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Problem Set 8

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1. In oligopoly, each firm is acutely aware of the production and marketing decisions of all competitors and carefully considers the potential competitive reactions in all decisions. Discuss whether firms in other market structures consider the potential reaction of competitors when making important marketing decisions.

In other structures firms do not consider the reactions of rivals. A monopoly is a single firm structure. In monopolistically and perfectly competitive markets the firms are independent of each other by assumption. In these structures, the number of firms is large and there is no interdependence among firms. Each firm takes its own individual decision on pricing and output, irrespective of its rivals actions and decisions.

2. Part of the debate among economists on US airline deregulation in the 1978 involved the theory of contestable markets. List the four characteristics of contestable markets and evaluate how well airline markets meet these criteria.

A contestable market in one in which there are a few firms, but the threat of new entrants, makes them behave competitively rather than monopolistically.
4 conditions:
• Ease of entry: This is the most important requirement. There is total freedom of entry into and exit from the market, the barriers to entry or exit are non-existent or very low in reality. There must be no government rule/ technical constraints on new firms.
• Knowledge: As with the perfectly competitive market, it is assumed that there is perfect knowledge in a perfectly contestable market. There are no problems of asymmetric information among the firms. Each firm has same set off information to base its decisions on.
• Product: The firms can sell homogeneous good (as in perfect competition) or heterogeneous goods (which is common in oligopoly, and more common in real life). This differentiation can be actual or

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