B.a.H Sem IV 08 Intermediate Microeconomics II Jan. 2018

UNIVERSITY OF DELHI
DELHI SCHOOL OF ECONOMICS

DEPARTMENT OF ECONOMICS
Minutes of Meeting
Subject : B.A. (Hons) Economics – 4th Sem. (2018)

Course : 08-Intermediate Microeconomics - II
Date of Meeting : 8th January, 2018
Venue : Department of Economics, Delhi School of
Economics, University of Delhi
Chair : Dr. Anirban Kar
Attended by:
S.No. Name College

1 S. Rubina Naqvi Hindu College
2 Sakshi Goel Bansal JDM College
3 Rakesh Kumar ARSD College
4 Apoorva Gupta Ramjas College
5 Rajiv Jha SRCC
6 Ankhush Garg PGDAV College
7 Surajit Deb Aryabhatta College
8 Akhilesh Kumar Yadav Satyawati College
9 Meenakshi Sharma Sri Venkateswara College
10 Shashi Bala Garg Lady Shri Ram College
1 Syllabus and Readings
Course Description
This course is a sequel to Intermediate Microeconomics I. It covers general
equilibrium and welfare, imperfect markets and topics under information
economics. To discuss imperfect market and information, we also need to
introduce students to strategic interactions and game theory. The emphasis will be
on providing conceptual clarity to the student coupled with the use of
1
mathematical tools and analytical reasoning. Abstract proofs can be
complemented by numerical examples.
Textbooks
1. Hal R. Varian [V]: Intermediate Microeconomics: A Modern Approach,
8th edition, W.W. Norton and Company/Affiliated East-West Press (India), 2010.
The workbook by Varian and Bergstrom could be used for problems.
2. C. Snyder and W. Nicholson [S-N]: Fundamentals of Microeconomics,
Cengage Learning (India), 2010, Indian edition.
3. M. J. Osborne [O]: An introduction to Game Theory, Indian Edition
Course Outline
1. General Equilibrium, Efficiency and Welfare
Equilibrium and efficiency under pure exchange and production; overall
efficiency and welfare economics Readings:
(i) [V]: Chapters 31 and 33
(ii) [S-N]: Chapter 13, p418-p427.
2. Strategic form game with perfect information;
(i) [O]: Chapter 2 (except 2.10), p13-p50
Mixed strategy and extensive form games with perfect information
(ii) [S-N]: Chapter 8 (p231-p253, except concepts already covered above);
3. Market Structure and Game Theory

Monopoly; pricing with market power; price discrimination; peak-load pricing;
two-part tariff; monopolistic competition and oligopoly;
(i) [S-N]: Chapter 14 (p464-p485); Chapter 15(p492-p507 and p511-p519)
4. Market Failure
Externalities; public goods and markets with asymmetric information
Readings:
(i) [V]: Chapter 34, 36 and 37, except 'Vickrey-Clarke-Groves Mechanism' ([V],
p711-p715).
Assessment
Semester examination:
The question paper will have two sections. Section A will contain 4
questions from topic 1 and 4. Students will be required to answer 2
2
questions out of 4. Section B will contain 4 questions from topic 2 and 3.
Students will be required to answer 2 questions out of 4.
Internal assessment:
There will be two tests/assignments (at least one has to be a test) worth 10
and 15 marks.
2 Corrections and Clarifications

Clarification 1: Smokers and Non-Smokers Diagram Figure:34.1,
Page:646, Chapter:34, Varian, 8th edition
A’s money is measured horizontally from the lower left-hand corner of the
box, and B’s money is measured horizontally from the upper right-hand
corner. But the total amount of smoke is measured vertically from the lower
left-hand corner.
Clarification 2: Bertrand Price competition Paragraph:6, Page:494,

Chapter:15, Nicholson and Snyder, 2010 Indian Edition
Case (ii) cannot be a Nash equilibrium, either. Let us look at two sub-cases
separately (ii − a) c < p1 = p2 and (ii − b) c < p1 < p2.
(ii−a) We shall show that Firm 2 has an incentive to deviate. In this subcase
Firm 2 gets only half of market demand. Firm 2 could capture all of market
demand by undercutting Firm 1’s price by a tiny amount . This could be
chosen small enough that market price and total market profit are hardly
affected. To see this formally, note that Firm 2 earns a profit ( by
charging p2 and can earn ( ) by undercutting. Change in
profit due to price cut is,
Because ) (downward sloping demand curve)
We want to show that Firm 2 can suitably choose the level of price cut, that is
, so that the above difference is positive.
3
Since p2 > c, any choice of strictly positive smaller than would be
profitable deviation for Firm 2.
(ii − b) If p1 < p2 Firm 2 earns zero profit. It can deviate to p1 and earn positive
profit.
Clarification 3: Capacity constraint Page: 501, Chapter:15, Nicholson

