Nash Equilibrium And Dominant Strategies In Oligopoly Markets

Economies of Scale in Market Types

Discuss About The Nash Equilibrium And Dominant Strategies?

Economies of scale are the benefits a firm obtains from expansion. In other words, as a company grows and increases production, the company is likely to experience a decrease in its costs. Economies of scale play a significant role in forming market types such as oligopoly and monopoly. An oligopoly is a market type that consists of only a few sellers or producers. The small number of firms in an oligopoly are capable of producing at a lower average cost an output level that forms a considerable portion of the whole available market. The auto industry is a good example of an oligopoly that gains from economies of scale.

Economies of scale can also form a monopoly, a market structure consisting of only one seller of a specific product. The single dominant firm in a monopoly is capable of producing at a low average cost at a given output level that is sufficient to meet the product demand of the entire market. The electric power industry is an example of a monopoly that benefits from economies of scale. On the other hand, there is no scope for economies of scale in a perfect competition because of the many small firms producing relatively little amounts, thus no one firm benefits from large-scale production. Similarly, a monopolistic competition, which consists of firms selling differentiated products, can lead to saturation of firms, which means that players are unable to make the most of the economies of scale (Referenceforbusiness.com, 2017).

In 2002/03, the airline industry was operating as an oligopoly with only a few players in the industry. For instance, Qantas Airways Group and Virgin Blue Airlines were the two major players in the airline industry in Australia. The two firms controlled the three major categories in the industry: domestic trunk, regional, and international (Aph.gov.au, 2017). An oligopoly market situation consists of a few interdependent companies sharing the market. The actions and reactions of competitors are taken into account when forming decisions. Furthermore, there exist few barriers to entry and exit. Also, oligopolies thrive on customer loyalty hence heavy advertising is the mantra (Agarwal, 2017).

A mutual benefit by Qantas and Virgin could be established in a Nash equilibrium strategy. Nash equilibrium is a term coined after John Nash a mathematician who described an equilibrium scenario whereby each participant wins because they derive the outcome they desire. If no participant changes their strategy, then a Nash equilibrium is achieved. For instance, Qantas and Virgin could adopt a cost-plus pricing strategy as a pricing rule. In this method, a firm determines its cost of production and then adds the desired profit margin by a markup. Cost-plus pricing can be explained through the application of the Nash equilibrium. If one dominant firm uses cost-plus pricing method, then the rest may follow suit so that the strategy becomes the rule (Guo, 2017).

Application of Nash Equilibrium in Oligopoly Markets

France’s economy is in the third phase of the business cycle, known as contraction. In general, a contraction is a period of sluggish economic activity (The Balance, 2017). At this phase, the economic growth weakens, the GDP growth rate falls below 2 percent, and the unemployment rate is high and could reach 10 percent. Also, during a contraction, the inflation rate tends to be lower as evidenced by France’s economy, which is slightly below 1 percent (Tradingeconomics.com, 2017).

Figure 1: AD/AS model for the French economy in 2017

Fig. 1 illustrates a shift in the AD to the left, from AD0 to AD1. A shift in AD to the left establishes a new equilibrium E1 which will result in a lower output and also a lower price level compared to the initial equilibrium E0. A decrease in government spending or increase in taxes leads to a decrease in consumer spending and a decrease in the AD to the left.

According to the AD/AS model, an increase in government spending, investment, consumption or exports can lead to an increase in aggregate demand thus higher economic growth. Ideally, the French government should be trying to increase the aggregate demand through government spending and an overhaul of the tax system. Furthermore, the unsound monetary policy favored in the euro-zone is detrimental to France’s economy (Luke, 2011).

The French economy is performing in dismal with high unemployment and weak economic growth. For this reason, the government should implement an expansionary fiscal policy in order to stimulate the economy. In this scenario, the government would increase spending and reduce taxes. The government could increase spending in the form of benefits and public employment while encouraging a budget deficit by reducing taxes (Michaillat and Saez, 2013). In 2, an increase in government spending and a reduction in taxes shifts the AD(Aggregate Demand) to the right, from AD1 to AD2. This shift also sets a new equilibrium E2 which results in a higher output and higher price level from P1 to P2.

