Microeconomics

Lecture 10
Petr Špecián, Ph.D.
Mail: [email protected]
Office hours: see InSIS
Stackelberg Oligopoly
Sequential games with a leader and a follower
are von Stackelberg games

Heinrich von Stackelberg (1905-1946) was a

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Stackelberg Games
Sequential games can be solved using backward induction
Q: What is the best response of the follower, firm B?
#$%&'!
A: Choose 𝑞! = 𝐵𝑅! 𝑞" =
$
Firm A knows this, anticipates B’s reaction

The leader makes a profit at least as large as its C-N equilibrium profit

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Stackelberg Duopoly

𝒒𝑩
Follower’s B-R

𝐶
𝑞',%
𝜋#,%
𝑞',&
𝑆
𝜋#,&
𝑞#,% 𝑞#,& 𝒒𝑨
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Price Competition
What if firms compete using price-setting
strategies?
• Games in which firms use only price
strategies and play simultaneously are
Bertrand games

Joseph Bertrand (1822-1900) was a French

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Bertrand Games
Assumptions:
• Each firm’s MC is constant at level ‘c’
• Homogeneous output
• Firms simultaneously set their prices
• No capacity constraint for the firms

→ Nash equilibrium where P = MC, i.e. P = c

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Bertrand Games
‘Proof’, part I:
• Suppose one firm sets its price higher than another firm’s price
• Then the higher-priced firm would have no customers
• Therefore, at an equilibrium, all firms must set the same price
‘Proof’, part II:
• Suppose the common price set by all firms is higher than marginal cost c
• Then one firm can just slightly lower its price and sell to all the buyers,
thereby increasing its profit
• Hence, the only common price which prevents undercutting is equal to c
(this is the only Nash equilibrium)

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Bertrand Paradox
Nash equilibrium of the Bertrand model is the same as the perfectly
competitive outcome
• 𝑃 = 𝑀𝐶, 𝜋 = 0
→ Bertrand Paradox: Could competition be so tough with only two
firms in the market?

Beware! Paradox is not very general - sensitive to assumptions

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Chapter 13
Input Markets I: Pricing

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Week #11: Reading
Compulsory: NS Chapter 13

10
Demand for Inputs

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Marginal Productivity Theory of Input
Demand
Input prices, too, are determined by the
forces of supply and demand
• Firms: demand side; households: supply
side
• Theory of input demand relies on Ricardo’s
theory of marginal productivity
• David Ricardo (1772—1823) was an English
economist

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Profit-Maximizing Behavior: Inputs
𝜋-max: hire more of any input 𝑖 until 𝑀𝑅( = 𝑀𝐸(
• 𝑴𝑬𝑲 , 𝑴𝑬𝑳 … marginal expense of hiring capital and labor
• Often called ‘marginal factor cost’ (𝑴𝑭𝑪)

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Profit-Maximizing Behavior and the Hiring of
Inputs
𝑴𝑹𝑲 , 𝑴𝑹𝑳 … extra revenue from hiring an additional unit of capital,
labor
• 𝜋-max:
𝑀𝐸) = 𝑀𝑅)

𝑀𝐸* = 𝑀𝑅*

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Price-Taking Behavior
Price taking in the input market:

𝑣 = 𝑀𝐸) = 𝑀𝑅)

𝑤 = 𝑀𝐸* = 𝑀𝑅*

• 𝑣… rental rate
• 𝑤… wage rate

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Marginal Revenue Product
Marginal revenue product of labor or capital (𝑀𝑅* , 𝑀𝑅) ) is the extra
revenue obtained from selling the extra output generated by hiring an
extra unit of labor or capital

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Marginal Revenue Product
Marginal product (𝑀𝑃) is additional physical product associated with
the extra unit of input
Marginal revenue (𝑀𝑅) is additional revenue an extra unit of output
brings in

𝑣 = 𝑀𝐸) = 𝑀𝑅) = 𝑀𝑃) ∗ 𝑀𝑅

𝑤 = 𝑀𝐸* = 𝑀𝑅* = 𝑀𝑃* ∗ 𝑀𝑅

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A Special Case—Marginal Value Product
If the firm is also a price taker in the goods market, 𝑀𝑅 = 𝑃
• Then,

𝑣 = 𝑀𝑃) ∗ 𝑃

𝑤 = 𝑀𝑃* ∗ 𝑃

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Marginal Value Product
Marginal value product (𝑀𝑉𝑃) of capital and labor is a special case of
marginal revenue product in which the firm is a price taker in the
output market

For a price taker in both input and output market therefore:

𝑣 = 𝑀𝑉𝑃)

