choosing prices or by choosing quantities, there
is some empirical evidence that, in the same
industry, some firms use price as the relevant
strategic variable while others compete by
choosing quantities – “hybrid case”, also called
“Cournot-Bertrand model”.
49
50
Which model?
• Quantity leadership: for example, when a

firm makes a capacity choice.
• Price leadership: for example, when a firm

distributes a catalog of prices.
51
Conjectural variations model
• The value of the conjecture firm i has about the
response of firm j to firm i’s move (conjectural
variation) varies across these models, the
boundaries being the perfect competition case, on
the one hand, and the collusion case on the other.
(Ex: each firm forms a conjecture about the variation in
the other firm's output that will accompany any
change in its own output.)
In between these two one may use any value for the
conjectural variation, depending on the type of
reaction one wants to model (more or less collusive).
52
Conjectural variations model
• Or you can choose different competing
(strategic) variables, such as R&D level,
advertising, stores location, …
• Choose the model and the competing

variable(s) that best suit your industry.
53
6. Cartels, collusion and dynamic stability

Collusion
Competition versus collusion: recall the prisoners’ dilemma
Competition implies a negative externality upon the other players in

the supply side. Colluding is a way of internalizing this externality.
2
What is Collusion, what different forms of collusion do we have & what differentiate them?
Collusion
• Collusion: firms agree to cooperate in order to restrict
output and raise prices.
stilltiende
• Tacit (or implicit) collusion: firms act without explicit

agreement to achieve the cooperative outcome. Can take
the form of a ‘gentleman’s agreement’ to fix prices and
output. Historical reasons. Focal points (ex in this case:
“round” numbers such as 99.99€).
• Explicit collusion: firms ostensibly agree to maintain their

joint profit maximizing output. Cartels -- such as DeBeers
and OPEC -- are obvious examples.
• Secret agreements (illegal in Europe by the Treaty of the EU,

in the USA by the Sherman Act)
3
Art 101, Treaty of the EU
1. The following shall be prohibited as incompatible with the internal
market: all agreements between undertakings, decisions by associations of
undertakings and concerted practices which may affect trade between
Member States and which have as their object or effect the prevention,
restriction or distortion of competition within the internal market, and in
particular those which:
(a) directly or indirectly fix purchase or selling prices or any other trading
conditions;
(b) limit or control production, markets, technical development, or
investment;
(c) share markets or sources of supply;
(d) apply dissimilar conditions to equivalent transactions with other trading
parties, thereby placing them at a competitive disadvantage;
(e) make the conclusion of contracts subject to acceptance by the other
parties of supplementary obligations which, by their nature or according to
commercial usage, have no connection with the subject of such contracts.
4
What types of agreements are allowed in collusion between firms?
Collusion
• Possible types of agreement
– increase price
– reduce quantity
– agree on the level of service quality (ex: airlines),
of advertising, etc.
– agree on sharing territories (territory restrictions,
ex: gas cylinders)
– etc.
5
Collusion
• A cartel of two firms chooses q1 and q2 to maximize
p = p(q1 + q2).[q1 + q2] - c1(q1) – c2(q2)
FOC:
p(q1*+ q2*)+p’(Q).[q1*+ q2*] = c1’(q1*) and
p(q1*+ q2*)+p’(Q).[q1*+ q2*] = c2’(q2*)
Hence the cartel chooses q1* and q2* so that

marginal costs are equal across firms. Intuition?
6
Collusion
y2
Isoprofit curves
OUTPUT COMBINATIONS THAT
for firm 2
MAXIMIZE TOTAL INDUSTRY PROFIT (“contract curve”)
Isoprofit curves
for firm 1
y1
If one firm thinks that the other’s output will remain constant, it will be tempted
to increase its own output and make higher profits.
7
Collusion
• Example: same as in the Cournot model
We get Q=12, p=28 and p=288. Given that MC1=MC2=4, total
production may be equally divided between firms and joint
profit also.
However: each firm has an incentive to cheat: stability
problem
For instance, if q1=6 firm 2 maximizes her profits by playing 9.
She gets p2=162 and firm 1 gets p1=108.
p2=[52-2(6+ q2)].q2 - 4q2, so q2*=9, p*=22
8
Why do firms use tacit collusion, and how?
Collusion
• If each firm believes that the other will stick to the
agreed output level, she benefits from increasing
own production, to sell more at the high price.
Even if the firm expects the other to cheat also, it
is better to increase production – prisoners’
dilemma (recall also the Bertrand trap).
• Solution: sustain collusion by introducing
punishments and infinitely repeating the game, as
long as the discount factor is sufficiently high –
tacit collusion.
9
Compare the different models & collusion based on order
of price, total output & CS from low to high
ComparisonPris:
bertrand < Stackelberg < Cournot < Collusion
total output: (produkter)
collusion < cournot < stackelberg < bertrand (HELT MOTSATT AV PRIS)
CS:
collusion < cournot < stackelberg < bertrand (HELT MOTSATT AV PRIS)
SO COMPARISION BETWEEN PRICE VS (TOTAL OUTPUT & CS)
ARE THE SAME BUT OPPOSITE
Price: BSCC (Bullshit Cock Cunt)
Bertrand < Stackelberg < Cournot < Collusion
Total Output:
Collusion < Cournot < Stackelberg < Bertrand
Consumer Surplus:
Collusion < Cournot < Stackelberg < Bertrand
10
Comparison
• In our example,
PB=4<PS=16<PC=20<PCollusion=28
QB=24>QS=18>QC=16>QCollusion=12
p1+2B=0<p1+2S=216<p1+2C=256<p1+2Collusion=288
11
Comparison
• In our example:
q2
f1(q2)
contract curve
Collusion Competitive equilibrium

12
Cournot
8
6 Stackelberg (1 leader)
f2(q1)
6 8 12 q1
12
Agreement sustainability
• Consider once again a simple prisoner's dilemma

game. Here (Defect, Defect) is an Equilibrium.
Cooperate Defect
Cooperate 3,3 0,6

Defect 6,0 1,1
13
• Game length may be
– uncertain,
– unknown or
– too long.
• What if the game is infinitely repeated? By “infinite”

we mean that there is at least some probability that
the game will be repeated (on every turn).
• If there is no last period, then no rollback.
• Use history-dependent strategies, that is, make your

choice dependent on what has happened in the
previous periods.
14
• Let utility take the form
ut
t =0 (1 + d ) t
where d is the opportunity cost of time (1/(1+d)t is

the discount factor for t periods)
15
• Suppose your opponent uses a “punishment” strategy: if you
cooperate, he will cooperate; if you defect, he will defect and
continue doing so forever (grim trigger strategy).
• The payoffs are:

3 3 3 3
Cooperate: 3 + + + + ... = 3 +
1 + d (1 + d ) (1 + d )
2 3
d
1 1 1 1
Defect: 6 + + + + ... = 6 +
1 + d (1 + d ) 2 (1 + d )3 d
3 1 2
Cooperation is better iff 3 + 6+ d
d d 3
• In this example you should cooperate unless you are extremely
impatient (the lower d is, the more patient the player is).
Example: maintain a cartel
16
Determinants of the discount factor
• The discount factor is
– decreasing in the market’s interest rate
– decreasing in the likelihood that this market
“disappears” (for instance because of a disruptive
innovation)
– increasing in the frequency of interaction
– increasing in the industry’s growth rate
17
More factors that affect the ability to collude
• Number and size distribution of sellers
– Few and similar → easier to collude
• Market structure
hele markedet hos få firma
– More concentrated → easier to collude
• Cost structures
– Similar → easier to collude
• Secrecy and retaliation
– Less secrecy, easier retaliation → easier to collude
• Social structure of the industry
– Social interaction → easier to collude
– Multimarket contact → easier to collude
• Product heterogeneity
– Homogeneous → easier to collude
• Turnover rate (rate of entry and exit)
– Low turnover rate→ easier to collude
18
• Trigger strategy: a player begins by cooperating but defects to
cheating for a predefined period of time as a response to a
defection by the opponent (trigger).
• Grim trigger strategy: punishment is forever. The most severe

trigger strategy (least forgiving and longest memory). Has
adequate deterrence but lacks credibility.
• Tit-for-tat strategy: the less severe trigger strategy (most

forgiving and shortest memory). If the opponent previously was
cooperative, the agent is cooperative; if not, the agent also
defects. Is credible but lacks deterrence.
19
• Collusion is easier to sustain in concentrated industries
and among similar firms
– Differently efficient firms: it becomes more difficult to
decide on profit sharing
• Collusion is also easier to sustain when firms compete
in more than one market (multimarket contact),
because they have more to lose from defecting. Ex:
airlines; dog food industry; ...
• Most favoured customer clauses also facilitate
collusion
• Contrary to what might be expected, information
sharing and price transparency may also enhance
collusion (see next)
20
Price cuts and price wars
• Antitrust policy and hard price observability make
collusion less likely
• Rivals’ price cuts may be difficult to observe: if my
demand is low, is it because the market is down or
because my rivals are cutting their prices? This doubt
may initiate a price war
• Occasional price wars may be necessary to discipline
collusive agreements
• Cutting price is more profitable when demand is high
(for instance, because of seasonality) than when it is
low, because there is more to gain therefrom.
21
Price cuts and price wars
• Price cuts may be initiated by
– strong competitors, in order to drive small ones out of
the market (ex: price war initiated in the cloud market
by Google)
– weak competitors, in order to gain market share
• Airline industry analysts say that the main reason for
price cuts in this industry are the financial troubles
experienced by some companies. These troubles reduce
the likelihood of continuation of the game and hence
decrease the companies discount factor.
• Note that the discount factor may be different for
different companies in the same industry.
22
Industry associations
• Industry associations facilitate the exchange of
information among market players and hence implicit
collusion.
• The following example illustrates the importance attached by authorities to
widespread information among market participants and even entry
candidates. In 2017 the Portuguese Association of specialised consumer
credit providers committed to eliminate the restrictive potential of the
information exchange system practiced among its members in the market
for specialized credit (leasing, long term rental, and others). The
competition authority considered that the information exchange system in
question “could be likely to promote a restrictive effect on competition,
through the likely reduction of uncertainty in the market, allowing
participants to act in the possession of sensitive information of its
competitors, as well as frequently monitor their strategic behaviour.” To
respond to the concerns expressed by the competition authority, the
Association committed to disclose information to non-members and,
namely, to provide full access to it by firms preparing market entry, under
the Authority’s supervision and taking into account the comments
presented by interested third parties.
23
Leniency programmes
• Started in the USA, but nowadays many other
countries have implemented their own
leniency programs.
• In Portugal, Lei da Clemência (Law 39/2006,
25th August. Lays down the legal regime for
exemption and special mitigation of fines for
infringement of national competition rules)
24
25
(cont.)
26
27
• https://www.concorrencia.pt/pt/artigos/adc-
sanciona-supermercados-e-distribuidor-de-
bebidas (3rd November 2021)
“...por terem participado num esquema de concertação de preços de venda ao público...”
“... mediante contactos estabelecidos através do fornecedor comum, sem necessidade de
comunicar diretamente entre si, as empresas participantes asseguravam o alinhamento
dos PVP nos seus supermercados, numa conspiração equivalente a um cartel, designada
na terminologia do direito da concorrência por “hub-and-spoke”, que elimina a
concorrência,...”
“... a prática durou mais de doze anos, entre 2003 e 2016, e visou vários produtos da Super
Bock, incluindo as cervejas Super Bock, Carlsberg, Cristal e Cheers, as águas Vitalis e Água
das Pedras, e ainda a sidra Somersby.”
“A AdC aplicou uma coima no valor total de mais de 92,800 milhões de euros.”
Extratos de conversações eletrónicas :

“…Pedia a tua ajuda para reposicionar o pvp de Pedras Salgadas a 1,59 € nas seguintes
lojas:...”
“... A [fornecedor] apresenta alguns pvp´s das nossas lojas, e solicita a nossa colaboração
para posicionar o artigo a 1.59, analisem o vosso shopping e informem por favor
a [fornecedor] para que junto dos operadores a quem estão a responder possom acertar
uma data para alinhamento de preços....”
28
yo
2. Games and strategy
Kapittel 4
Applications of Game Theory
While used in a number of disciplines, game theory is most notably used as
a tool within the study of economics. The economic application of game
• Economics theory can be a valuable tool to aid in the fundamental analysis of
industries, sectors, and any strategic interaction between two or more firms.
• Political Science
• Biology
• Sociology
• Psychology
• Medicine = Game theory is a theoretical framwork for conceiving
social situations amog competing players. In some respects,
game theory is the science of strategy, or at least the optimal
• Environment decision-making of independent and competing actors in
a strategik setting
• Army Using game theory, real-world scenarios for such situations as
• … pricing competition and product releases (and many more) can be

laid out and their outcomes predicted
Game theory is the process of modeling the strategic interaction

between two or more players in a situation containing set rules
and outcomes
2
så et market med kun 2 eller 3 konkurrenter endrer strategi basert på handlingene til de andre konkurentene:
interaction
Context
• Consider an industry with just two or three firms,
of approximate size. If one ot these firms decides
to cut price/advertise more/expand capacity/find
a new location/launch a new product/..., it may
induce the others to do the same.
• But then the other’s reaction may change the
antecipated profitability of that strategy
– need to take that into account
• This is interaction
• Agents are interdependent (?)
3
A game
• A game is a mathematical/formal way of
modelling players’ interaction
• Applies to business decisions, but also to
everyday life
4
A game
• Interaction means that each player’s actions impact
the other(s) player(s)
• Players think and behave strategically, taking
interaction into account, and aim at optimizing a
given objective function (they behave rationally)
• In order to define a game, specify the set of players,
the set of possible strategies for each and the
associated payoffs. Also, the timing of the game and
the information set at each decision node
5
Two forms of game representation
• Matrix form (or normal form):
samtidige avgjørelser
– for strategic
games with
dominance
simultaneous decisions
– look for dominant and dominated strategies
– then look for Nash equilibria Nash - likevekt (?) *
• Game-tree form (or extensive form)
– for games with sequential moves etterfølgende trekk
– solve backwards
– strategies: set of contingent decisions at each
node betingende beslutninger
Nash equilibrium: no player is able to improve its payoff by unilaterally changing its strategy,
given the strategy of the other player(s), or, stated differently,
each player chooses the optimal strategy for himself,
6
given that the other player(s) are choosing the optimal strategy for themselves (look for best responses)
Several types of games
• Cooperative games / Noncooperative games
• In pure strategies / In mixed strategies
• Non repeated / Repeated
• Simultaneous / Sequential
• With symmetric information / With asymmetric

information
7
Strategic dominance
strategisk dominanse ( en av strategiene for
spillere i spill med samtidige avgjørelser)
• Occurs when one strategy is better than all the

other possible strategies for one player, no
matter what the opponents do. This strategy is
called dominant strategy.
• A strategy is dominated if, independently of what
the other players do, this strategy earns a player a
smaller payoff than some other strategy. Hence,
a strategy is dominated if it is always better to
play another strategy. altså er dominant og dominerte strategier motsetninger
du kan lese fra en matrise om spillerne har en dominant strategi:
- Hvis en av spillerne vil kjøre samme strategi (samme valg) uavh. av valget til den andre spilleren 8
har spilleren en dominant strategi
Vi ser på pepsi sitt valg, hvis cola velger de ulike alternativene:
- Vi C velger dont advertise står Pesi mellom 60 dollar for adv. og
50 dollar for dont adv. Pepsi vil altså velge adv.
- Hvis C velger adv. står P mellom 25 for adv 0g 0 for dont adv.
Pepsi vil altså fortsatt velge advertise
<=> samme beslutning uansett hva cola gjør