Figure 2: Expansionary Fiscal Policy effect

The EU requires that member countries cap their annual budget deficit to 3 percent of GDP and manage a debt of 60 percent of GDP. France’s current debt to GDP is at 96 percent while its budget deficit is slightly above the requirement at 3.4 percent of GDP. This means that France is on the right track in terms of budget deficit but there is a deviation in its debt to GDP (Tradingeconomics.com, 2017).

Expansionary Fiscal and Monetary Policies

The European Central Bank(ECB) is the institution with the mandate in monitoring the monetary policy in France and other eurozone member states. Also, eurozone members such as France operate under the euro as the official currency (Bank, 2017).

An Expansionary Monetary Policy is necessary when an economy is in the contraction phase of the business cycle. In order to stimulate economic growth, more money needs to be put into peoples pocket, thus a reduction in the interest rates would be a prudent move. Lower interest rates reduce the cost of borrowing, reduces the cost of mortgages and other interest repayments, and increases the demand for export goods. In addition, the monetary authorities could also lower the reserve requirement held by banks and purchase securities from banks and other security firms. An expansionary monetary policy would trigger economic growth hence increase the aggregate demand by shifting it to the right (Moffat, 2017).

In the long run, Improving workers’ skills through education and investment in infrastructure would boost economic growth. For instance, skilled workers demand higher wages and increase employment. This upgrade in the productivity of labor would be beneficial to the overall economy due to the improvement in skill level, training, and education. Furthermore, infrastructure is the foundation of economies since good infrastructure has a multiplier effect on the overall economy (Luke, 201). For example, better infrastructure creates better business environment due to improved efficiency. Also, jobs will be created in the process which would increase consumer spending leading to economic growth. Fig. 3 illustrates a boost in economic growth by shifting the LRAS(Long run average supply) curve to the right from LRAS0 to LRAS1 and the AD to the right, from AD0 to AD Also, economic growth is illustrated by an increase in the GDP output from Y0 to Y1 but the same price is maintained because in the long run firms and consumers are well aware of the prices, so the GDP output will be determined by other factors such as, labor, capital, technology and natural resources but not on the price level. This also explains why the long run aggregate supply curve is inelastic.

Figure 3: Long run effect of educating workers and improving infrastructure

References

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 Aph.gov.au. (2017). Australian Airline Industry – Parliament of Australia. [online] Available at: https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/pubs/rp/rp0203/03RP10#aair [Accessed 13 Sep. 2017].

Bank, E. (2017). Monetary Policy. [online] European Central Bank. Available at: https://www.ecb.europa.eu/mopo/html/index.en.html [Accessed 18 Sep. 2017].

Economics.fundamentalfinance.com. (2017). Nash Equilibrium and Dominant Strategies- Game Theory – Fundamental Finance. [online] Available at: https://economics.fundamentalfinance.com/game-theory/nash-equilibrium.php [Accessed 13 Sep. 2017].

Guo, V. (2017). Cost Plus Pricing 101: The Necessities and Your Pricing Strategy. [online] Priceintelligently.com. Available at: https://www.priceintelligently.com/blog/bid/161014/cost-plus-pricing-101-the-necessities-and-your-pricing-strategy [Accessed 13 Sep. 2017].

Luke, J. (2017). AD-AS Model Explained. [online] Available at: https://econproph.com/2011/03/02/ad-as-model-explained/ [Accessed 19 Sep. 2017].

Michaillat, P. and Saez, E. (2013). A theory of aggregate supply and management demand as functions of marketing tightness with prices as parameters. Cambridge, Mass.

Moffat, M. (2017). Expansionary vs. Contractionary Monetary Policy. [online] Available at: https://www.thoughtco.com/expansionary-vs-contractionary-monetary-policy-1146303 [Accessed 18 Sep. 2017].

The Balance. (2017). The 4 Critical Stages of the Business Cycle. [online] Available at: https://www.thebalance.com/what-is-the-business-cycle-3305912 [Accessed 14 Sep. 2017].

Tradingeconomics.com. (2017). France | Economic Indicators. [online] Available at: https://tradingeconomics.com/france/indicators [Accessed 14 Sep. 2017].

Theweek.com. (2017). Emmanuel Macron has misdiagnosed France’s ailing economy. [online] Available at: https://theweek.com/articles/705135/emmanuel-macron-misdiagnosed-frances-ailing-economy [Accessed 13 Sep. 2017].