Modelling Firms and Markets

Welcome to the module Modelling Firms and Markets – an introduction to the economics of information and uncertainty. Multi-person decision problems under uncertainty have always played a crucial role in financial markets. For instance, if you buy a stock in a firm, your profit will depend on whether or not its market goes up. To understand decision-making processes and find their possible solutions in real-world problems (such as contracts, mechanisms, bank runs, etc.) you first need to learn how to think strategically. For this, you need to understand some basic and standard market problems among players.

Learning outcomes

By the end of this module you will be able to:

• explain the basic equilibrium concepts such as Nash equilibrium (pure and mixed)
• apply theNash equilibrium in oligopoly competition (Cournot & Bertrand)
• solve simple repeated games using backward induction and define subgame perfect equilibrium
• identify the concept of a Bayesian game and find its equilibrium
• define perfect Bayesian equilibrium and explain the signaling problem
• apply the concepts of adverse selection and moral hazard in different microeconomic contexts and explain how risk and information asymmetry affect the efficiency of contracting
• discuss the role of incentives and optimal contracting in addressing this issue related to asymmetric information
• outline and discuss the various types of auctions and the revenue equivalence principle
• derive the general equilibrium of specific economies.

Tuition and assessment

Students are individually assigned an academic tutor for the duration of the module, with whom you can discuss academic queries at regular intervals during the study session.

You are required to complete two Assignments for this module, which will be marked by your tutor. Assignments are each worth 15% of your total mark. You will be expected to submit your first assignment by the Tuesday of Week 6, and the second assignment at the end of the module, on the Tuesday after Week 10. Assignments are submitted and feedback given online. In addition, queries and problems can be answered through the Virtual Learning Environment.

You will also sit a three-hour examination on a specified date in September/October, worth 70% of your total mark. An up-to-date timetable of examinations is published on the website in July each year.

Study resources

• Study guide: The module study guide is carefully structured to provide the main teaching, defining and exploring the main concepts and issues, locating these within current debate and introducing and linking the assigned readings.
• Key texts: 
  • Gibbons R (1992) A Primer in Game Theory. Harvester Wheatsheaf.
  • Campbell DE (2018) Incentives: Motivation and the Economics of Information. 3rd Edition. Cambridge University Press.
• Readings: Throughout the module you will be directed to study a selection of readings, including journal articles, book extracts and case studies that are of particular relevance and interest to the topics covered in the module.
• Virtual learning environment: You will have access to the VLE, a web-accessed study centre. Via the VLE, you can communicate with your assigned academic tutor, administrators and other students on the module using discussion forums. The VLE also provides access to the module Study Guide and assignments, as well as a selection of electronic journals available on the University of London Online Library.

Study calendar 2022/23

Study calendars are subject to change.

Module overview

Unit 1 Static Games of Complete Information

• 1.1 Normal (Strategic) Form Game and Iterated Deletion
• 1.2 Nash Equilibrium
• 1.3 Mixed-Strategy Nash Equilibrium
• 1.4 Existence of Nash Equilibrium
• 1.5 Applications of Nash Equilibrium
• 1.6 Conclusion

Unit 2 Dynamic Games of Complete Information

• 2.1 Dynamic Games of Complete and Perfect Information
• 2.2 Subgame Perfection – Generalisation of the Backwards Induction
• 2.3 Repeated Games

Unit 3 Static Games of Incomplete Information

• 3.1 Cournot Competition of Incomplete Information
• 3.2 Normal-Form Representation of Static Bayesian Games and Bayesian Nash Equilibrium
• 3.3 Applications
• 3.4 The Revalation Principle
• 3.5 Conclusion

Unit 4 Dynamic Games of Incomplete Information

• 4.1 Perfect Bayesian Equilibrium
• 4.2 Application
• 4.3 Refinements of Perfect Bayesian Equilibrium
• 4.4 Conclusion

Unit 5 Hidden Action (Moral Hazard)

• 5.1 Introduction
• 5.2 Examples of the Hidden Action Problems
• 5.3 Moral Hazard and Insurance
• 5.4 Principal–Agent Problem: the Model and Optimal Wage Contract
• 5.5 Conclusion

Unit 6 Hidden Characteristics (Adverse Selection)

• 6.1 Responding to Hidden Information – Price Discrimination
• 6.2 Sellers with Private Information – the Market for Lemons
• 6.3 Credit Rationing and the Stiglitz-Weiss Model
• 6.4 Bundling and Product Quality
• 6.5 Adverse Selection and Insurance
• 6.6 Conclusion

Unit 7 Auctions

• 7.1 Four Types of Auctions
• 7.2 Outcome Equivalence for Private Value Auctions
• 7.3 Sealed-Bid Auction
• 7.4 Revenue Equivalence
• 7.5 Common Value Auctions
• 7.6 Conclusion

Unit 8 General Competitive Equilibrium

• 8.1 General Equilibrium in a Pure Exchange Economy
• 8.2 The Arrow-Debreu Model
• 8.3 The Fundamental Theorems of Welfare Economics
• 8.4 Externality
• 8.5 The Issue of Convexity
• 8.6 Common Property Resources
• 8.7 Conclusion

Module samples

• M458 Module Introduction (PDF)
• M458 Specimen Examination (PDF)
• M458 Unit 1 (PDF)

Disclaimer

Important notice regarding changes to programmes and modules