First-year courses · Social sciences

Microeconomics II: games, oligopoly, labour and welfare

Microeconomics II flashcards: game theory, Nash equilibrium, oligopoly models, labour markets, surplus, deadweight loss, public goods and information problems.

40 cards4 topicsAbout 15 minutes a roundTypical second-term first-year microeconomics (market structure, factor markets and welfare)

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About this deck

This deck picks up where a first unit on supply, demand and costs leaves off. It is for students in the second half of a first-year microeconomics course, or an early intermediate course, and it covers basic game theory (dominant strategies, Nash equilibrium, the prisoner's dilemma, sequential and repeated games), oligopoly and imperfect competition (collusion, Cournot, Bertrand and Stackelberg models, concentration measures), labour markets (marginal revenue product, monopsony, minimum wages, wage differentials) and welfare economics (consumer and producer surplus, deadweight loss, public goods, common resources, Pigouvian taxes, the Coase theorem and asymmetric information).

You should already know how to read supply and demand diagrams, what marginal cost and marginal revenue mean, and why a competitive firm sets price equal to marginal cost. The algebra needed is solving a pair of linear equations and finding the area of a triangle.

For game theory cards, draw the payoff matrix and circle each player's best response before naming the equilibrium. For the oligopoly and welfare cards, sketch the diagram, shade the area being described, and then do the arithmetic in the example. Testing yourself on what changes when one assumption changes (two firms become many, a tax is added, the employer becomes the only buyer of labour) builds the intuition that exam questions target.

Common mistakes: assuming a Nash equilibrium must be the best outcome for the players (the prisoner's dilemma shows it need not be); confusing a public good with any good the government provides; and computing deadweight loss with the price change alone instead of the triangle between demand and supply.

Before you start: A first unit of microeconomics: supply and demand, elasticity, costs, perfect competition and monopoly.

All 40 cards

Cover the definitions with a sheet of paper and test yourself, or use the study modes above.

Game theory

Game (in economics): A situation of strategic interdependence described by players, the strategies each can choose, and the payoffs that result from every combination.Example: Two coffee shops choosing high or low prices, with profits depending on both choices.
Payoff matrix: A table listing each player's payoff for every pair of strategies; by convention the row player's payoff is written first.Example: Cell (Low, High) = (12, 2) means the row firm earns 12 and the column firm earns 2.
Dominant strategy: A strategy that gives a player a higher payoff than any alternative, no matter what the other players choose.Example: If Low earns more than High whether the rival plays High or Low, Low dominates.
Nash equilibrium: A set of strategies where each player's choice is a best response to the others, so no one gains by changing strategy alone.Example: If each firm's best reply to Low is Low, then (Low, Low) is one.
Prisoner's dilemma: A game in which each player has a dominant strategy, yet playing it leaves both worse off than if both had cooperated.Example: Both silent: 1 year each. Both confess: 5 each. One confesses: 0 for them, 10 for the other. Confess dominates, so both get 5.
Sequential game and backward induction: A game where players move in turn; solve it by starting at the last decision and working back to the first.Example: An entrant decides first; if the incumbent would accommodate rather than fight after entry, entry is the equilibrium.
Credible threat: A threatened action that the threatening player would actually want to carry out when the moment comes.Example: Promising a price war that would cost the incumbent more than sharing the market is not one.
Repeated game: The same game played many times; the prospect of future punishment can sustain cooperation that fails in a one-shot game.Example: Tit-for-tat: cooperate first, then copy the rival's previous move.
Mixed strategy: Choosing among actions at random with set probabilities, often used when no equilibrium exists in pure strategies.Example: A penalty taker who always shoots left is easy to read; shooting left and right unpredictably avoids that.

Oligopoly and market structure

Oligopoly: A market with a few large sellers whose decisions on price and output affect each other, usually protected by barriers to entry.Example: Canadian wireless service and commercial airlines are frequent textbook examples.
Collusion and cartels: Firms agreeing to restrict output or fix prices to act like a monopoly; unstable because each member gains by cheating, and price-fixing is illegal under Canada's Competition Act.Example: OPEC sets production quotas for member countries.
Cournot model: Firms choose quantities simultaneously, each taking the rival's output as given; the result lies between monopoly and perfect competition.Example: P = 100 - Q, MC = 10, two firms: each makes 30, Q = 60, P = 40 (monopoly would give Q = 45, P = 55).
Bertrand model: Firms with identical products and costs compete on price; undercutting drives price down to marginal cost even with only two firms.Example: With MC = 10 for both, any price above 10 is undercut, so P = 10.
Stackelberg model: A leader chooses output first and the follower responds; the leader produces more and earns more than in the simultaneous-quantity case.Example: P = 100 - Q, MC = 10: leader 45, follower 22.5, Q = 67.5, P = 32.5.
Kinked demand curve: An oligopoly model where rivals match price cuts but ignore price increases, which can explain sticky prices.Example: Demand is elastic above the current price and inelastic below it, giving a gap in marginal revenue.
Herfindahl-Hirschman Index: A concentration measure equal to the sum of squared market shares in percent; it reaches 10,000 for a single seller.Example: Shares 40, 30, 20, 10: 1600 + 900 + 400 + 100 = 3000.
Concentration ratio: The combined market share of the largest few firms, such as the four largest (CR4).Example: Shares 40, 30, 20, 10 and no other firms: CR4 = 100%.
Monopolistic competition: Many sellers of differentiated products with free entry; firms have some pricing power, but long-run economic profit is zero.Example: Restaurants and hair salons in a city.
Barriers to entry: Factors that keep new firms out, such as economies of scale, patents, licences, control of key inputs or network effects.Example: A new pharmaceutical firm cannot copy a drug still under patent.

