4 - Oligopoly And Strategic Behaviour

Question 1

2 different oligopolies

Answer 1

• Collusive oligopolists (Cartel model)
• Non-collusive oligopolists (Quantity setting oligopolists)

Question 2

1) Collusive oligopolists

What is a cartel (a trust)

Answer 2

A combination of firms that acts as it were a single firm

• Cartel is a shared monopoly
• Make a formal agreement, to work together, to restrict output
• E.g. OPEC, 13 oil exporting nations that coordinate to find fair output and price levels

Question 3

What’s the full cartel outcome

Answer 3

Price and quantity at which joint profit is maximised

• Firms in a cartel can earn greatest amount of profit when they collectively behave like a monopolist and maximise industry profits

Question 4

What’s the full cartel outcome - illustrated as a graph

Answer 4

• Its the same graph as a monopoly (says ‘industry’ after MC for example to differentiate between full cartel outcome and monopoly)
• MR = MC is profit maximisation
• The area before the MR curve and above the MC curve is the profit of the cartel

Question 5

A cartel may not sell at the quantity and price of profit maximisation because of 2 reasons….

Answer 5

1) When a cartel holds price above marginal cost, it creates incentive to ‘cheat’

2) New firms will be attracted to the market because there’s positive economic (profit to be made)

Question 6

Incentive to cheat graph

Answer 6

• Straight horizontal line where the agreed cartel price is
• marginal cost curve curving up from below the price line to above
• One of the firms in the cartel may cheat, by increasing output to where MR = MC to therefore profit maximise

Question 7

What happens if one firms cheats

Answer 7

If one firm cheats, the others will cheat and increase output as well, causing price to fall as there’ll be excess supply, Law of demand

• Cartel agreement no longer valid

Question 8

How to achieve full cartel outcome (maximise profit)
- There’s 2 ways

Answer 8

1) Cartel must punish cheaters, therefore needs a central authority, to stop firms increasing output (cheating)

2) Cartel must limit entry of new firms; without limiting entry, many cartels have failed. Without barriers to entry new firms will enter as there is positive economic (profit to be made)

• Other reasons of failed full cartel outcome is change in consumer preference, recession as people purchase less

Question 9

2) Non-collusive oligopolists (Quantity setting oligopolists)

What are the following assumptions of quantity setting oligopolists

Answer 9

• 2 firms in the industry - Duopoly - Compete against each other
• Entry into the market is completely blocked
• Firms produce homogenous (Same) products
• Firms have identical constant marginal cost; because products are same

Question 10

Market equilibrium - why quantity setting oligopolists are non-collusive

Answer 10

• 2 firms are rivals
• Each firm is concerned about its own profits
• If one firm can raise its profits by increasing its output at the expense of its rival, it will do so

Question 11

Equilibrium

What’s it called when a firm chooses best course of action, given what the other firms doing

Answer 11

Firms chosen a ‘best response’

Question 12

When do we have ‘Nash equilibrium’

Answer 12

A market is in equilibrium when no firm wants to change its behaviour unilaterally (without other firm knowing)

Question 13

When is the market at Nash equilibrium

2 reasons

Answer 13

• When no firm wants to change its behaviour unilaterally
• When each firm is choosing the strategy that maximises its profits given the strategies of the other firms in the market

Question 14

What’s the final cournot (Nash) equilibrium (graphs in book)

Answer 14

The 2 reaction curves on one graph, they should meet