<=> DOMINANT STRATEGI
ser på samme for cola:

- hvis P velger adv. vil C gjøre adv (25 mot o)
- hvis P velger dont adv. vil C gjøre adv (60 mot 50)
<=> samme beslutning uavh av P
<=> DOMINANT STRATEGI
begge kommer til å adv, å få et dårlig outcome :( de burde egentlig

begge to ikke advertiset, men men.. DETTE KALLES PRISONERS DILEMMA!!!
(eneste lovelige strategien tit for tat (repeated games) hvor man pga erfaring
velger en annen strategi enn naturlig fordi de ulike partene vet de begge to vil
tjene mer på dette
Some solutions for noncooperative
games ikke- sammarbeidene
likvekt
• Equilibrium in dominant strategies: the best
strategy for each player is independent from the
strategy chosen by the other(s) player(s)
• Strategy x dominates strategy y if x is preferred to y in
every occasion. In many games there are no dominant
strategies.
9
1) sjekk først etter dominant strategi:
Cola har ikke dette, men Pepsi har det og vil alltid velge LO
2) Se etter Nash: Pepsi har dominant strategi og vil alltid velge

Low output. Derfor vet Cola hva Pepsi vil velge, og kan velge det
beste for sin del gitt situasjonen, i dette tilfellet High Output
derfor er den jeg har ringte rundt Nash equilibrium

mens du løser for å finne dominante strategier og nash equibrium
ring rundt som her. Her har ingen dominante strategier men vi har
2 nash equilbrium. Vi kan altså både ha 0,1 eller 2 nash
games samarbeidene spill
Some rules:
– If there is a dominant strategy, choose it
– Do never choose a dominated strategy (solving the
game by “elimination of dominated strategies”)
– In case only one of the players has a dominant
strategy, choose for the other player the best strategy
given the choice of the dominant strategy of the
former.
If it is not possible to find the game’s equilibrium by applying these
rules, the reason is that the game has no equilibrium in dominant
strategies. Look for the Nash equilibrium.
10
games
• Nash equilibrium: no player is able to improve its

payoff by unilaterally changing its strategy, given the
strategy of the other player(s), or, stated differently,
each player chooses the optimal strategy for
himself, given that the other player(s) are choosing
the optimal strategy for themselves (look for best
responses)
11
games ikke -samarbeidene spill
A set of strategies is a Nash equilibrium if player’s A choice is

optimal given the choice of B, and the choice of B is optimal given
the choice of A. Each player chooses the optimal strategy for
himself, given that the other(s) choose(s) the strategy that is
optimal
*
for each one of them. In this situation no player has an
(gjort av en pers) (depart /avvike)
incentive to unilaterally deviate, since none can improve its result
by means of a unilateral strategy change, that is, given the
other(s)’ strategy(ies).
Nash equilibrium: Combination of moves in which no player
would want to change his/her strategy unilaterally. Each chooses
his/her best strategy given what the others are doing (or given
the beliefs of what the others are doing).
* insentiv = en ting som moviterer en til å gjøre noe
12
Prisoner’s dilemma
• The prisoner’s dilemma is a game between
two prisoners that illustrates that
cooperation is difficult to sustain even
when it is mutually beneficial
The Prisoner's Dilemma
- the most well-known example of game theory.
Consider the example of two criminals arrested for a crime: no hard evidence to convict them. However, to gain
a confession, they question each one in separate chambers. The prisoner cant communicate. Officials present
four deals, often displayed as a 2 x 2 box:
1. If both confess, they will each receive a five-year prison sentence.

2. If Prisoner 1 confesses, but Prisoner 2 does not, Prisoner 1 will get three years and Prisoner 2 will get nine
years.
3. If Prisoner 2 confesses, but Prisoner 1 does not, Prisoner 1 will get 10 years, and Prisoner 2 will get two years.
4. If neither confesses, each will serve two years in prison.
13
The most favorable strategy is to not confess. However, neither is aware of the other's strategy and
without certainty that one will not confess, both will likely confess and receive a five-year prison sentence.
The Nash equilibrium suggests that in a prisoner's dilemma, both players will make the move that is best
for them individually but worse for them collectively.
The expression "tit for tat" has been determined to be the optimal strategy for optimizing a prisoner's
dilemma. Tit for tat was introduced by Anatol Rapoport, who developed a strategy in which each
participant in an iterated prisoner's dilemma follows a course of action consistent with their opponent's
previous turn. For example, if provoked, a player subsequently responds with retaliation; if unprovoked,
the player cooperates. (For eksempel, hvis den blir provosert, reagerer en spiller senere med
gjengjeldelse; hvis det ikke er provosert, samarbeider spilleren.)
Confess or not to confess, that’s the
prisoners dilemma
The dominant strategy for each player is to confess. Not to confess is a
dominated strategy.
Equilibrium in dominant strategies: (Confess, Confess)
Hvorfor blir det de gitte tidene, eks at den som ikke tilstår
får værre straff enn den som tilstår? :
14
Prisoner’s dilemma PD
hvem er agenten?
• The prisoners’ dilemma illustrates the agents’

difficulty in sustaining cooperation
• Cooperation fails even when it would lead all
agents to a better outcome
• Cooperation is difficult to sustain because it is
not in each players’ individual interest
• This game illustrates a conflict between
individual incentives and joint incentives,
typical of many business situations
15
An Arms-Race game
væpne og avvæpne spill: PD is applied to arm races
Decision of the United States (U.S.)
Arm Disarm
U.S. at risk U.S. at risk and weak
Arm
Decision
USSR at risk USSR safe and powerful
of the
Soviet Union U.S. safe and powerful U.S. safe
(USSR)
Disarm
USSR at risk and weak USSR safe
http://gametheory101.com/courses/international-relations-101/arms-races/
https://www.britannica.com/topic/arms-race/Prisoners-dilemma-models
16
An advertising game
reklame / markedsførende
Marlboro’ s Decision
Advertise Don’t Advertise
Marlboro gets $3 Marlboro gets $2

billion profit billion profit
Advertise
Camel gets $3 Camel gets $5
Camel’s billion profit billion profit
Decision
Marlboro gets $5 Marlboro gets $4
Don’t
Advertise
Camel gets $2 Camel gets $4
17
Cease-Fire in Ukraine
• Kind of a “prisoners’ dilemma”.
Russia
Cease-Fire Do not Cease-Fire
500 800
Cease-Fire 500 0
Ukraine
Do not Cease-Fire 0 100
800 100
18
Multiplicity of equilibria
Example: A movies’ game
• In 2010, Warner Bros. and Fox must decide
when to release Harry Potter and The
Chronicles of Narnia.
• Two possibilities: November or December.
• December is a better month, but
simultaneous release is bad for both.
19
A movies’ game
Fox
November December
250 800
November 250 500
Warner
December 500 400
800 400
Two Nash equilibria: (N,D) and (D,N)

What actually happened: Warner=November; Fox=December
20
Some notes
• Unless otherwise stated, each player wants to
maximize his payoff
• Maximizing the difference to the rival's payoff or
minimizing the rival’s payoff may be important
when the firm wants to induce rival’s exit in an
intertemporal profit maximization
• But then we can include that in the payoffs and
consider relative instead of absolute payoffs.
• Nash equilibrium assumes a lot about what

people know.
21
Application
• Propose a Reduce/Not Reduce polluting
emissions game between countries.
• Do the same for a producing green/non green
between competing firms.
22
Battle of sexes
He
Opera Football
2 1
Footballl Opera
3 1
She
0 3
0 2
There are two Nash equilibria (O,O) and (F,F), but they lack “equity”.
Coordination game.
23
Chicken (or hawk-dove) game
A chicken game describes two players heading toward each other. If the players
continue on the same path, they bump into each other; if one swerves out of
the way and the other doesn't, the swerver "loses" and is labelled the chicken,
while the second wins.
Player 1
Swerve Straight
Straight Swerve
0 1
Player 2
0 -1
-1 -10
1 -10
There are two Nash equilibria: (Swerve, Straight) and (Straight, Swerve).
It is beneficial for the players to play different strategies: anti-
coordination game.
24
Another possible representation of the
Chicken game
Player 1
Swerve Straight
Straight Swerve
3 6
Player 2
3 1
1 -1
6 -1
25
Equilibrium multiplicity
• As we have seen, there are games with more than one Nash
equilibrium. In the example below there are two: (HP,HP)
and (LP,LP), that is, either both firms charge a high price, or
both charge a low price. How can we choose one?
Firm B
High Price Low Price

10 4
Firm A
Price Price
Low High
10 4
2 5
2 5
26
26
Equilibrium multiplicity
• One of the equilibria - (HP,HP) - is superior to the other
(both firms are better off). It may be considered a focal
point, that is, an equilibrium that would occur even if
players do not communicate.
• However, if (LP,LP) is reached only coordination among
the firms can eventually lead to a change to (HP,HP).
• If no equilibrium is superior to the other (this means that

one of the firms prefers a given equilibrium and the
other firm prefers the other), then it is impossible to
predict, with no further information, which equilibrium
will prevail (it may depend, for instance, on the order of
play).
27
Sequential move games
Kapittel 4.2 i boka
• Use Backward Induction (Rollback) to Find

Equilibrium – Subgame Perfect Nash Equilibrium
• In the former price game, decisions are taken
simultaneously (or, equivalently, not knowing
what the rival has chosen), so the game is
represented in matrix form.
• However, if one of the firms decides first, the
game becomes sequential (represented in
extensive form)
28
this is an example of a game tree (4.2)
A price game
• The equilibrium becomes unique: (10,10)
High price (10,10)
High price Firm B

Firm A
Low price (4,4)
High price (2,2)
Low Price
Firm B
samme som i boka men bare snudd andre veien
Low price (5,5)
29
• Playing first means commitment.
• The value of commitment is the payoff difference
between simultaneous and sequential moves for
the player who commits.
• In the price game example the value of
commitment for firm A is equal to 10-5=5 in case
the equilibrium in the static game was (low price,
low price), or 10-10=0 in case the equilibrium in
the static game was (high price, high price).
30
• For a commitment to have strategic value, it
must be:
– visible to others
– and credible
• Examples: rules vs discretion; lowest price
guarantee
• Credible commitment may have a significant
strategic value
31
First mover advantage or second
mover advantage?
• Depends on the game being played.
• Other examples where the order may matter:
– Adoption of a new technology/ Class presentation
of a project: is it better to be the first or the last?
– Sequential bidding by two contractors: is it better
to be the first or the last?
32
Sequential games
• Hypothetical example of choosing standards: two
companies, A and B, two standards, A and B. Each
company prefers to choose its own standard, but it is good
when there is compatibility, i.e., both use the same
standard.
• Firm A chooses first: Standard A (10,5)
Firm B
Standard A
Firm A Standard B (4,4)

Standard A (2,2)
Standard B
Firm B
Standard B (5,10)
33
First mover advantage or second
mover advantage?
• Sometimes the order does not matter. See the
following merger game:
– Consider an industry with four firms. Firms 1 and
2 may decide to merge, and so may firms 3 and 4.
– Consider that the payoffs are as described in the
following matrix if decisions are taken
simultaneously. Then both pairs will merge.
34
A merger game
not a constant sum game
Pair 1+2
Merge Don’t merge