Labour markets

Marginal product of labour: The extra output produced by hiring one more worker, holding other inputs fixed; it usually falls as more workers are added.Example: Output rises from 50 to 55 units with the sixth worker, so that worker adds 5 units.
Marginal revenue product: The extra revenue from one more worker: marginal product times marginal revenue (times price for a competitive firm).Example: 5 units x $8 price = $40 per hour.
Derived demand: Demand for an input that exists because of demand for the goods the input helps produce.Example: Demand for carpenters rises with demand for new housing.
Profit-maximizing hiring rule: A firm in a competitive labour market hires until the marginal revenue product of the last worker equals the wage.Example: If MRP is $40 and the wage is $25, hiring more is profitable until MRP falls to $25.
Backward-bending labour supply: At high wages, the income effect (wanting more leisure) can outweigh the substitution effect, so hours supplied fall as the wage rises.Example: A consultant earning $300 an hour may choose to work fewer hours than at $100.
Monopsony: A labour market with a single dominant employer, which pays below the marginal revenue product and hires fewer workers than a competitive market.Example: A mine that is the only major employer in a remote town.
Minimum wage in a model: A price floor on labour. In a competitive model a binding floor reduces employment; under monopsony a floor in the right range can raise both wages and employment.Example: Competitive case: a floor above equilibrium lowers the quantity of labour demanded.
Compensating wage differential: Extra pay needed to attract workers to jobs with unpleasant, risky or remote conditions.Example: Northern and night-shift positions often pay a premium.
Human capital: The skills, knowledge and health workers build through education, training and experience, which raise their productivity and earnings.Example: Completing an apprenticeship raises an electrician's marginal product.

Welfare, public goods and information

Consumer surplus: The difference between what buyers are willing to pay and what they actually pay, summed over all units bought; the area under demand above price.Example: Demand P = 100 - Q at price 40: Q = 60, so 0.5 x 60 x 60 = 1800.
Producer surplus: Revenue received above sellers' minimum acceptable prices; the area above supply and below price.Example: Supply P = 10 + Q at price 55: Q = 45, so 0.5 x 45 x 45 = 1012.5.
Deadweight loss: Total surplus lost when output differs from the efficient quantity, for example because of a tax, monopoly or price control.Example: Demand P = 100 - Q, supply P = 10 + Q, $10 tax: Q falls from 45 to 40, so loss = 0.5 x 10 x 5 = 25.
Pareto efficiency: An allocation where no one can be made better off without making someone else worse off.Example: Splitting a pie fully between two people is efficient however unequal the split; leaving a slice uneaten is not.
Public good: A good that is non-rival (one person's use does not reduce another's) and non-excludable (people cannot easily be kept from using it).Example: National defence and a public fireworks display.
Free-rider problem: People benefit from a good without paying, which leads private markets to underprovide non-excludable goods.Example: Neighbours who skip contributing to a shared snow-clearing fund still get a clear street.
Common-pool resource: A good that is rival but non-excludable, so it tends to be overused (the tragedy of the commons).Example: Open-access fisheries such as the northern cod stock before the 1992 moratorium.
Club good: A good that is excludable but non-rival, at least until congestion sets in.Example: A streaming service or a toll road with little traffic.
Pigouvian tax: A tax on an activity equal to its marginal external cost, so private decision makers face the full social cost.Example: If each tonne of emissions causes $50 of damage to others, a $50 per tonne charge internalizes it.
Coase theorem: If property rights are clear and bargaining is costless, private negotiation reaches an efficient outcome regardless of who holds the rights.Example: A factory and a laundry can bargain over smoke; high transaction costs make this fail with thousands of affected people.
Adverse selection: Before a deal, the better-informed side's hidden characteristics drive away good matches, which can shrink or collapse a market.Example: In used cars, buyers who cannot spot lemons offer low prices, so owners of good cars stop selling.
Moral hazard: After a deal, a party changes behaviour because someone else bears part of the cost of their actions.Example: A fully insured driver may park in riskier spots.