MW20.1 Advanced Microeconomics

Holger Graf

Lehrstuhl fur MikrookonomikFriedrich-Schiller-Universitat Jena

Winter 2017-18

Two courses in one

MW20.1a (course no. 55878)

Corresponds with the study and examination regulation of 2010, therefore 3 ECTS areawarded (examination no.: 310711)

MW20.1 (course no. 128079)

Students who would like to take advantage of the new study and examinationregulation of 2016 have to register under the new examination number 313261 for 6ECTS.

Holger Graf MW20.1 Advanced Microeconomics, Winter 2017-18 2

Course Organisation

I Lecture: Thursday 16:15 17:45, HS 8

I Tutorial: Friday 12:15 13:45, HS 7

I Grading: Midterm exam (MW20.1) and final written exam (MW20.1 andMW20.1a)

I Midterm exam (45 min.): tbd

I Exam (60 min.): Tuesday, March 6 2018, 10:00 12:00, HS 1 Physics

I Consultation: Tuesday 10:00 12:00, Room 5.21

I Email: holger.graf@uni-jena.de

I Slides: http://www.microtheory.uni-jena.de/teaching/courses/advanced-microeconomics/

I Literature: is announced for each chapter

Holger Graf MW20.1 Advanced Microeconomics, Winter 2017-18 3

http://www.microtheory.uni-jena.de/teaching/courses/advanced-microeconomics/http://www.microtheory.uni-jena.de/teaching/courses/advanced-microeconomics/

Outline

Part I Strategic Decisions and Oligopoly

Part II Decisions under Uncertainty and Asymmetric Information

Holger Graf MW20.1 Advanced Microeconomics, Winter 2017-18 4

Part I

Strategic Decisions and Oligopoly

Introduction

Oligopoly with Homogeneous Goods

Oligopoly with Product Differentiation

Cartels

Research & Development

Holger Graf MW20.1 Advanced Microeconomics, Winter 2017-18 5

Literature

I Church, J., Ware, R. (2000), Industrial Organization, Boston: McGraw-Hill.

I Dasgupta, P., Stiglitz J. (1980), Industrial Structure and the Nature ofInnovative Activity, Economic Journal 90, 1980, 266-93.

I Kreps D.M., Scheinkman J.A. Quantity Precommitment and BertrandCompetition Yield Cournot Outcomes, The Bell Journal of Economics 14(2),1983, 326-337

I Shy, O. (1995), Industrial Organization, Cambridge (Mass.): MIT Press.

I Tirole, J. (1988), The Theory of Industrial Organization, Cambridge (Mass.):MIT Press.

Holger Graf MW20.1 Advanced Microeconomics, Winter 2017-18 6

Introduction

Strategic Decisions and Oligopoly

Introduction

Oligopoly with Homogeneous Goods

Oligopoly with Product Differentiation

Cartels

Research & Development

Holger Graf MW20.1 Advanced Microeconomics, Winter 2017-18 7

Introduction

Industrial Organisation I

Subject matter

I Industrial Organization = IO

I . . . broadly defined as the field of economics concerned with markets thatcannot easily be analyzed using the standard textbook competitive model(Richard Schmalensee)

Characteristics

I Analysis of the interaction between market and firmsI Firms maximise their profitsI Households are considered via demand functionI Analysis of market equilibrium under market power

I Partial analytical (interdependencies with other markets are disregarded)

I Theoretical basis for competition policy and regulation of markets

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Introduction

Industrial Organisation II

I Perfect competition as unrealistical ideal case because of the followingassumptions:

I Many suppliers and customers (atomistic market structure)I Homogeneous goodsI Complete informationI No transaction costsI Infinite reaction timeI Maximisation (utility-/profit maximisation)

Topics

I Competitive conduct in oligopoly

I Firms product choice

I Cartels

I Research & development

I Market entry and exit

Always: focus on strategic conduct

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Introduction

Traditional Industrial Organisation

I Empirical orientation (descriptive, case studies)

I SCP-paradigm: (SCP = structure-conduct-performance)

basic conditions: consumer demand, production, elasticity of demand, tech-nology, substitutes, raw materials, seasonality, unionization, rate of growth,product durability, location, lumpiness of orders, scale of economies, methodof purchase, scope economies

Structure (S) - Conduct (C) - Performance (P)