20 10
Don’t Merge
Pair 3+4
20 25
merge
25 15
10 15
• Now admit that pair 1+2 chooses first (and that the decision is
irreversible). Does the equilibrium change? And what if pair 3+4 is
the first to choose?
• No first-mover advantage.
35
Some considerations
• How reasonable is rollback/backward induction
as a behavioral principle?
• It may work to explain actual outcomes in simple
games, with few players and moves.
• But is more difficult to use in complex sequential
move games such as Chess. We can’t draw out
the game tree because there are too many
possible moves. Although it is a game with a
finite number of moves, it looks like a game with
an infinite number of moves because this number
is unknown.
36
Short-run versus long-run decision
variables
• Some variables are easier to adjust than
others. For example, it is easier to change
price than to change capacity of production.
• Variables which are more difficult to adjust
correspond to long-run choices, whereas
variables which are easier to adjust
correspond to short-run choices.
37
Constant-sum games and Non-
constant-sum games
• Constant-sum game: each participant's gain or
loss is exactly balanced by the losses or gains of
the other participants. These games are
distributive, as the pie cannot be enlarged by
negotiation.
• Zero-sum games are a particular case of constant
sum games where the sum of each outcome is
always zero. (Ex: chess.)
• Non-constant-sum game: participants can all gain
or loose. There can be efficiency gains, the pie
can be enlarged. Ex: trade.
38
Pure versus mixed strategies
• Nash's theorem: for any game, there exists at
least one (Nash) equilibrium. However, this may
involve randomization (mixed strategies).
• So far: pure strategies (that is, choose one
strategy with probability 1)
• But players can also choose randomly: mixed
strategies. Choose one strategy with a given
probability p where 0<p<1, and the other
strategy with the complementary probability
0<1-p<1. Corresponds to being “unpredictable”.
39
Matching pennies game
Player 2
Heads Tails
1 -1
Heads -1 -1 + 1 = 0 1 1-1=0
Player 1
-1 1
Tails
1 0 -1 0
• Zero-sum game? Yes

• No solution?
• Try to be unpredictable, choose randomly
between heads and tails ( no rythm)
40
No equilibrium (in pure strategies)
• Nash's theorem: for any game, there exists at
least one (Nash) equilibrium. However, this
may involve randomization (mixed strategies).
41
p_wine(-1) + (1-p_wine)*(-1) = p_wine(-2) + (1- p_wine)*(0) <=> p_wine = 1/2 = 50% av gangene
q_check*(-2) + (1- q_check)*(1) = q_check(0) + (1- q_check)*(0) <=> q_check = 1/3 = 33% av gangene
mixed strategy nash equlibrium
Drunk driving politiet setter opp check point 1/3 av gangene
og sjåføren drikker vin 50% av gangene
• Police is concerned about drunk driving

• Can set up an alcohol check point or not. The check point catches
drunk drivers, but has costs
• Drivers decide whether to drink wine or cola before driving. Wine gives
them more utility, but if they are caught, they must pay a fine
• There’s a cost for the society of drunk driving, that the police takes into
account. Politiet må velge om han skal sette opp check point eller ikke
dyrt Police
Check point No Check point
-1 -2 tallene regerer til de

Wine negative eller positive
-2 1 effektene
Driver
med valgene til aktørene
Cola -1 0
foretrekker vin
men vil ikke bli tatt
0 0
negativ (-1) fordi det er dyrt

men -2 fordi det er enda værre om han ikke blir tatt når han drikker vin 42
-1
-2
-2 1
Må bruke mixed strategies, polititet er interessert i..

Prob av driver å være drunk eller ikke
it is not for sure that a given strategy is going to be sure
the strategies must be indifirent of eachother
randomize between the two: sometimes chooses option 1 and sometimes option 2
-2 *prob + 0 (1-p) = 1p +0(1-p)

police there or indiference of the police
both strategies of the police must give the police the expected payoff
Drunk driving
• In this game there is no Nash equilibrium in
pure strategies.
• Let’s look for a Nash equilibrium in mixed
strategies.
• A mixed strategy is a probability distribution
over the set of actions.
43
Drunk driving
• Suppose the police sets up the check point with
probability p. Then, the driver is indifferent
between wine and cola if his expected utility is
the same for both choices:
p(-2)+(1-p)1=px0+(1-p)x0, which yields p=1/3
• Suppose the police expects drivers to drink wine
with probability q. Then, the police is indifferent
between setting up the check point or not if:
q(-1)+(1-q)(-1)=q(-2)+(1-q)x0, which yields q=1/2
44
player 2
player 1
starter med player 1 sin mixed strategy: spiller 2 sin mixed strategy:
EU left = EU right EU down = EU up
EU left = f(p_up), der p_up er sanns. for at spiller 1 spiller opp EU down = f(p_left)
EU right = f(p_up) EU up = f(p_left)
tre likninger med tre ukjente
EU down = p_left*(-1) + (1-p_left)*(0)
EU left= f(p_up) er når player 2 alltid velger left EU up = p_left(3) + (2-p_left)*(-2)
noen % av gangene ville spiller 1 få -3, andre 1 p_left(3) + (1-p_left)*(-2) = p_left*(-1) + (1-p_left)*(0)
<=> p_left = 1/3 av gangene, gjør at for spiller 1 er det samme
EU left = p_up*(-3) + (1-p_up*)(1) om han spiller spiller up eller ned
EU right = p_up(2) + (1-p_up)*(0)
hvis de spiller etter P_up = 1/6 og P_Left= 1/3
p_up*(-3) + (1-p_up*)(1) = p_up(2) + (1-p_up)*(0) gir det mixed strategy nash equilibrium, ingen av spillerne kan endre
<=> p_up = 1/6, så hvis spiller 1 opp 1/6 av gangene og ned strategiene og forvente å gjøre bedre.
5/6 av gangene,
er spiller 2 indifferent
Drunk driving
• This is a mixed strategies Nash equilibrium: the police
sets up the check point with probability 1/3 and the
driver drinks wine with probability ½.
• Said differently, the police randomizes between check
point and no check point and chooses check point 1/3
of the times; the driver randomizes between wine and
cola and chooses wine ½ of the times.
• This strategy of the police is the best response to the
driver’s strategy and vice-versa.
• Since there is no pure strategies equilibrium, this is the
unique Nash equilibrium of this game.
45
Another way to interpret the
equilibrium in mixed strategies
• If the driver assigns a probability of 1/3 to the
existence of a check point, he drinks wine ½ of
the times. And if the police assigns a
probability of ½ to drivers drinking wine (that
is, the police expects half of the drivers to
drink wine and half to drink cola), then, with
this payoff matrix, the optimal decision is to
set up the check point 1/3 of the times (or,
said differently, in 1/3 of the locations).
46
Application
• Now find the mixed strategies Nash
equilibrium for the game Reduce/Not Reduce
polluting emissions game between countries,
or for the game producing green/non green
between competing firms.
• You will obtain the probability with which
each player will reduce emissions/produce
green, given the payoffs associated with each
possible strategies combination.
47
Mixed strategies equilibrium
• In a mixed strategies equilibrium, every
action played with positive probability must
be a best response to other players’ mixed
strategies.
• Players must be indifferent between actions
played with positive probability.
48
One-shot versus Repeated games
• One-shot games: games in which each player
chooses one action only once
• Repeated game (also called stage game): a
one-shot game repeated a given number of
times (finite or infinite)
• Each player can react to the other(s)’
choice(s), which may give room to new
equilibria.
49
Repeated games Kap 4.3 i boka
• Firms and other agents usually interact in a

repeated way
• Repetition opens the door to the possibility of
retaliation and thus helps enforcing (cartelization)
• When players do not know when the game is
going to end (the game is indefinitely repeated,
which means that the game duration is infinite or
finite but unknown), they have something to lose
from deviating from “good" actions, and a greater
reward if they stick to the “good” actions.
50
Repeated games
• Game repetition motivates cooperation
• This is why many economic relations are
based on informal contracts, which shows
that a “natural” enforcement exists
• Culture and values also help enforcement
51
Repeated games
• What if the prisioners’ dilemma is played
repeatedly?
• An agreement is self-enforcing if it is a Nash
equilibrium of a repeated game
• We will see more on repeated games when
we come to the “Cartels, collusion and
dynamic stability” chapter
52
Repeated games
• In repeated games there may exist the possibility
of renegotiation. “Bygones” become “bygones”
and retaliation (punishment) ceases.
• When renegotiation is highly likely, breaking the
agreement is also highly likely
• Need for credibility of the equilibrium system of
rewards and punishments (being renegotiation
proof)
• Discuss: sovereign debt renegotiation
53
I et prisoners dilemma, der begge velger et dårligere outcome enn de kunne pga nash equilibrium, er eneste lovlige
strategien for å komme seg ut av det tit -for-tat, (repeated games) hvor man pga erfaring velger en annen strategi enn
naturlig fordi de ulike partene vet de begge to vil tjene mer på dette
Punishment strategies s:61
• Trigger strategy: a player starts cooperating but defects

to cheating for a predefined period of time as a
response to a defection by the opponent (trigger).
• Grim trigger strategy: punishment is forever. The most

severe trigger strategy (least forgiving and longest
memory). Has adequate deterrence but lacks
credibility. har tilstrekkelig avskrekkelse, men mangler troverdighet
• Tit-for-tat strategy: the least severe trigger strategy

(most forgiving and shortest memory). If the opponent
previously was cooperative, the agent is cooperative; if
not, the agent also defects. Is credible but lacks
deterrence.
trigger: sammearbeider først, men når motstanderen gjør en uforventet handling, gjengelder man dette. ulike straffer,
og lengden for straffen varierer. Grimtrigger er den værste, da straffen varer for alltid, selv om den andre spilleren
kun gjore én uventet handling.
tit for tat - straffen fortsetter så lenge den andre spilleren fortsetter.
54
Information
• Introduce a new player, Nature.
• Example:
– Nature first “chooses” the type of the firm: for
example, one who invests in CSR for altruistic motives
or for strategic motives
– The consumer does not know the real type of the
firm, so tries to extract information from observing its
choices (ex: the amount spent in CSR)
– This is an example of a signaling game
• Other examples: principal-agent models
(employer and employee, insurance company
and car driver, …)
55
3. Definition of the relevant market and

concentration measures
What are the 2 different markets we need to define? geographic market & product market
wider: economic integration & E-commerce
What can cause the geographic market to become.. narrover: high transportation cost, non tradable goods
check: which locations are affected by your price setting?
(i) wider?
(ii) Narrower?
Relevant market
How do you check if an area is part of your products geographic market?
• For two or more firms to compete, they must be in the same

market. So, it is important to correctly define the relevant
market (also for competition policy purposes). We must
define
– the geographic market and
– the product market
• The geographic market became wider due to economic

integration and to e-commerce.
– When transportation costs are high relative to price the
geographic market will be narrower
– The same for non tradable goods ikke byttbare
– The limits of the geographic market are found by checking
whether the price in one location affects the price in another
location Hvis prisen du setter på brusen din påvirker prisen meråker
er meråker del av ditt geografiske market, hvis ikke
2
så er det ikke det
What includes a products product market? product market: all goods that are DEMAND & SUPPLY supstitutes
demand sub: price increase for A <=> customers buys more B
What is the difference between demand & supply substitutes? supply sub: price increase for A <=> other firms producing B, produce
some A as well (increase in total supply of A)
Relevant market
• Product market definition must include all goods
that are close demand or supply substitutes.
– product B is a demand substitute for A if an increase in
the price of A causes consumers to use more B instead
of A
– product B is a supply substitute for A if, in response to
an increase in the price of A, firms that are producing
B switch some production to A (increasing the total
supply of A)
– In both cases, the presence of B constraints the
pricing of A
demand substittut - cola øker prisen, forbrukerne drikker mer pepsi
supply substittut - to brusfabrikker. ene fabrikken øker prisen på en av varene, og den andre
fabrikken svarer med å produsere større andel av dette produktet 3
1. ask people in the industry 2. Use cross price elasticity
How do you define the product market? (4 strategies) 3. Look at price correlations 4. SSNIP test
Relevant market
• To define the product market:
– ask people in the industry about rivals and other products
– use the cross-price elasticity. Tells us the percentage
increase in demand for good i when the price of good j
increases by 1%. It is high among products in the same
market and low among products in different markets
cross price elasticity (i different from j)
dQi Pj > 0 i and j substitutes
ij
dPj Qi < 0 i and j complements
positive cross-price elastisy: A & B SUBS
What does positive cross-price elasticity mean? and negative?
negative cross price elasticity: A & B COMPLIMENTS
– look at price correlations; prices of goods in the same

market tend to move together but be careful with
exceptions: the prices of two goods not in the same market
but that use the same input may be highly correlated; and
the opposite, two goods that are in the same market but
use different inputs may not have a high price correlation.
4
How do u perform the SSNIP test & what does it tell us?
Relevant market SSNIP is a way to check if the market is well defined.

