Q.
Characteristics of a perfectly competitive market:
A perfectly competitive market is characterized by several key
features:
1. Many Buyers and Sellers: There are a large number of
buyers and sellers, none of whom have significant
market power to influence prices.
2. Homogenous Products: Firms sell identical or nearly
identical products, meaning consumers perceive no
difference between the goods offered by different
sellers. Q. Trade Agreements and Nash Equilibrium
3. Free Entry and Exit: Businesses can enter or exit the The payoff table for the United States and China is as
market without significant barriers or costs. follows (first value = U.S. payoff, second value =
4. Perfect Information: Both buyers and sellers have China's payoff):
complete and accurate information about prices,
China: Low Tariffs China: High Tariffs
products, and market conditions.
[Link] Takers: Individual firms and consumers must accept the
market price as given, as they are too small to influence it. U.S.: Low Tariffs $45,000, $45,000 $80,000, $20,000
U.S.: High Tariffs $20,000, $80,000 $30,000, $30,000
Q. Peter's Market Power and Profit Maximization: (i) U.S. dominant strategy
Peter's demand and marginal revenue equations are given as: If China chooses Low Tariffs, U.S. prefers Low
Demand: Tariffs ($45,000 > $20,000).
If China chooses High Tariffs, U.S. prefers Low
P=80−8Q
Tariffs ($80,000 > $30,000).
Marginal Revenue: Thus, the U.S. always prefers Low Tariffs,
MR=80−16Q regardless of China's choice.
Marginal Cost: (ii) China's dominant strategy
MC=40 If U.S. chooses Low Tariffs, China prefers Low
i. Does Peter have any market power? How can you Tariffs ($45,000 > $20,000).
tell? If U.S. chooses High Tariffs, China prefers Low
Yes, Peter has market power. We can tell this because his demand Tariffs ($80,000 > $30,000).
curve (P=80−8Q) is downward-sloping. In a perfectly competitive Thus, China also always prefers Low Tariffs.
market, a firm's demand curve would be perfectly elastic (iii) Nash equilibrium
(horizontal). The fact that marginal revenue ( Both countries choose their dominant strategy: (Low
MR=80−16Q) is different from price and declines at a faster rate Tariffs, Low Tariffs) with payoffs ($45,000,
than the demand curve further indicates market power. $45,000).
ii. What is Peter's profit-maximizing quantity? (iv) Is the Nash equilibrium Pareto optimal?
To find the profit-maximizing quantity, Peter should set Marginal No, because both countries could be better off
Revenue (MR) equal to Marginal Cost (MC). with High Tariffs ($30,000 each) if they could
MR=MC coordinate to avoid the prisoner’s dilemma.
80−16Q=40 However, without cooperation, they are stuck in a
16Q=80−40 16Q=40 Q=1640 suboptimal equilibrium.
Q=2.5
So, Peter's profit-maximizing quantity is 2.5 units.
iii. What price should Peter charge at that profit-
maximizing quantity?
To find the price Peter should charge, substitute the profit-
maximizing quantity (
Q=2.5) into the demand equation.
P=80−8Q
P=80−8(2.5) P=80−20
P=60
Therefore, Peter should charge a price of $60 at the profit-
maximizing quantity.