Chapter Outline

The Cournot model assumes that competitors keep quantity fixed.
1. A demand and reaction curve can be derived for each firm.
2. Total output will be greater than a monopolist would produce, and price will be lower than the monopoly price.
The Bertrand model assumes that competitors keep price fixed, but price competition will inevitably lead to a competitive solution.
The Stackelberg model assumes that a firm expects its competitor to act like a Cournot duopolist, and responds strategically.
Game theory helps to explain how firms will act in an interdependent situation.
1. The prisoner's dilemma example illustrates how dominant and non-dominant strategies affect choices.
2. In joint profit-maximizing situations the game is between the cooperators and the defectors to the agreement.
3. Advertising strategy provides an example of how interdependence leads to decisions predicted by game theory.
4. A Nash equilibrium can occur when one firm has a dominant strategy, even though the other firm does not.
5. The tit-for-tat strategy promotes stability in business decisions.
6. Sequential games require that credibility be established or doomsday devices be implemented.
Contestable market theory separates sunk costs from fixed costs to show how entry, even with high fixed costs, is a likely deterrent to monopoly type behaviour.
The spatial model of monopolistic competition focuses on distance as a characteristic of a product that influences demand.
1. The example of providing the optimal number of restaurants in a circular community shows that consumers consider transportation costs in addition to the meal cost in deciding which restaurant to patronize.
2. The optimal number of restaurants occurs where the increased cost per meal, because of smaller output per establishment, is just equal to the travel cost reduction to the consumer because the restaurant is closer.
The product characteristic approach applies to characteristics other than distance.
Increasing returns to scale may or may not lead to a monopoly supplier in the industry.
The role of advertising as a determinate of consumer preference has been overplayed by some of those who accept Galbraith's revised sequence model.
(Appendix) In markets with decreasing cost two firms may coexist due to the potentially ruinous consequences for any firm trying to drive out its competitor. Although a merger between the two firms is often the best solution from the standpoint of both firms, anti-competitive regulations usually restrict such strategies.
(Appendix) The cost of variety is likely to be borne by those most able to bear the higher cost of differentiated production.
(Appendix) Brand proliferation by a firm, even when there are no discernible differences among its brands, may be profitable in that it may induce consumers to switch from a competitor’s brand.

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