- simulate a 5 or 10% price rise in restricted market
• Define the product market (cont): - profit rises <=> well defined marked
- profit goes down <=> identify main sub, widen marked def &
restart
– Perform the SSNIP test (Small, but Significant, and

Non-transitory Increase in Price): simulate a 5 or 10%
rise in price in a restricted market; if profits rise, the
market is well defined; if they fall, then identify main
substitute, widen market definition and restart
– Qualitatively: goods have the same characteristics, so
consumers view them as close substitutes. Producers
show similar technical capabilities (supply side
substitutes)
SSNIP, eksempel:
-UNA pizzeria øker prisen fra 180 per pizza til 200 kr, kun i Trondheim
- øker inntekten? <=> markedet er veldefinert
- senkes inntekten? <=> identifiser Unas substitutt, utvid markedsdefinisjonen og restart
(se både på geografisk område hvis mulig og produktmarketsdefinisjon(=markedet med alle produkter
som både er forbrukersubstitutter og forsynersubstitutter)
Kvalitativt: varer med like egenskaper, forbrukerne ser dem som erstatninger.
Produsenter viser lignende tekniske evner 5
Competition Authority imposes fines of 9.29
million euros to companies of the Galp Energia
group for anti-competitive practices in bottled gas
“In which market did the violation of competition rules occur?
Violation of competition rules by the companies of the Galp Energia group occurred
in the LPG (liquefied petroleum gas) bottled market. Bottled LPG, commonly
referred to as gas cylinders, is obtained from the refining of petroleum or natural
gas and is mainly used for domestic purposes in individual heating, hot water
production and cooking.
It is estimated that over 2 million Portuguese households purchase LPG in bottle,
supporting an invoice of around € 250 per year.”
"(...) the companies were prohibiting their bottled LPG distributors to sell outside
the geographical area defined in the contract, even when spontaneous orders from
consumers located outside their contract territory were made (passive sales). ”
6
Which is the relevant market?
In October 2019 the Laboratório de Patologia Clínica Hilário de Lima, S.A.

proposed the acquisition of São Lázaro Laboratório de Análises Clínicas, S.A.,
which provides clinical analysis in the Portuguese regions of Braga, Guimarães
and Chaves. The proponent operates in the markets of clinical analysis/clinical
pathology, cardiology, imaging, medical genetics, veterinary clinical pathology.
The notifying company proposes the clinical analysis market as the relevant
market for this concentration operation. The notifying company affirms that
the services provided by the notifier and by the acquired company are also
provided, in competition, by laboratories, clinics, private healthcare
institutions, social solidarity institutions (“IPSS”), private hospitals, and public
hospitals. The Health Regulatory Authority and the Competition Authority
state that public hospitals do not belong to the set of competitors.
According to the notifying company, the samples collected can be transported
to laboratories located at a significant geographical distance from the
collection point. Hence, the operators existing in the national territory exert a
significant competitive pressure over all operators. However, the regulator
considers that a 30-minute distance should be considered to determine the
area of influence of the providers.
7
8
What does market concentration tell us? market concentration tells us wheather
step 2, etter å definert relevant market:
the market is closer to perfect
Concentration competition or monopoly:

high conc <=> most sales for small
amount of firms
low conc <=> many small firms
• Having defined the relevant market, we can evaluate

concentration. This helps us tell whether the market
is closer to perfect competition or monopoly.
• A given market is highly concentrated if a large

fraction of total sales lies in the hands of a small
number of firms.
• The concentration degree depends on the number

and relative size of firms.
step 2, konsetrasjon på markedet:
høy konsentrasjon <=> stor salgsfraksjon for få firma <=> mer monopolistisk
lav konsentrasjon <=> stor salgsbredde for mange firma <=> perfekt konkurranse
9
Concentration
• Concentration indices should be:
– Easy to compute
– Independent of the market size
– Easy to interpret. For example, if the range is an
interval ( [0,1], or another) 0% -100%
• Concentration measures are related to
concentration curves
• A concentration curve describes the relation
between the accumulated percentage of the total
production/sales in the market and the
accumulated number of firms in the market,
ordered according to the firms’ size.
10
What do a concentration curve decribe? a conc. curve describes the relation between % of
How do we interpret the concentration of a markets in a concentration curve? total sales in the market & the number for firms
Concentration in the market, ordered according to the firms

size.
• The inequality in firms’ sizes is expressed by the

concavity of the concentration curve
her ser vi et sett med konsetransjonskurver
for ulike marked
y-akse: % av total produksjon
x-akse: antall firma som har gitt % av total
Siden A har mindre firmaer (kommet kortere produksjon
på x-aksen før den når 100%) er A den kurvene A,B,C og D: ulike market.
med konsentrerte, nærmest monopolistisk
av disse markedene Beskriver konkurranseformen for ulike
marked gjennom å vise konsetrasjonsnivå
• In this example market A is the most concentrated and D is the

least concentrated. In market D firms are symmetric (the
concentration curve coincides with the diagonal).
• The comparison of B and C is more difficult. B has less firms than
C (and than D, and more than A). We must compute the size of
the area between the respective concentration curve and the
diagonal. The market with the highest size is the more
concentrated one (is farther from the diagonal)
Jeg er usikker på hvilket areal de mener vi skal kalkulere i dette siste punktet, for å avgjøre hvilket marked
som er mest konsentert: HJELP, tegn inn i graf 11
tell 4 changes in firms can change the concentration index concentration index rises if..
1. big firm takes sales from little firm
Concentration 2. bigger firm than existing in market enters
3. merge of firms
decreases if..
4. small firm enters market
• In a good concentration index,

– a transfer of sales from a small firm to a large one
should increase the concentration index
– the entry of a small firm (keeping constant the relative
shares of the existing ones) should decrease the
concentration index, and the opposite in the case of the
exit of a small firm. (Note that the entry of a sufficiently
large firm may increase concentration)
– the merger of 2 or more firms should increase the
concentration index since the merger may be
decomposed as transfer of sales + exit of the smallest
firm in the merger
God konsentrasjonsindex <=> veldefinert konsindex
- den øker hvis et stort selskap overtar salg fra et lite firma
- den senkes hvis et lite firma inntar markedet, og vise versus
- den kan øke hvis et firma større enn de eksisterende firmaene i markedet entrer
- den øker vi 2 eller flere firma slår seg sammen 12
Some Concentration Indexes
høyere indeks <=> mer konsentrert
C_4 referer eks til hvor stor markedsandel de 4 største firmaene i markedet har av hele markedet
K
CK si eks C_4 = (S_1 + S_2 + S_3 + S_4) /total sale, hvor S = salg
i 1
where si is the market share of firm i, with firms

sorted in descending order according to share.
N
si=qi/Q, and Q q i , where N=total number of
firms. i 1
C4, C5 and C8 are the most widely used Ck. However

we shall opt for the most adequate in each market. The
higher Ck the more concentrated the market. These
indexes are insensitive to rank changes inside the group
considered or outside it.
eks neste side
13
C_5 = 84.4 %
<=> de fem største firmaene har 84.4% av salgene for hele markedet
K
CK si
i 1
• Ck is easy to compute since we only need

information on the k largest firms
• It is easy to interpret, since it takes values in
the interval [k/n,1], where k/n corresponds to
minimum concentration (n equal sized firms)
and 1 corresponds to maximum concentration
(monopoly)
14
How do u measure C_k?
What is the cons and pros of C_k?

kritikk mot C_k:
divide the number of firms sales on total sales
• Critics to Ck: k er vilkårlig valgt
pro: easy to compute & interpret
con: k is randomly chosen, only concider information from one
– k is arbitrarily chosen point of the concetration curve, & transfer of sales may not affect
– only considers information from one point of the

concentration curve. Markets B and C in the previous
figure, for instance, have different ranking depending
on the value chosen for k (C is more concentrated if
we take k<5, whereas B is more concentrated if we
take k>5)
– a transfer of sales may not affect the index. In the
example below, industry 1 is more concentrated than
industry 2, yet they both present the same C4. vi ser her at Industri
1 er mer
monopolistisk enn 2,
men med denne
forenklede metoden
fremgår ikke dette i
indeksen
15
How do u compute Herfindahl index (H) & Herfinhadl-Hirsman index (HHI)?
What does H & HHI range from and to, & what will be considerer a highly concentrated market for HHI?

N
2
Herfindahl-Hirshman index (HHI): H
i 1
s i
Takes into account all points of the concentration curve (it is

therefore harder to compute since one needs information on
all firms in the market – but we can approximate it if we don’t
have all the information) H går fra 0 til 1
H = 1 = høyeste konsentrasjon =
monopolistisk
The higher H, the more concentrated the market. H = 0 = laveste konsentrasjon =
perfekt konkurranse
H varies between 1/N (N firms of equal market share)

2
1 1
H N dette er Herfindahl Index (H)
N N
and 1 (just one firm, H=1).
H gives more weight to larger firms (in the formula the weight
to each market share is the market share itself).
Kalkulere HHI markedskonsetrasjon:
- du opphøyer % markedsandelene i andre for hvert firma i markedet og summere disse nummerne
eks: 4 firma, med 30%,30%,20%,20% : 30ˆ2 + 30ˆ2 + 20ˆ2 + 20ˆ2 = 2600
- eks, største verdi <=> monopol: HHI = 100ˆ2 = 10 000
- laveste verdi <=> mer konkurranse, kan nesten bli 0 i perfect competition, hvis vi har tusenvis av firmaer 16
- KEY POINT: Et market med HHI over 2000 kan ses på som HØYT KONSENTRERT
Hva er fordelenen med HHI ift de andre metpdene?
dette viser hvordan HHI er ye mer

presis ang.
konsentrasjonsnivå
på markedet enn
enn de andre metodene, siden den tar
hensyn til asymmetry:
de andre metodene tar ikke hensyn til at

en overføring av salg fra et mindre firma
til et større egentlig gjør markedet
mer konsentrert
c is a measure of market shares inequality. H can be expressed as a function

of c and n.
H thus takes into account not just the number n of firms,

Hence but also asymmetry among them, that is, the crossing with
H klarer å ta hensyn til at ét
firma har høy andel av hele the upper horizontal line in the concentration curve and its
markedet concavity, respectively. H depends positively on asymmetry
selv om totalt sett de eks 5
største firmaene tar samme del among firms and negatively on their number. 17
av kaka
1/antall
By comparing the value of H for a given market with 1/N firma
we get an idea of how far we are from a market

structure with N firms of equal size.
/
Normalized H: 𝑁𝑜𝑟𝑚𝑎𝑙𝑖𝑧𝑒𝑑𝐻 = Ranges between 0
/
and 1 (N>1)
Problems: i) H is a static measure; ii) how to compute it

when there are holdings and cross-participations?
18
Example of the English cement market in 1978:
But APCM had 26% of

Aberthaw, Tunnel was the
owner of Ribblesdale, etc…
If these cross shares represent
control, then we can build a
new table and compute the
true concentration indexes.
Så hittil har ingen av konsentrasjonsindeksene tatt hensyn til at enkelte firmaer kan ha
dels-eienskap til andre firmaer i samme markedet!
19
What does Adelman number tell us?

A = 1 / Herfindal indec (H_max)
• Adelman number (or equivalent number of

firms)= 1/H. Interpretation: number of equal sized
firms that would exist in a market with this value
for H. Compare with the number of existing ones
and draw conclusions.
Hvis markedet har flere selskaper enn tallet A <=> ikke veldig konsentrert, mer konkurranse
Hvis markedet har færre selskaper enn tallet A <=> konsentrert, mindre konkurranse
Samme som antall selskap <=> tallet H er representativt
• Facilitates the interpretation of the concentration

index. For example, H= 0.385 implies A=2.59 (this
means the market is as concentrated as a market
with 2.59 firms of equal size)
20
H klarer å ta hensyn til fordelingen av markedsanndel innenfor samme market. S_1 i industri 1 har 60% av markedet,
som reprenterer i en høyere H, selv om totalt stt de 8 største bedriftene i markedet totalt sett har samme prosentandel
av markedets totale salg
21
prosentandeler
C_4 = de 4 største firmaene angir x % av totalt market

C_8 = de 8 største firmaene angir x% av totalt market
HHI = hvor konsentrert markedet er fra 0 til 10 000. Hvis HHI er over 2000 er det høyt konsentrert
N = antall firma i markedet. Vi ser N er lav når HHI er høy og motsatt 22
Concentration
The value of the concentration measures depends crucially on the
definition of the relevant market.
Example:
The US Government had a case against IBM. The US Government
claimed that IBM had a dominant position in the mainframe market. In
1983 the market shares in this market were:
IBM 64%
konsentrasjonsverdien vil selvfølgelig avhenge
Burroughs 11% av hvilket market du ser på som relevant:
større market vil gi lavere konsentrasjonsverdi
Honeywell 6% enn små market
NCR 6%
Others 13%
IBM argued that its relevant market was data processing, which
included PCs. In this larger market its share was only 39%.
23
Concentration
Other examples:
Also: recall the Google example at the end of chapter 1.