and Snyder, 2010 Indian Edition
For the Bertrand model to generate the Bertrand paradox (the result that
two firms essentially behave as perfect competitors), firms must have
unlimited capacities. Starting from equal prices, if a firm lowers its price the
slightest amount then its demand essentially doubles. The firm can satisfy
this increased demand because it has no capacity constraints, giving firms a
big incentive to undercut. If the undercutting firm could not serve all the
demand at its lower price because of capacity constraints, that would leave
some residual demand for the higher-priced firm and would decrease the
incentive to undercut. The following discusses a situation where price
competition does not lead to marginal cost pricing.
Consider the following simplified model, where two firms take part in a
twostage game. In the first stage, firms build capacity K1,K2 simultaneously. In
the second stage (first stage choices are observable in this stage) firms
simultaneously choose prices p1 and p2. Firms cannot sell more in the second
stage than the capacity built in the first stage. Let qi be the output sell of Firm
i in stage 2, then qi ≤ Ki. Suppose that the marginal cost of production is zero
and capacity building cost is c per unit. Let us assume that capacity building
cost is sufficiently high,
Market demand curve is D(p) = 1 − p. If the firms choose different prices, say
pi > pj, then the firm which has set lower price (Firm j) face the demand D(pj)
and sell the minimum of D(pj) and Kj (because it can not produce more than
its capacity). That is qj = min{D(pj),Kj}. Firm i, which has chosen a higher price,
faces the residual demand at pi, which is (D(pi)−qj). Therefore, sell of Firm i is
the minimum of the residual demand and it’s capacity, that is qi = min{(D(pi)
− qj),Ki}.
4
If the firms choose the same price pi = pj = p, then the demand is equally shared
(that is each firm faces demand ). However if a firm has a capacity smaller
than , it supplies its capacity and the residual demand goes to the other
firm.
Before we start our analysis, note that the maximum gross profit a firm can
earn is bounded by the monopoly profit, which is
Thus the maximum profit net of capacity cost is ( ). Since c is greater

than , to earn non-negative profit, firms will choose a capacity smaller than
.
We will analyze the game using backward induction. Consider the
secondstage pricing game supposing the firms have already built capacities
in the first stage. We shall show that
Nash equilibrium. Note that at this price, total demand is .

Hence output sells are, .
Is a deviation pj < p∗ profitable?
In case of such deviation Firm j charges a smaller price than Firm i, because
pj < p∗ = pi. This increases Firm j’s demand. However it does not increase Firm
j’s sell because it is already selling at its capacity Kj∗. This reduces j’s profit
and such deviation is not profitable.
Is a deviation pj > p∗ profitable?

In case of such deviation Firm j charges a higher price than Firm i, because pj
> p∗ = pi. Firm i still sells Ki∗ and Firm j faces the residual demand (D(pj)−Ki∗) =
(1−pj−Ki∗). Gross profit of j is [pj(1−pj−Ki∗)]. If this profit is a decreasing
function of pj, then we can claim that the deviation (price increase) was
unprofitable. To check, let us differentiate [pj(1 − pj − Ki∗)] with respect to pj.
< (1 − 2p∗− Ki∗) because pj > p∗
5
= [1 − 2(1 − Ki∗− Kj∗) − Ki∗] because = Ki∗ +
2Kj∗− 1
≤0 because
Therefore ) is a Nash equilibrium of the
second stage price competition game. At this equilibrium firms use their full
capacity, that is . Gross profit of Firm 1 is [(1
] and that of Firm 2 is [(1
It can be shown that the above is the only Nash equilibrium of the second
stage game. A situation in which p1 = p2 < p∗ is not a Nash equilibrium. At this
price, total quantity demanded exceeds total capacity, so Firm 1 could
increase its profits by raising price slightly and continuing to sell .
Similarly, p1 = p2 > p∗ is not a Nash equilibrium because now total sales fall
short of capacity. Here, at least one firm (say, Firm 1) is selling less than its
capacity. By cutting price slightly, Firm 1 can increase its profits (formal
analysis is similar to the case pj > p∗ = pi).
Now we are ready to analyze the first stage of this game. Firm i’s profit net of
capacity cost is, πi = [(1 − Ki∗ − Kj∗)Ki∗] − cKi∗. Firms are choosing capacities
simultaneously. This is exactly like the Cournot game. We can obtain
equilibrium choice of capacities by solving the best response functions.
Equilibrium choice of capacities are . Thus the price at the
second stage will be ), which is greater than zero. Therefore
unlike Bertrand competition, ‘price-competition’ in this game does not lead
to marginal cost pricing.

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UNIVERSITY OF DELHI

DELHI SCHOOL OF ECONOMICS

Subject : B.A. (Hons) Economics – 4th Sem. (2018)

S.No. Name College

1 Syllabus and Readings

3. M. J. Osborne [O]: An introduction to Game Theory, Indian Edition

3. Market Structure and Game Theory

2 Corrections and Clarifications

Clarification 2: Bertrand Price competition Paragraph:6, Page:494,

Because ) (downward sloping demand curve)

Clarification 3: Capacity constraint Page: 501, Chapter:15, Nicholson

Thus the maximum profit net of capacity cost is ( ). Since c is greater

Nash equilibrium. Note that at this price, total demand is .

Is a deviation pj > p∗ profitable?

< (1 − 2p∗− Ki∗) because pj > p∗

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