- number of buyers andsellers

- barriers to entry- product differentiation- vertical integration- diversification

- advertising- research & development- pricing behavior- plant investment- legal tactics- product choice- collusion- merger and contracts

- price- production efficiency- allocative efficiency- equity- product quality- technical progress- profits

I Criticism: onesided causal process from S over C to P

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Introduction

New Industrial Organisation

I Stronger theoretical focus increasing level of abstraction

I Strategic interaction between market actors explicit mutual dependency of decisions

I Game theoretic modeling game theory

I Inclusion of dynamic elements endogenising market structure as a result of conduct and performance(feedbacks between S, C and P)

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Introduction

Game Theory I

Subject matter

I Analysis of interdependent decisions:

The optimal result for an actor is not only dependent on its own actions but alsoon decisions taken by other actors, who themselves strive for an optimal result(interactive decision theory, strategic situation)

I Short:

Interdependency of decisions between rational actors;

These interdependencies are recognised and incorporated by all actors

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Introduction

Game Theory II

Elements of the game

I Playersi I = {1, . . . , n}

I Strategy for player i (in strategy space Si)

si Si

I Strategy profiles = (s1, . . . , sn) = (si, si) ,si = (s1, . . . , si1, si+1, . . . , sn)

I Reward function for player i

ui (s) = ui (si, si)

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Introduction

Game Theory III

Nash equilibrium

I Definition:An outcome is said to be a Nash equilibrium if no player would find it beneficialto deviate provided that all other players do not deviate from their strategiesplayed at the Nash outcome.

I Formally:

s = (si , si) with ui (s

i , si) ui (si, si)si Si (i I)

Subgame perfect (Nash) equilibrium

I Definition:A strategy profile is a subgame perfect equilibrium if it represents a Nashequilibrium of every subgame of the original game. More informally, this meansthat if (1) the players played any smaller game that consisted of only one part ofthe larger game and (2) their behavior represents a Nash equilibrium of thatsmaller game, then their behavior is a subgame perfect equilibrium of the largergame.

I Games with complete information are solved through backward induction

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Oligopoly with Homogeneous Goods

Strategic Decisions and Oligopoly

Introduction

Oligopoly with Homogeneous GoodsBertrand-OligopolyCournot-OligopolyStackelberg-OligopolyComparison

Oligopoly with Product Differentiation

Cartels

Research & Development

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Oligopoly with Homogeneous Goods Bertrand-Oligopoly

Bertrand Model I

Model framework

I Market for a homogeneous good q, produced by two firms (duopoly)

I Quantity supplied by firms 1 and 2: q1 and q2 with aggregate supply

q = q1 + q2

I Firms 1 and 2 produce with constant marginal costs c1 and c2

I Price competition:simultaneous decision concerning prices p1 and p2

I Atomistic demand with demand-function

D (p) , D (p) < 0, D (c) > 0

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Oligopoly with Homogeneous Goods Bertrand-Oligopoly

Bertrand Model II

Equilibrium

I Basic Idea: Consumers always buy from the cheapest supplier

(1 0, 2 0, 1 + 2 = 1)

I Firm-specific demand for firm i:

Di (p1, p2) =

0 for pi > pj

iD (pi) for pi = pjD (pi) for pi < pj

with i, j = 1, 2 (i 6= j)

I Profit function of firm i:

i (p1, p2) = (pi ci) Di (p1, p2) , i = 1, 2

I Conduct: each firm chooses the profit maximising price taking the price of thecompetitor as given

Nash equilibrium:(pb1, p

b2

)with 1

(pb1, p

b2

) 1

(p, pb2

)2

(pb1, p

b2

) 2

(pb1, p

)p

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Oligopoly with Homogeneous Goods Bertrand-Oligopoly

Bertrand Model III

Two cases

Duopoly with identical marginal costs: c1 = c2 = c

I mutual underpricing leads to pb1 = pb2 = c

competitive market equilibrium (zero profits)

Duopoly with different marginal costs: c1 < c2

I mutual underpricing now leads to pb1 = pb2 = c2

Profits only for firm 1

1(pb1, p

b2

)= (c2 c1) 1D1

(pb1, p

b2

)

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Oligopoly with Homogeneous Goods Bertrand-Oligopoly

Bertrand Model IV

Could firm 1 increa