24
Concentration
An example of the use of the H index in the European antitrust legislation
25
Relationship between market structure
(as measured by concentration) and
competition
– monopoly: a dominant firm (not necessarily just one); few

price competition, except when threat of entry is sufficient
to force incumbent firms to set low prices (H>0.6)
– perfect competition: many firms; the good is
homogeneous; perfect information; intense price
competition (the demand faced by each firm is horizontal);
if there are no barriers to entry, positive economic profits
drive new firms in and profits vanish (H<0.2; some
authors prefer H<0.1 or 0.15)
fra minst til mest konkurranse:
For monopolier <=> høy konsentrasjon <=> H> 0.6
For oiligopoly <=> 0.2< H< 0.6
For monopolistisk konkurranse <=> H < 0.2
For perfekt konkurranse <=> lav konsentrasjon <=> H< 0.2 26
competition
– monopolistic competition: many firms; differentiated product; the
demand faced by each firm is negatively sloped; entry may erode
existing profits (H<0.2 ; some authors prefer H<0.1 or 0.15)
– oligopoly: few firms of approximately equal size; the market
equilibrium depends on the way firms compete (prices, quantities
or other strategic variable) (0.2<H<0.6; some authors use
0.1 instead of 0.2)
markedsstruktur i form
av konsentrasjon
oppførsel
The level of competition (Conduct), connected with market
Structure, is one of the factors that determine Profitability.
(remember chapter 0)
27
competition
• However, market shares and concentration
measures are not always a perfect indicator
of market power.
• Although a high market share is usually
taken as evidence of market power, market
shares are imperfect indicators of market
power for instance if entry is easy.
Hvis markedet er lett å starte opp i, trenger ikke det ledende firmaet i markedet å ha mye makt
28
Volatility
Ustabilitet - indikator
Instability index
| |
0<𝐼 =∑ <1
I and H tend to be negatively correlated: in more

concentrated markets, market share stability is
higher. Jo høyere H, jo mer konsentert
Jo høyere I, jo mindre konsentrert
<=> motsatt sammenheng
<=> konkurransepregede markeder er mindre stabile
29
Volatility
Ii is important to study the determinants of industry concentration

and market share instability simultaneously. Industry concentration
should not be used as the sole measure of market structure and
competition. It may happen that concentration is high but so is
instability: in this case there is much competition, because firms are
frequently changing position.
30
0. Course presentation

(Hours/week: 2T + 1.5P)

Faculty
• Theoretical sessions: Thursdays, 10:30-12:30
(mcatalao@tecnico.ulisboa.pt)
• Problems sessions: Thursdays, 9:00-10:30

Inês Carrilho Nunes
(ines.c.nunes@tecnico.ulisboa.pt)
2
Course objectives
• This course covers business strategies in imperfectly
competitive markets, that is, in monopolies and in
oligopolies. For oligopolies emphasis is put on strategic
interaction and games. The course also covers the impact of
business decisions on consumers and, in this respect, the
role of regulators.
• Upon completion of the course students should be able to
i) understand business decisions in imperfectly
competitive markets and the corresponding social
impact,
ii) think strategically, and
iii) using logical reasoning, analyse with some formality
market equilibria, applying simple models.
3
Program
0. Course presentation
1. Revision of some principles in Microeconomics
2. Games and strategy
3. Definition of the relevant market and concentration measures
4. Dominant firm and monopolistic competition
5. Oligopoly: quantity competition without leadership; price competition
without leadership; quantity competition with leadership; price
competition with leadership; conjectural variations, other competing
variables and oligopoly solutions
6. Cartels, collusion and dynamic stability
7. Pricing strategies
8. Product differentiation
9. Market power
10. Entry and exit: barriers to entry; predation; mergers; free entry and social
welfare
11. Innovation
12. Networks
13. Competition Policy and Regulation
4
Basic Bibliography
• Introduction to Industrial Organization, Luís
Cabral, 2nd edition, 2017, MIT Press
• Economia Industrial, Luís Cabral, 1994,
McGraw-Hill Portugal
• A primer in Game Theory, Robert Gibbons,
1992, Prentice Hall
• Economia da Empresa, José Mata, 9ª ed.,
2016, Fundação Calouste Gulbenkian
5
Additional Bibliography (optional)
• Mergers and Acquisitions – The Industrial Organization Perspective, Duarte Brito
and Margarida Catalão-Lopes, 2006, Kluwer Law International
• Cases in European Competition Policy, Bruce Lyons ed., 2009, Cambridge University
Press
• Games and Decision Making, Charalambos Aliprantis, and Subir Chakrabarti, 2000,
Oxford University Press
• Modern Industrial Organization, Dennis Carlton and Jeffrey Perloff, 2005,
Pearson/Addison Wesley
• The Theory of Industrial Organization, Jean Tirole, 1991, MIT press
• Industrial Organization: A Strategic Approach, Jeffrey Church and Roger Ware,
2000, McGraw-Hill
• Industrial Organization – Theory and Applications, Oz Shy, 1995, MIT Press
• Industrial Organization – A European Perspective, Stephen Martin, 2001, Oxford
University Press
• Industrial Organization in Context, Stephen Martin, 2010, Oxford University Press
• Nonlinear pricing, Robert Wilson, 1993, Oxford University Press
• Economics, Organization and Management, Paul Milgrom and John Roberts, 1992,
Prentice-Hall
6
Assessment
• MAP30 in week 4 (October 21), worth 20%
+ MAP45 in week 11 (December 9), worth
40% + MAP45 in week 16 (January 27),
worth 40%.
• Alternatively, final exam on the 17th
February covering all the material and
replacing the whole grade. Exam
duration=2 hours.
7
What is Industrial Organization
• “Industrial” versus “Services” or “Primary
sector” (agriculture, fishery)
• Markets...
• ... but imperfectly competitive
• Cement industry, banking industry,
pharmaceutical industry, ...
• Advanced Microeconomics
8
• Microeconomics: extreme market structures
(perfect competition; monopoly)
• Industrial Organization: intermediate market
structures (oligopolies, more realistic) +
Regulation
• “Economics of imperfect competition”
• Focus on strategies: price competition, product
positioning, advertising, innovation, …
• Double perspective: the firm’s and the policy
makers’
9
Market Structures, from the most
competitive to the least
competitive
disse to ligner,
disse to ligner med unntak av siden det dominante bedriften dominerer nesten
produktdifferensiering (?) hele markedet, mens monopoly dominerer hele
PERFECT MONOPOLISTIC MONOPOLY

OLIGOPOLY DOMINANT FIRM
COMPETITION COMPETITION
intermediate (?) nummer av konkurrenter,
like i størrelsen
Monopolistic competition is similar to perfect competition, with the

exception of product differentiation, which already grants some degree of
market power. Dominant firm is close to monopoly (it’s not pure monopoly,
but almost). The intermediate one, with an intermediate number of
competitors which are similar in size, is oligopoly.
10
• Another double perspective: positive and
normative analysis.
– Positive analysis (how things are): is there market
power; which are the implications of it?
– Normative analysis (how things should be): what
policy makers can do about market power
11
• Important topics:
– Market definition (boundaries, players,
elasticities, ...)
– Margins
– Strategies
– Interaction
– Market power – the capacity to price above
marginal cost; acquire and maintain market
power to maximize firm’s value; impact on
consumers
rammer, spillere, elastisitet, marginer, strategier, interaction,
marketsledere, kapasitet til å prise over marginalcost; få og holde på marketskraft for å maksimere
bedriftens verdi; impact på consumers
12
• Important topics (cont.):
– Concentration and consolidation
– Efficiency losses or gains
– Market intervention/Competition Policy/Industrial
Policy
– Consumer welfare/social welfare
- konsentrasjon og konsolidatsjon (?)
- Effektivtetstap eller økninger
- marketspåvirkning / konkuransepolitikk / industriell politikk
- forbrukers welfare / social welfare
13
A few examples
14
15
cont’d
16
17
18
cont’d
19
20
21
22
23
24
https://www.androidauthority.com/nintendo-switch-vs-ps5-xbox-1142360/
August 20, 20220
25
Structure
Number of players
Market shares Exogenous betyr..
Entry conditions
Product characteristics
Vertical integration
Exogenous
Conduct betyr..
Conduct factors
Strategic behavior (pricing, Technology
advertising, R&D, ...) Demand (elasticity,
Collusion seasonality, ...)
Legal environment
Performance
Static and dynamic
efficiency
Profits
Welfare (equity) 26
• Game theory based approach
• Mathematical formulation of the problems
• Finding the solution(s)
27
• Fair play video (AdC):
http://vimeo.com/111244017
28
1. Revision of some principles in

Microeconomics

Basic microeconomic principles
• Demand and supply
• Elasticity
• Costs
• Equilibrium
• Surplus Surplus betyr..
• Competition
• Monopoly
2
• What Economics is about: how to efficiently
allocate resources to produce value
• Resources are scarce as compared with needs,
so agents face trade-offs and an opportunity
cost when they use the resources
3
• How do agents take decisions?
– Multiple objectives; constraints
• Tradeoffs:
– “There is no such thing as a free lunch”
– Taking a given decision implies that you must forego something
• Ex: to the beach or to the cinema?
• The cost of something is given by the value of the best
thing that you must give up to obtain it:
– Opportunity cost = value of the best alternative allocation
4
• Trade can benefit everyone:
– It allows each one to specialize in what he does best
• Markets are usually a good way of organizing production
• Main economic agents: firms, consumers, Government
• Economic agents respond to incentives
5
• Firms operate in one or more markets and
choose their strategies (marketing and others)
aiming at maximizing profits
• Any markets is characterized by those who, in

the same geographic space, intend to buy a
given good or service (D- demand ) and by
those who intend to sell (S – supply)
6
Demand
• From the combination of tastes (represented
by indifference curves) and budget
possibilities, we obtain the optimal basket for
consumers (where the highest indifference
curve is tangent to the budget line).
• A demand function is obtained that relates
the quantity demanded of a given product as
a function of its price and other variables.
7
Demand driving factors
• Factors that affect the quantity demanded of a
given good:
– Tastes: Preferences/Fashion/Culture
– Its price
– The price of related goods:
• substitutes
• complements
– Income
– Expectations
– Population structure
8
Demand determinants: Price
• Usually demanded quantity falls as price
increases (exceptions like some luxury goods)
• Law of demand: demanded quantity increases as

price falls. Two reasons:
– consumers who already acquire the good can buy more
quantity with the same level of available income (income
effect)
– and those who were buying other goods (substitutes) can
now start consuming this (substitution effect)
9
Demand determinants: Price
• How demanded quantity varies with price

depends on consumers’ sensitivity to price
changes
– Demand price elasticity
10
The demand curve
P
Q
P D D1: demand contracts
D D2: demand expands
D2
D
D1
Q
Movements along the curve: price and quantity change

Curve shifts: other determinants change
11
Demand determinants: substitutes
and complements
• Substitutes – when the price of good 1
increases, demand for good 2 increases
– Coca-cola vs Pepsi; (bottled water and tap water)
når cola øker prisen
kjøper flere pepsi
• Complements – when the price of good 1

increases, demand for good 2 decreases
– Computer and printer; car and gasoline Når pc-er øker i pris
kjøper færre printere
når biler øker i pris

kjøper færre diesel
12
Demand determinants: substitutes
pepsi sin etterspørselgraf endres som følge av at cola senker
prisen - mindre etterspørsel, selv om de holder samme pris
siden flere bytter til Cola Pepsi
Cola
Market 1 Market 2
cola senker prisen, og får høyere etterspørsel
da etterspørselgrafen deres er lik
før P1
etter P1’
før
D2
D1 D2’ etter
Q1 Q1’
Price in market 1 falls, demand in market 2 contracts.

(there was a change in quantity demanded in market 1 – movement along the curve; there was a change
in demand in market 2 – curve shift)
konlusjon:
hvis et substitutt senker prisen sin
vil etterspørselgrafen din gå ned, og omvendt
13
Demand determinants: complements
dette fører igjen til høyere etterspørsel av diesel,
og etterspørselsgrafen til diesel heves pga
høyere salg av bil fører til høyere forbruk av diesel
Bil Diesel
Market 1 Market 2
Prisen på en bil senkes. Etterspørselsgrafen er den samme
noe som fører til høyere etterspørsel av bilen
P1
P1’
D2’
D1 D2
Q1 Q1’
Price falls in market 1, demand expands in market 2.

Konklusjon:
Hvis et kompliment senker prisen, øker
etterspørselen hos begge. etterspørselsgrafen din går opp
14
Demand determinants: income
• As income increases
– demand increases – normal goods
• holiday trips; cars
– demand decreases – inferior goods
• software, music and movies’ piracy; fast food; own
brands; public transportation
Konklusjon:
når folk får mer penger bruker de mer penger på normale varer (både
esssentials og luksusprodukter)
De bruker også mindre penger på middelmådige eller lavkvalitetsprodukter
som software, musikk, fast food, public transport..
15
Demand determinants:
Preferences/Fashion/Culture
• Consumers are not all equal
– Some prefer red to blue
– Zara, Massimo Dutti, Bershka, Stradivarius,
Pull&Bear
– Some prefer ecological/bio products
– Fashion increases demand

Etterspørsel er også avh av markedets kultur og preferanser i smak, mote og trender..
16
Demand determinants: Expectations
• The decision to buy today is influenced by the
expectations concerning future prices
– Promotions
– Announcement of a gasoline price increase
– Computers’ price, mobile phones’ price, …
D2
D1 D
Q
etterspørsel avhenger også av forventninger knyttet til fremtidens priser; hvis markedet forventer
prisene å øke kraftig i framtiden kan de «sikre» seg varene nå. 17
Demand price elasticity
• Firms pay particular attention to their
consumers’ sensitivity to price changes, in
order to set their pricing policies
• How does demanded quantity vary when

price changes?
• Demand price elasticity is a measure of such

sensitivity hvor mye påvirkes forbrukerne dine av endringer i prisen?
= etterspørsel-pris-elastisitet
18
• Ratio between two proportional variations
• Elasticity ( ) = (∆% demanded Quantity) / (∆%
Price) for small changes in price
= forholdet mellom diff i mengde/ diff i pris
– Note: ε=
𝑑𝑄 𝑃
𝑑𝑃 𝑄
• Also: ε=
(because d(log x)=dx/x
19
On which factors does demand
price elasticity depend
– Preferences
– Type of the good / necessity degree
• Highly necessary
• Superfluous
– Weight in terms of budget
– Existence of substitutes
– Opportunity cost of the time needed to search for
alternatives
– Switching cost to a substitute
– Being a complement of other(s)
– Timing horizon
– In general, on the determinants of the demand for the
good under analysis
20
prisendring trenger altså ikke føre til umiddelbar etterspørselnedgang, da forbrukerne trenger tid for
å finne et bedre alternativ
21
• Demand Elastisk etterspørsel =
over 1.
isen er for høy,
folk kjøper ikke hvis pr
etterspørselnedgang
– Rigid or Inelastic prisøkning vil føre til
under 1.
uelastisk etterpørsel=
• Elasticity < 1 folk kjøper fortsatt ved
høy pris.
til etterspørselnedgang
prisøkning vil ikke føre
– “of unitary elasticity”

• Elasticity = 1
– Elastic
• Elasticity > 1
22
Elastisitet og selskapers inntekt
Elasticity and firms’ revenue