𝑤 = 𝑀𝑉𝑃*

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Changes in Input Prices: Short Run
SR: fixed capital and variable labor

Labor will exhibit diminishing marginal physical productivity →

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Changes in Input Prices: Single Variable Input
Case
MVPL
Wage 𝑀𝑉𝑃)

𝑤! = 𝑀𝑉𝑃"!
𝑤*
𝑤# = 𝑀𝑉𝑃""
𝑤(

𝐿* 𝐿( Labor (person-hours)
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Changes in Input Prices: Long Run
LR: all inputs are variable
Substitution effect (SE): response to a change in the input’s relative
price
Output effect (OE): results from a change in the firm’s output level

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Decrease in Price of Labor (Long Run)
𝐾
𝑤′ 𝑤! < 𝑤
𝑆𝑙𝑜𝑝𝑒 = −
𝑤 𝑣
𝑆𝑙𝑜𝑝𝑒 = −
𝑣
𝑤′
𝑆𝑙𝑜𝑝𝑒 = −
𝐾* 𝐸 𝑣
𝐹
𝑆𝐸 𝐾(
𝑂𝐸 𝐴 𝑞(
𝑞*

𝐿* 𝐿( 𝐿
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𝑆𝐸 𝑂𝐸
Decrease in Price of Labor: Output Choice
𝑃 𝑀𝐶
𝑀𝐶’

𝑃0

𝑞1 𝑞2 𝑞 24
Response of Input Demand to Price Changes
The size of the SE will depend upon:
1. How easy it is to substitute other factors of production for labor
2. The length of time period

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Response of Input Demand to Price Changes
The size of the OE will depend upon:
1. How large is the decrease in 𝑀𝐶 brought about by the 𝑤 decrease
• Depends upon how important labor is in production
2. What will happen with 𝑃 and 𝑄-demanded in the final market
• Depends upon the price elasticity of demand for the final product

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Input Supply

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Input Supply
Resources come from three major sources:
• Labor is provided by individuals
• Capital equipment is produced by firms for other firms to buy or rent
• Natural resources are extracted from land and can be used outright
or sold

Capital and natural resources have upward-sloping supply curves, what

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Allocation of Time
People must choose how to allocate their available fixed time between
work and other activities

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Labor Supply and Wages
For individuals, wages represent the opportunity cost of not working
at a paying job

Individuals will balance the rewards from working against the psychic
benefits of other, nonpaid activities – leisure

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A Simple Model of Time Use
Assume:
1. Two uses of time: (paid) work and leisure
2. 𝑈 = 𝑈(𝐶, 𝐻)

𝐶 … consumption of market goods

→ indifference map

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A Simple Model of Time Use
The opportunity cost of leisure is the real wage rate determined in the
market, i.e., the consumption given up
• An extra hour of leisure costs one hour’s wage (𝑤)

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Utility from Leisure and Work
𝑆𝑙𝑜𝑝𝑒 = −𝑀𝑅𝑆
Consumption
(𝐶)

𝑈3
𝑈(
𝑈*

𝐿𝑒𝑖𝑠𝑢𝑟𝑒 (𝐻) 34
Constraint
Enjoy up to 24 hours of leisure by not working
→ horizontal intercept

Working, you can spend up to 24 ∗ 𝑤 on consumption

Slope of the constraint = −𝑤

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Utility-Maximizing Choice of Leisure and Work
𝑆𝑙𝑜𝑝𝑒 = −𝑤
𝐶
24 ∗ 𝑤 𝑀𝑅𝑆 = 𝑤

𝐴
𝐶∗
𝑈3
𝑈(
𝑈*

𝐻∗ 24 𝐻 36
Substitution Effect of a Change in Wage (𝒘)
Substitution effect of a change in 𝑤
• ↑𝒘 → ↑OC of leisure → motivates an individual to work more

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Income Effect of a Change in Wage (𝒘)
Income effect of a change in 𝑤
• If leisure is a normal good, higher income will increase the demand for
it → ↑𝒘 motivates an individual to work less

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Substitution & Income Effect: Increase in
Wage
𝑆𝑙𝑜𝑝𝑒 = −𝑤′
𝐶
𝑆𝑙𝑜𝑝𝑒 = −𝑤
𝑤′ > 𝑤
24 ∗ 𝑤′
𝑀𝑅𝑆 = 𝑤′
𝑀𝑅𝑆 = 𝑤
𝐶*∗ 𝐹
24 ∗ 𝑤 𝐴
𝐸 𝑈(
𝐶5∗
𝑈*

𝐻*∗ 𝐻5∗ 24 𝐻
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