A plug for a recent paper: one of my Twitter followers asked for a non-technical explanation, so here it is.
Flavio Menezes and I just released the latest version our paper “The Strategic Industry Supply Curve,” available at http://www.uq.edu.au/economics/abstract/586.pdf. The central aim of the paper is to extend the standard graphical analysis of supply and demand, familiar to every first-year economics student, to cases where markets are imperfectly competitive (monopolies and oligopolies). At present, these markets are analyzed using quite different theoretical tools, making only limited use of graphical representations.
The main innovation is the notion of the strategic industry supply curve, representing the locus of Nash equilibrium outputs and prices arising from additive shocks to demand. Special cases include monopoly, Cournot and Bertrand oligopoly and competition in linear supply schedules.
As in the standard graphical analysis, we can
* use measures of consumer and producer surplus to determine the distribution of the welfare gains from trade between consumers and producers
* derive elasticity measures for supply and demand
* analyse the comparative statics of cost shocks
Our analysis allows us to view imperfect competition as analogous to a case where producers engage in ‘cost-padding’. That is, the difference between the strategic supply curve (an equilibrium concept) and the industry supply curve (the sum of the supply curves of individual firms) can be seen as the measure of the ‘economic rents’ afforded by imperfect competition.
Our analysis has important implications for competition policy. For example, competition regulators examine industry supply curves, but do not directly assess the efficient costs of production. So, they are unable to distinguish directly between efficient costs and the ‘cost-padding’ associated with strategic behavior. Rather, the extent of such cost-padding is implicit in the the specific form of competition that it is assumed in the analysis (e.g., Cournot versus (differentiated) Bertrand). Conversely, assumptions about the form of competition are largely arbitrary and not informed by data. The approach in merger regulation contrasts sharply with that of monopoly price regulation, where the focus is on determining the monopolist’s efficient cost, so as to set efficient (in a second-best sense) prices.
The arbitrary nature of economists’ assumptions about the strategy spaces appropriate for game-theoretic representations of economic problems has been a long-standing theme of ours (refs). In this paper, we have turned this criticism around and shown how an explicit treatment of the strategy space can not only yield powerful new tools for economic analysis but can enhance the scope of such familiar tools as demand-supply diagrams.