• When Elasticity < 1, if the firm increases price revenues
increase
• When Elasticity = 1, if the firm increases price revenues do
not change
• When Elasticity > 1, if the firm increases price revenues
decrease
Note: profit=revenues-costs
elastisitet under 1 = uelastisk = selskaps inntekt øker ved prisøkning
elastistet over 1 = elastisk = selskap inntekt senkes ved prisøkning
Elastitet lik 1 = selskapets inntekt er stabil ved prisøkning
23
Elasticity and firms’ revenue
• Demand curves where quantity responds differently to the
same price change:
mindre endring i etterspørsel for samme prisnedgang
hvis kurven er brå
P0
P1
DA
DB
Q0 Q1 Q0 Q1
More elastic More rigid
mer elastisk uelastisk
• Quantity’s response depends on the curve’s slope and on the departing

point.
24
Ved endringer i produkter i ulike
prisklasser kan samme person ha ulik
sensitivitet til prisendringer
25
Selected estimated demand price elasticities (USA)
Good/service Price elasticity

Elastiske
Peas 2.80 produkter =
Lottery 1.90 folk kjøper kun
ved gode priser
Taxis 1.24
Furniture 1.00
Shoes 0.70
Legal advice 0.61 Uelastiske produkter =
folk kjøper uavh. av
Health insurance 0.31 pris
Bus travel 0.20 (essentilas)
Home electricity 0.13
Samuelson 18e
© 2005 McGraw-Hill Interamericana de España.
Todos os direitos reservados
26
Cross-price elasticity
Kross- priselastisitet = et mål på om et produkt er et substitutt eller kompliment
Positiv (+) = subsitutt = etterspørsel
• Positive: goods are substitutes går ned hvis substitutt senker pris
Negativ (-) = etterspørsel går opp hvis
kompiment senker pris
• Negative: goods are complements den deriverte av opprinnelig mengde mhp ny pris
* (ny pris /opprinnelig mengde)
ELLER
𝑑𝑄1 𝑃2 %diff av mengdeetterspørsel av 1
ε12 = / %diff av prisendring av 2

ELLER
𝑑𝑃2 𝑄1 (ny mengde - opprinnelig mengde)/snittmengde
/
(ny pris - opprinnelig pris)/snittpris
, der snitt = sum / 2
• Example: cross price elasticities between

different car models
Eksempelvis kan man gjøre kross-pris elastisitet mellom ulike bilmodeller..
vil prisnedgang i én teslamodell øke eller senke etterspørselen av andre teslamodeller??
27
Income elasticity
inntekstelastisitet:
• Negative: inferior goods

(-) : dårligere produkter
(+): normale produkter
(0,1): necessitites
(1+): luksusprodukter
• Positive: normal goods (den deriverte av mengden mhp inntekt)
*(inntekt/mengde)
– Lower than 1: necessities ELLER
– Greater than 1: luxury goods (nytt behov - opprinnelig behov)

/ (nytt + opprinnelig behov) /2
/
𝑑𝑄 𝑌
η= (ny inntekt - opprinnelig inntekt)/
𝑑𝑌 𝑄 (ny + opprinnelig inntekt) /2
ELLER
%diff i mengdeetterspørsel
/ %diff i inntekt
28
både pris og etterspørsel kan synke samtidig,
Puzzles eks pga inntekt hos forbrukere
• It may happen that price decreases and so

does consumption. This does not necessarily
mean an upward sloping demand curve,
because other factors (income, for instance –
recall income effect and substitution effect)
may have changed as well.
• See gasoline demand application (LC, pg 25-
26)
29
Demand curve estimation
• Several approaches
– Collect data from who has bought what and at what
price (example: customer card records)
Some difficulties
• separate price effect from the effects of other determinants
• identification problem: market data results from the
combination of demand and supply forces
– Surveys
– Experiments
– Use general ideas on elasticity related with the good
nature (exs: specific or not; luxury or necessity; long
or short term; …) etterspørselkurve- estimering:
- samle inn data for hvem som har kjøpt hva, og til hvilken pris
(vanskeligpga ulik priseffekt fra effekter fra andre beslutninger,
samt identikasjonsproblemer)
- surveys
- eksperimenter 30
- elastitetsideer relatert til produktets natur
Consumers’ rationality
• If consumers’ rationality fails, there is room to complement
standard economic theory with behavioural economics.
• For the (small) percentage of consumers that behaves
irrationally, use behavioural economics.
• Behavioural economics (and the associated neuroeconomics)
is the result of the integration of concepts from psychology
and economics and uses experiments to describe the players'
choices. It is primarily positive theory, whereas classical game
theory is mainly normative, pinpointing the decisions players
should take under the assumptions made.
• Example: according to experiments, consumers are more
sensitive to losses than to gains.
31
Consumers’ rationality
• Other example: additive consumption is a form of irrational
behaviour. A smoker who wants to kick his habit is described as two
people in conflict, one who wants a long life and another one who
loves tobacco. Instead of a single self taking decisions, dual-self
models propose an explanation for time inconsistency and
hyperbolic discounting, that is, the fact that players prefer a smaller
amount today than a higher amount tomorrow, but when faced with
the same prospective choice to happen in a year from now they
prefer the higher amount. This explanation is based on the idea that
there is a short-term self who wants to drink, smoke, etc., and, at the
same time, a long-term self who wants to be healthy.
• In contrast, other authors argue that economics tools can be

appropriately applied to addictive behaviours. The formation of
wants is the field of the psychologist, the economist investigates the
consequences of any given set of wants.
32
Supply determinants
forsyning
• Which factors drive supply?

– Cost of production factors - negatively
• wages, raw-materials’ prices, interest rate, rents
– Technological progress - positively
– Expectations of future price changes
– Competition
man forsyner mindre med høye produksjonskostnader,
slik som lønn, materialpriser og renter
og mer med teknologisk fremgang
forventninger om fremtidige prisendringer/kostnadsendringer påvirker også, samt konkurranse
33
The supply curve
P S Når prisen øker minker mengden produsert
Når prisen senker øker mengden produsert
Q S S1: supply contracts

pris / produksjonskostnader?
S1 S S2: supply expands
P S
S2
produksjonsmengde
Q
Movements along the curve: price and quantity change
Curve shifts: determinants change
34
Some costs
• Fixed costs: costs in which the firms incurs,
independently of the quantity produced (ex: set up
costs; office rent)
• Variable costs: increasing in quantity (ex: raw

material) Fixed cost: faste kostnader som leie, set up cost osv
Variable costs: kostnader som varierer med produksjonsmengde
som råmaterialer
• Total costs = FC+VC Sum av begge to
35
Some costs
• Marginal cost: the change in total cost
when quantity produced increases by one
unit
Marginal cost: endring i totale
kostnader når produsert mengde
Total øker med én enhet
Cost TC
Total cost graf starter med fixed cost,
og øker med Q (produksjonsmengde)
FC
Q
Marginal
Cost Marginal cost graf - vi ser altså at
MC marginal cost ikke er kostant
men avh av mengden
Q* Q
36
A parenthesis…
• Economic analysis is marginal: marginal cost
versus marginal benefit
• In order to decide, compare the increase in
cost and the increase in revenue
• A profit optimizing firm chooses the quantity
for which marginal cost and marginal revenue
are equal marginal cost: kostnad for å øke med én enhet
marginal benefit: inntekt for å øke med én enehet
sammenlign økning i kostnader og inntekt:
Profitoptimiseringsselskap velger produksjonsmengden, som gir
lik marginalkost som marginalinntekt
37
Gjennomsnittlig kostnad: hvor mye det gjennomsnittlig koster å produsere en enhet
= totale kostnader(aka fixed + variable) / produksjonsmengde
Some costs
• Average (or unitary) cost: how much it costs,
on average, to produce each unit.
• AC=TC/Q
• Average cost=average fixed cost + average variable cost. The average
fixed cost is always decreasing in Q; the average variable cost may be
increasing or decreasing.
AC
Gjennomsnittlig fixed cost minker med
menke, siden MC
totale fixed cost er den samme og vil
MC
fordeles på flere enheter.
Average variable cost kan både øke og AC
senkes
Q
38
Marginal versus average costs
vi bruker disse for ulike formål:
• Marginal costs serve to decide the level of

production
• Average costs serve to compute the profit
level and decide whether to produce or not
39
for å besktibe hvordan input blir output bruker vi isoquants, som er ulike kombinasjoner av input som gir like level
output, kan både være lineær (substituerbart) og rettvinklet (kompementerbart)
Production function
• How inputs are transformed into outputs
• Mathematical relationship that can be graphically
represented by isoquants (different combinations
of inputs that yield the same level of output)
• Two extreme cases:
– linear isoquants = perfect substitutability between
inputs
– Isoquants forming a 90o angle = perfect
complementarity between inputs
40
Production function
?
• Example of intermediate case: Cobb-Douglas

function with convex isoquants
• Law of diminishing marginal returns
41
Production: Costs and Technology
• The quantity employed of some production factors
may be adapted more quickly and easier than the
quantity of others mengden ansatt i enkelte deler av produksjon er enklere å tilpasse
enn andre: eks antall arbeidere VS anleggsdimensjon
Number of workers versus plant dimension
• Short run: not all production factors can be adjusted

according to the firm’s needs
– Ex: training of specialized employees
• Long run: sufficiently long, so that all production

factors can be adjusted according to the firms’ needs
man trenger tid for å tilpasse seg enkelte behov, eks kurs for spesialiserte arbeidere
42
Scale economies
• In the long run, costs may grow:
– proportionally to quantity (constant returns to
scale)
– more than proportionally (decreasing returns to
scale or scale deseconomies)
– less than proportionally (increasing returns to
scale or economies of scale), a case in which
average cost is decreasing
Én av tre typer økonomier man kan operere under:
scale: man ser hvordan kostnader øker ift mengde, kan brukes hvis demand er høyt nok; minimum efficent scale er
mål på minste demand man kan ha for at dette er effektivt.
scope: Den felles produksjonskostnaden for to eller flere produkter er lavere enn summen av de separate
produksjonskostnadene
Experience: snittkostnader synker i akkumlert tidligere produksjon. come out av erfaring og kunnskap. gir det 43
sittende bedriften en fordel, og kan hindre entries..
Scale economies
Average Cost economies deseconomies
= kostnader øker mer enn
of scale of scale proposjonalt med mengden
AC
inntil dette punktet går gjennomsnittlig kostnader per produkt

produsert ned med økende produksjonsmengde
As long as demand is large enough, it is not necessarily a bad choice to operate

under scale deseconomies.
Minimum efficient scale: minimum quantity for which scale economies are
exausted Economies of scales are showing (marginal cost (=the cost of producing one
additional unit) descreased as the volume of output increases. They have high fixed
cost and low marginal cost, and the strong scale economies in book publishing
imply that the gap between price & marginal cost is particularly high. 44
Scope economies
Den felles produksjonskostnaden for to eller flere produkter er lavere enn summen av de separate produksjonskostnadene
Eksempler: Såpe, sjampo, balsam, dusjgel, Elektrisitet til husholdningsbruk og til industrielle formål - Togruter, Banker, Sykehus
Årsaker: markedsføringsøkonomi, FoU, levering, leverandørrabatter, ...
• The joint production cost of two or more products is

lower than the sum of the separate production costs
Examples
– Soap, shampoo, conditioner,
Tekst
shower gel
– Electricity for domestic use and for industrial purposes
– Train routes
– Banks
– Hospitals
Reasons: marketing economies, R&D, provisioning,

suppliers’ discounts, … research & development
45
Experience economies
• Experience economies are learning
economies. Average cost decreases in
accumulated past production
• Come out of accumulating experience and

know-how
• Give the incumbent firm an advantage and

may be a barrier to entry
46
47
Profit maximization?
• Usually managers’ objectives are different
from those of shareholders
• Agency problems
• However, market correction mechanisms
(such as manager’s reputation, market
competition, capital markets and takeovers)
tend to ensure that firms don’t depart much
from profit maximization
48
49
The market equilibrium occurs in the intersection
of the demand and supply curves
marketsprisdemand: behovkurve Supply: tilbudskurve
Excess supply = demand

shortage
overflødig tilbud = mangel på etterspørsel
= marketslikevekt: her er etterspørsel og tilførsel lik
Excess demand = supply

shortage
Overflødig etterspørsel = mangel på tilbud
produksjonsmengde
Samuelson 18e
© 2005 McGraw-Hill Interamericana de España.
Todos os direitos reservados
eks her har vi «Excess supplu, og har produsert mer enn

markedet ønker
50
Market equilibrium
Supply
• S expands S S’ Q and P New market equilibrium
• S contracts S S’’ Q and P New market equilibrium
Demand
• D expands D D’ Q and P New market equilibrium
• D contracts D D’’ Q and P New market equilibrium
S’’
S S
S’
D’
D D’’ D
hvis tilførsel øker, øker mengden og prisen senkes
hvis tilførsel senkes, senkes mengde og prisen øker
Hvis ettersprøsel øker, øker mengden og prisen

Hvis etterspørsel senkes, senkes megnden og prisen
51
Alle dissene endringene i tilførsel og etterspørsel gir nye «market equilibirum», som er intersection -punktene over
Gains from trade
• Consumer surplus: area below the demand curve and above the
gevisten
equilibrium price. Represents the gain consumers derive from the forbrukerene får fra
transaksjonen
transaction (difference between the maximum price they were

willing to pay and the market price)
• Producer surplus: area above the supply curve and below the
equilibrium price. Represents the gain that producers derive from
the transaction (difference between the market price and the
minimum price at which they were wiling to sell). It is an
approximate measure of profit
pris
dette er grafen for pris avhengig av solgt mengde
P ( QˆD) , som du får ved å løse Qˆd mhp P
P CSS :Supply = tilførsel
gevinsten forbrukere får fra transaksjon:
max-pris
(max.pris – markedspris)*behov fra market / 2,
Der max.pris = pris ved 0 solgte enheter (sett inn 0 i Qˆd)
CS
Equilibrium price Pe consumer surplus
= pris som reflekter Producer surplus PS: gevinsten produsenter får fra transaksjonen.
likevekt mellom (markedspris - minstepris)* behov fra market / 2
tilbud og etterspørsel PS
= også lik total profitt = pris*mengde - pris*MC
(denne må vi regne for monopolist, DF og CF hver for seg)
minstepris D demand = etterspørsel
quantity
Qe Q 52
Competitive markets
• Usual firm’s objective: profit maximization
• Profit level depends on the market structure
• Competitive market / monopolisitic competition /

oligopoly / dominant firm / monopoly
profitt level avhenger av konkurranseforholdene for bedriften
53
54
Competitive markets
• In a perfectly competitive market no firm is able to
influence the market’s equilibrium (P or Q):
– many small firms
– product homogeneity
– no entry or exit barriers (production factors perfect long-
term mobility)
– perfect information (all agents know the same and this is
everything)
Consumers acquire from the firm which sells at the lowest price.
Each firm is so small as compared with the entire market that its
quantity choice does not influence the market price. So, each
firms takes price as a given (it is “price-taker”) and then chooses
the quantity to produce: this is its unique decision.
Perfect competivite markets: ingen bedrifter kan påvirke likevekstpunktet mellom markedspris og mengde
mange små bedrifter med like produkter, ingen entry eller exit barrierer, og alle har all info
produksjonsmengden deres påvirker ikke markedspirs (som er gitt), og må velge produksjonsmengde 55
Competitive markets
• Market demand is negatively sloped, but
demand faced by each firm has zero slope.
P P
prike- taker. konstant marketspris, så produksjonsmengden
til hvert firma påvirker ikke prisen de kan tilby
Demand faced by a single firm

Market demand
Q Q
i det store bildet, med alle aktørene på markedet,
vil marketsprisen senkes ut ifra antall produkter på markedet
56
Competitive markets
• How does a firm in a competitive market chooses its
optimal quantity:
first derive the firm’s supply curve from its MC
curve, then for given P (resulting from the market
equilibrium of aggregate demand and aggregate
supply) quantity is determined.
• For any firm in a competitive market we have that

MR=P (because P is a given, that is, it does not change
with the firm’s quantity, so d(PQ)/dQ=P and hence profit
maximization occurs at P=MC). først utlede bedriftens tilførselskruve fra
markedskruven, så for den gitte markedsprisen,
er mengden gitt
57
Competitive markets
• Each firm’s supply curve corresponds to the upward part of its MC
curve. Why? Because for any given P dictated by the market, the
firm’s optimal decision is to produce Q such that MC(Q)=P. If the firm
would produce more than that, its MC would be higher than the price
obtained; in turn, if the firm would produce less it would still have the
opportunity to profitably produce more.
pris
MC The MC curve gives us, for
MC(Q2)>P1 each P, the optimal production
of the firm: this is an optimality
relation between P and Q, that
P1
is, a supply curve.
MC(Q3)<P1
mengde
Q3 Q1 Q2 Q
her ser vi den optimale produksjonsmengden for hver pris 58
Competitive markets
• The declining zone of the MC curve is irrelevant for the
supply curve, because the firm may profitably increase its
production (MC<P).
MC
vi ser at det er to produksjonsmengder som begge gir samme

markedspris. Vi kan øke til Q*!
Q4 Q* Q
59
Competitive markets
• Market supply correponds to the horizontal aggregation of
individual supply curves.
• For 10 firms:
MC i = Si Market supply
Qi 10 Qi = QT Q
hver firmas produksjonsmengde Total produksjonsmengde
60
Competitive markets
• The market price comes from the equilibrium between
aggregate demand and aggregate supply. At that price
each firm produces Qi and total quantity is QT. If P>MCi
then each firm profits:
profit=[P-AC(Qi)]Qi>0
S MC i
ACi
P* P*
AC (Qi)
D
QT Q Qi
Market Firm
61
Competitive markets
• So new firms will enter (ex: banks after the legislation change that allowed
privates to operate). This is the long-term movement.
• Aggregate S moves outwards, P decreases and so do profits. QT rises, but Qi
decreases because P falls (hence the increase in QT comes from the higher
number of firms in the market). Equilibrium is reached when economic
profits become null, that is, when P=MCi=min ACi.
S MC i
ACi
S’
P* P*
QT Q Qi
Market Firm
62
Competitive markets
• These cost curves include the opportunity cost of
all production factors. Hence, economic profit=0
means that the firm’s capital is being remunerated
at the very same level it would obtain in the best
alternative, so does not move to another sector
and the market is stable.
• Zero economic profit does not mean zero
accounting profit.
• If there is excess entry firms will bear losses, so
some of them will decide to exit. Market supply
contracts and P rises until a new equilibrium is
reached.
63
Competitive markets
• In case of demand contraction, P falls, firms present negative profits, so
some of them leave. Then aggregate supply contracts, P rises and the
market reaches a new equilibrium, with a lower QT, Qi is the same but
there are less firms.
S’ ACi
MC i
S
S’
loss i form av mindre tilførsel.
D loss
D’
Q
Market level Firm level
• To determine price, use the MC curve; for profit or loss, use the AC curve.
Bestemme ny pris: bruk MC kurve
proftt/tap = AC kurve 64
Competitive markets
• In an industry where the good is homogeneous,
there are no barriers to entry and information is
perfect, so firms can not sustain positive economic
profits for long. So they will try to differentiate, set
up entry barriers and/or“create” imperfect
information (ex: financial markets).
• But then what is the aim of addressing this market

structure?
65
Competitive markets
benchmark:
referanseindeks
en standard eller et referansepunkt som ting kan sammenlignes eller vurderes mot.
• Look at it as a benchmark
• Perfectly competitive markets are efficient because:
– they are statically efficient
• the quantity produced is such that the production cost of
the last unit exactly matches its valuation by consumers
(allocative efficiency) P=MC short run supply in competitive market is given by this
price = marginal cost, hvor MC is derivative av TC
• production occurs at the minimum cost (technical or

productive efficiency) P=minimum AC
– they are dynamically efficient, because they promote
improvement of products and production techniques
Fullstendig konkurransedyktige markeder er effektive fordi:
- de er statisk effektive
• mengden som produseres er slik at produksjonskostnaden for den siste enheten nøyaktig samsvarer med forbrukerens verdsettelse
(allokativ effektivitet) P = MC
• produksjon skjer til minstekostnad (teknisk eller produktiv effektivitet) P = minimum AC 66
- de er dynamisk effektive fordi de fremmer forbedring av produkter og produksjonsteknikker
Competitive markets
• Fundamental theorem: in a competitive market
the equilibrium output and price maximize total
surplus
• Role of the Government: take measures to
increase competition
Grunnleggende teorem: i et konkurransedyktig marked maksimerer likevektsproduksjonen og prisen det totale overskuddet
• Regjeringens rolle: iverksette tiltak for å øke konkurransen
67
Competitive markets
• Sunk costs: irreversible, no matter what the company does
• What changes in factor mobility when we distinguish sunk
from non sunk costs? Firms do not leave the market as soon
as they face negative profits
• They exit when revenues are inferior to nonsunk costs, that

is, when price falls below the minimum of the nonsunk
average cost.
• Sunk costs are irrelevant for firm’s decisions.
Senkede kostnader: irreversible, uansett hva selskapet gjør
• Hvilke endringer i faktormobilitet når vi skiller sunket fra ikke -sunkede kostnader?
Bedrifter forlater ikke markedet så snart de står overfor negativ fortjeneste
• De går ut når inntektene er dårligere enn ikke -sunkede kostnader, det vil si når prisen faller under minimum av den ikke -sunke
gjennomsnittskostnaden.
• Senkede kostnader er irrelevante for firmaets beslutninger.
68
Competitive markets
• When some of the costs are sunk, the price level above
which new firms enter is not the same as the price level
below which playing firms exit. There is a price interval
inside which no entry or exit movements occur.
AC
MC
Nonsunk AC irreversible
P1
P2
• Når noen av kostnadene senkes, er prisnivået som nye firmaer kommer over ikke det samme som prisnivået
under hvilket spillfirmaene går ut. Det er et prisintervall der det ikke skjer noen inn- eller utstigningsbevegelser.
69
Competitive markets
• Usually firms in the market are differently efficient
(heterogeneous). For a given price, they produce different
quantities. The most efficient, having special management
skills that cannot be imitated or any other comparative
advantage, will have a positive economic profit, even in
the long-run and survive (competitive selection).
AC 1
MC 2
MC 1 AC 2
P
2
Q1 Q2
70
Monopoly
• Firms use to possess some capacity to influence the
market price (this capacity is called market power).
This means that they face a non horizontal demand
curve. Possible reasons for this: few firms, no close
substitutes, imperfect information, barriers to free
allocation of production factors, network
economies.
• Firms try to differentiate the good they are selling

(physical characteristics, points of sale, image,
bonuses, ...), in order to enjoy some market power.
Bedrifter bruker litt kapasitet til å påvirke markedsprisen (= kalles markedsmakt).
Dette betyr at de står overfor en ikke -horisontal etterspørselskurve
Mulige årsaker til dette: få bedrifter, ingen nære substitutter, ufullkommen informasjon, barrierer for gratis tildeling av
produksjonsfaktorer, nettverksøkonomier.
• Bedrifter prøver å differensiere det gode de selger (fysiske egenskaper, salgssteder, image, bonuser, ...)
71
for å få litt markedsmakt.
pris
Monopoly
her ser vi at B er større kloss
enn A og inntekt går opp
P1 P2 loses A but wins B, Revenue
P3 P4 loses C, wins D, Revenue her ser vi at C er større enn D,
P1 inntekt går ned
A
P2
B
P3
P4 C B/C C
B D mengde
Q*=quantity that maximizes Revenue

Q* Q
vi ser at det finnes enn mengde som maksimerer inntekt
72
Monopoly
• A monopolist firm will never sell above Q*,
because costs rise and revenue declines. So it will
choose Q<=Q*, depending on costs.
• Marginal revenue: MR= R/ Q

In continuous terms, it is the change in revenue as
quantity sold increases marginally.
Et monopolfirma vil aldri selge over mengden som maksimerer inntekt
, fordi kostnadene stiger og inntektene synker. Så den vil velge Q <= Q*, avhengig av kostnader
(enten mindre eller lik mengden som maksimerer inntekt) .
• Marginal inntekt: MR = differanse i inntekt / differanse i mengde
I kontinuerlige termer er det endringen i inntekt ettersom mengden solgt øker marginalt.
73
Monopoly
• As Q rises, MR>0 but declining; is zero at the Revenues maximum
(point above which the firm does not want to increase production)
and becomes negative.
R
Q*
MR
Monopolies vil alltid produsere innenfor denne mengden
Q*
74
Monopoly
• MR=dR/dQ=d(aQ-bQ2)/dQ=a-2bQ
When D is linear, MR presents the same intercept with the vertical axis as
D and double slope. MR= Marginal revenue = Marginal inntekt
- Når D (etterspørsel) er lineær, presenterer MR
det samme skjæringspunktet med den vertikale aksen
som D (etterspørsle) og dobbel skråning.
a
P = a - bQ
D
MR
a/2b a/b
• MR is related with (demand elastiticy):

𝑑𝑅 𝑑(𝑃𝑄) 𝑑𝑃 𝑑𝑄 𝑑𝑃 𝑄 1
𝑀𝑅 = = = 𝑄+𝑃 = 𝑃+𝑃 =𝑃 1−
𝑑𝑄 𝑑𝑄 𝑑𝑄 𝑑𝑄 𝑑𝑄 𝑃 𝜀
75
Monopoly
inntekt.. etterspørsel elasticiticy
Elastisk etterspørsel = over 1.
𝑀𝑅 > 0 ⇔ 𝜀 > 1 MR marginal inntekt over 0
folk kjøper ikke hvis prisen er for høy,
𝑀𝑅 < 0 ⇔ 𝜀 < 1 prisøkning vil føre til etterspørselnedgang
𝑀𝑅 = 0 ⇔ 𝜀 = 1 uelastisk etterpørsel= under 1.

MR marginal inntekt under 0
folk kjøper fortsatt ved høy pris.
prisøkning vil ikke føre til etterspørselnedgang
>1
=1
<1
MR D
Firms enjoying some market power will not operate in the
inelastic part of demand, because for that set of values they
can increase profits if they reduce Q (revenue increases and
costs decrease).
76
Monopoly
pris > average cost
• >0 iff R>TC, which is equivalent to P>AC

TC totale kostnader
R inntekter
MC
AC
P1
D
AC1
MR
Q1 77
Monopoly
• The firm must take into account the effect of
a change in Q over P: if Q is increased, P must
fall and it may not be worth.
• It is worth if MR>MC, so the firm will increase
Q up to the point where MR=MC (maximum
distance between TC and R, parallel tangents
to the two curves). In this way one
determines Q1.
• =(P1-AC1)Q1, where P1 is taken from the

demand curve and P1-AC1 is the profit margin
per unit sold.
Firma må ta hensyn til effekten av en endring i Q over P: hvis mengden økes, må prisen falle, ikke alltid gunstig..
- Det er verdt hvis Marginal inntekt > Marginal kostnad, så firmaet kan øke mengden opp til punktet der MR = MC
(maksimal avstand mellom TC og R, parallelle tangenter til de to kurvene). På denne måten bestemmer man Q1. 78
pi = (P1-AC1) Q1, hvor P1 er hentet fra etterspørselskurven og P1-AC1 er fortjenestemarginen per solgt enhet.
Monopoly
• However, from a social point of view, the
efficient decision is to produce Q such that
P=MC (production cost of the last unit=valuation
of the last unit). When firms enjoy some market
power, MR is different from P and the optimal
firm’s choice (MR=MC) yields Q below the
socially efficent level. Price is higher.
Fra et sosialt synspunkt er imidlertid den effektive beslutningen å produsere mengden Q slik at pris P = Marginal kostnad MC
(produksjonskostnad for den siste enheten = verdivurdering av den siste enheten).
Når bedrifter nyter en viss markedsmakt, er marginal inntekt MR forskjellig fra P pris
og det optimale firmaets valg (MR = MC) gir mengden Q under det sosialt effektive nivået. Prisen er høyere.
79
Monopoly
• In the interval [Q1 , Q*] there are consumers
willing to pay for this good more than it costs
producing it, however they do not have access to
it due to the firm’s market power.
MC
(Q*, P*) is the social
optimum
P1 AC
P*
D
AC1
MR
Q1 Q*
I intervallet [Q1, Q*] er det forbrukere som er villige til å betale for denne varen mer enn
det koster å produsere den, men de har ikke tilgang til den på grunn av firmaets
markedsstyrke. HÆ? hvorfor vil ikke de selge det for denne prisen¿¿
80
fixed cost
Monopoly variable costs
• FC do not influence the firm’s choice of Q and P (VC do, because MC depends
on them). FC just influence the profit level (because they enter AC) and hence
the firm’s choice on whether to produce (Q>0) or not.
TC
FC (Fixed cost) påvirker ikke
firmaets valg av mengde Q og
pris P (variable cost VC gjør,
fordi marginale kostnaderMC
er avhengig av dem). R
FC påvirker bare
overskuddsnivået (fordi de
går inn i AC =average cost )
og dermed firmaets valg om
de skal produsere (Q> 0) eller AC
ikke. MC
AC
P1
D
MR
81
Q1
Monopoly
• Recall that 𝑀𝑅 = 𝑃 1 −
• MR=MC, so 𝑃 1 − = 𝑀𝐶 marginal revenue (inntekt) = marginal cost
and hence 𝑃 = 𝑀𝐶
The higher the demand elasticity, the less the firm is able to
profit from market power, since it is compelled to set a lower P
(recall that >1, because firms will not choose to operate in the
inelastic area of D).
82
Monopoly
• P-MC=mark-up is larger the less elastic is
mark - up = tillegg lagt til på prisen for å få profit
D. tillegget er større jo mindre elastisk etterspørsel er,
altså jo mindre påvirkelig markedet er for prisøkninger
𝑃 − 𝑀𝐶 1
• Price-cost margin = 𝑃
=
𝜀
in a
monopoly
It is a measure of the degree of market

power.
83
Monopoly
• Objectives:
– for the firm, maximize profit
– for the managers, maximize own welfare,
which is also a function of wages and fringe
benefits, as well as status. If managers are
stockholders their own objectives become
more aligned with the firm’s (agency
problems).
Mål:
- for firmaet, maksimere fortjenesten
- for lederne, maksimer egen velferd, som også er en funksjon av lønn og frynsegoder, samt status.
Hvis ledere er aksjonærer, blir deres egne mål mer i tråd med firmaets (byråproblemer).
84
Monopoly
• Managers who want to maximize sales (for prestige
motives or because they receive some comission on
sales) produce more than would be optimal for the firm.
To sell this higher quantity, price must fall
TC
R
Firmaer ønsker å maksimere inntekt:
Q that maximizes profit
Managers kan også ønske å masimere salg:
Q that maximizes sales
Q that maximizes Q that maximizes

profit sales
• Firms with market power produce less and charge a
higher price than competitive firms
85
Monopoly
• Objections to market power:
a) generates a welfare loss
b) genetares X inneficiency
c) generates expenses related with acquiring
and maintaining market power (noninformative
advertising, lobbies, capture, …)
• Innvendinger (protest/ motargument) mot markedsmakt:
a) genererer et velferdstap (neste side)
b) genetares X ueffektivitet (s:90)
c) genererer utgifter knyttet til å skaffe og opprettholde markedsmakt
(ikke -informativ reklame, lobbyer, fangst, ...) (s:92)
86
Monopoly
a) generates a welfare loss:
• Welfare is measured by producer and consumer
surplus
• Social welfare is the sum of both
• Market power implies a social welfare loss, because
only part of the consumer welfare loss is transfered to
producers (as profit).
• This social welfare loss is the main reason for
competition policy and for the existence of regulatory
bodies that intend to restrict market power.
a) genererer et velferdstap:
• Velferd måles etter produsent og forbrukeroverskudd (Sosial velferd er summen av begge)
• Markedsmakt innebærer et sosialt velferdstap, fordi bare en del av forbrukerens velferdstap overføres til produsenter (som fortjeneste)
• Dette tapet av sosial velferd er hovedårsaken til konkurransepolitikken og til eksistensen av reguleringsorganer som har til hensikt
87 å
begrense markedsmakten.
Monopoly
• Under perfect competition the equilibrium would be (Q2,P2).
Under market power it is (Q1,P1).
forbrukeroverskudd begoldt
CS - Consumer surplus kept
CS - Consumer surplus transferred to

P1
the producer forbrukeroverskudd overført til produsent
P2 SWL MC SWL – Social welfare loss (because in
[Q1 , Q2 ] the marginal valuation of each
unit is larger than the cost of producing it,
D
MR but these units are not produced). Also
called Harberger triangle (only a tringle
Q1 Q2 when D and MC are linear) or excess
burden.
SWL - Tap av sosial velferd (fordi i [Q1, Q2] er den marginale verdsettelsen av hver enhet større enn kostnaden for å produsere den,
men disse enhetene blir ikke produsert).
Også kalt Harberger -trekant (bare en tringle når D og MC er lineære) eller overdreven belastning. 88
Monopoly
• The SWL represents allocative inefficiency
• But monopoly power also implies a transfer from
consumers to firms
SWL representerer allokativ ineffektivitet
• Men monopolmakt innebærer også en overføring fra forbrukere til bedrifter
89
Monopoly
b) generates X inneficiency:
• Market power reduces competitive pressure and
allows unnecessary expenses - X inneficiency.
The firm operates above the minimum cost
curve, so Q is lower and P is higher than in the
absence of X inefficiency.
• This is productive inefficiency.
b) genererer X inkludert:
• Markedpriskraft reduserer konkurransepresset og tillater unødvendige utgifter - X inkludert.
Firmaet opererer over minimumskostnadskurven, så Q er lavere og P er høyere enn i fravær av X ineffektivitet.
• Dette er produktiv ineffektivitet.
90
Monopoly
Lost surplus mistet overskudd
Profit obtained Lost profit mistet fortjeneste

PX
from consumer P
surplus MC X
fortjeneste fra
forbrukeroverskudd MC
Dispersed profit
spredt fortjeneste D
MR
QX Q
The difference between MCX and MC is the amount that managers and
employees misappropraite, per unit sold. A poorly managed firm (usually
quoted below its potential) is a good target for acquisition.
Forskjellen mellom MCX og MC er beløpet som ledere og ansatte misforstår, per solgte enhet.
Et dårlig administrert firma (vanligvis sitert under potensialet) er et godt mål for oppkjøp.
91
Monopoly
c) generates expenses related with acquiring
and maintaining market power (lobbies, …)
• To enjoy a market power position, firms are willing to
spend (in lobbies, public opinion campaigns, studies and
reports, ...) up to the amount that they will earn with the
position. This is known as the capture problem. This
expense does not imply a social welfare loss, it is just a
transfer from some agents (the firm) to others.
• Some legal barriers grant incumbents market power (ex:
licenses). Firms are willing to spend resources to sustain
this position. This is called rent seeking.
Noen juridiske barrierer gir etablerte markedsmakt (f.eks. Lisenser).
Bedrifter er villige til å bruke ressurser på å opprettholde denne posisjonen. Dette kalles leiesøk.
92
Monopoly
• Out of the three objections to market power
presented, a) is the most serious because b)
can be corrected by the market (the firm is
acquired by another one) and c)
corresponds to a transfer from some agents
to others.
93
Monopoly
• Many utilities (electricity, telephone, …)
have been privatized or open to
competition, so are no longer good
examples of monopolies. But there are
others.
• Whether a given market can be considered a
monopoly depends on the definition of that
market itself, and this is related with the
existence of substitutes and demand
elasticity.
94
Application I
95
Application II
96
Application II (cont.)
97
Application III
PHARMACIES WILL RECEIVE PREMIUM FOR SELLING GENERICS
It will be 15 cents for every euro of white-label drugs sold. The goal is to
increase market share.
Pharmacies will receive 15 cents for every euro of generic drugs they sell. The
financial incentive given by the Ministry of Health aims to increase the share
of white-label medicines. The measure that has been under discussion with
the National Pharmacy Association since last year will advance next Monday.
According to Health Minister, Paulo Macedo, in a first stage the goal is to

transform the almost 47% of the market share of generics in Portugal into
50%. “What we want is to reach 50% now and then move to 60%”, said Paulo
Macedo.
Published 2015-02-03
98
Application IV
EASYJET STARTS NEW ROUTE BETWEEN PONTA DELGADA AND LISBON ON
MARCH 29
The company will offer three weekly flights and tickets from € 32.49.
“EasyJet will start flying on March 29 on an A320 aircraft, initially three days
per week, Tuesday, Thursday and Sunday, with a fourth frequency after June”,
stated Javier Gandara at the presentation of the airline's operation in Ponta
Delgada, Azores.
EasyJet's Iberian director said tickets will go on sale on the airline's website
starting Wednesday, with a price of 32.49 euros per trip.
On October 31, the National Civil Aviation Institute informed all air carriers
that the Government decided to liberalize air transport between Terceira
Island and the mainland, as well as between Ponta Delgada (Airport João Paulo
II) and the continental territory, i.e. the routes Lisbon/Ponta Delgada/Lisbon,
Lisbon/Terceira/Lisbon, Oporto/Ponta Delgada/ Oporto and
Oporto/Terceira/Oporto.
Another low-cost airline, Ryanair, also announced last Friday that it will start
flying to the Azores from April 1st, offering trips between Ponta Delgada,
Lisbon, Oporto and London for a total of 20 weekly flights.
99
Application IV (cont.)
EASYJET STARTS NEW ROUTE BETWEEN PONTA DELGADA AND LISBON ON MARCH 29
For the Azorean Secretary of Tourism and Transport, Vítor Fraga, the entry of new operators
does not diminish the challenges faced, instead increases the responsibility of all, in order
to respond with quality, innovation, creativity and responsibility to this growth potential.
The Secretary of State for Infrastructure, Transport and Communications, Sérgio Monteiro,
stated that before the liberalization of the two routes in the Azores (S. Miguel and Terceira)
there was in the archipelago “a kind of invisible barrier which, for reasons of social and
even political nature, was impossible to transpose until now”.
For Sérgio Monteiro, more than that “it has been worth the effort started in 2012 and
continued until now.”
100
Application IV (cont.)
IT IS NOT JUST EASYJET. RYANAIR WILL ALSO FLY TO THE
AZORES
Route liberalization will streamline the destination.
The Government has decided to assign trade routes to the Azores to two low-
cost airlines. After EasyJet announced yesterday that it would make the
connection between the mainland and the island, today is Ryanair's turn to
confirm that it will also be presented in the Azores archipelago.
101

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Industrial Organization

2021/22, 1st Semester

Margarida Catalão Lopes

• Market power is measured by the Lerner

where p is a price vector.

If total cost can be split into n costs,

– if the monopolist is selling substitutes (eij>0), the

• It is clear from the formula that the degree of

• The conjectural variation g: expectation of the rivals’

• Other values for g: as g decreases (increases),

• All other things equal (ceteris paribus), the

• Ceteris paribus, the higher the demand elasticity,

2021/22, 1st Semester

Margarida Catalão Lopes

Hotelling model consumer perception (the role of

(American mathematical statistician

• Setting a switching cost different from the rivals’

Switching costs are often pointed out as a reason for

• Consider a setup similar to the one shown for

However, hidding information about prices

• Informative advertising (describe the product; fitted especially for

• Advertising as an investment in brand equity.

• Higher concentration implies that the firm benefits more from

2021/22, 1st Semester

• In a perfectly competitive market, the law of one

• Non-linear pricing: the average price paid per unit

• Testing for the existence of price discrimination:

– identify buyers who value the product differently

• Price discrimination is commonly seen as unfair (although the

• The existence of transport costs also makes it difficult to

• Until now we have seen discrimination along the curve.

• Another way for the company with market

• Exs : electricity, water, gas, taxis, sports

• But to buy Q1 consumers would be willing to pay A + B + C, so the

• The company may choose to offer a price menu and then

• This practice is useful in situations of asymmetric

• This menu pricing may be implemented in

• Low-valuation consumers get zero surplus, high-

There are different demands, but the firm is not able

P1 and P2 are the optimal prices for

• This practice is related with asymmetric valuations

• The stronger the impact of P1 over market 2

• In many cases the company should not

• Penetration pricing: start with a low price when launching the

• Price skimming: start with a high price and sell

• Prices with learning economies: price goes down

The decision of the capacity to be installed has to do

4. Dominant firm and monopolistic

2021/22, 1st Semester

• Pure monopolies are hard to find. But markets

h=elasticity of the supply of the fringe

FOC=first order conditions

• So we conclude that the existence of a competitive

Follower’s supply, S(p)

q f * qD* qT* Quantity

2021/22, 1st Semester

• Neither does the monopolist firm interact: it sets

• There exists interaction among firms when they are

• Game Theory: a tool employed to analyze strategic

– quantity leadership – Stackelberg model

• Equilibrium: point at which neither firm in the pursuit of

• Consider two firms producing a

• Given q2e, firm 1's F.O.C. is

• Each firm takes the quantity set by its competitors as a given,

• The equilibrium is a set of outputs (q1, q2) such that each

This yields q1=12, q2= 6, p=16, p1=144, p2*=72