Lecture 4- Oligopoly and strategic behaviour Flashcards
What is a cartel?
A combination of firms that acts as it were a single firm.
“shared Monopoly”
What is the aim of cartels?
They aim to achieve profits grater than they could as individual competitors in a perfectly competitive market, where firms usually earn zero economic profit in the long run.
What is the full cartel outcome?
Cartels achieve full cartel outcome by collectively producing the profit maximising output and setting a price corresponding to marginal levels.
What are some factors determining a cartels success?
Prevent cheating- Cartels often enforce strict agreements or monitoring systems to ensure members adhere to output restrictions.
Restrict entry- Cartels may attempt to limit new entrants by lobbying for government policies, acquiring critical inputs or erecting other entry barriers.
Describe the incentive to cheat in a cartel
When a cartel has successfully raised the market price above the marginal cost, all members benefit.
However, this increase in price creates an opportunity for individual firms to produce more than the agreed output and increase their profits.
Why does cheating occur in cartels?
Price taking behaviour
Lack of binding enforcement to stick to the agreed level of output.
What are some mechanisms to prevent cheating in cartels?
Monitor output levels
Fines and punishment
Threat of retaliation (price wars or flooding the market).
Explain the key assumptions of the quantity-setting oligopoly model.
It has a duopoly structure, where the market only consists of 2 firms.
There is blocked entry into the market, which creates a stable, closed competitive environment where only the existing firms influence market outcomes.
Homogenous products- The products offered by both firms are identical in quantity and features.
Identical and constant marginal costs- Each firm faces the same cost per additional unit of production.
Explain strategic behaviour in a duopoly
Interdependence- Each firms output directly impacts the market price and, consequently the other firms profits.
Residual demand curves- Each firm faces a residual demand curve, representing the market demand left after accounting for the rivals output.
Profit maximisation- the equilibrium is reached when neither firm can improve its profit by unilaterally changing its output.
What is the nash equilibrium?
A market is in nash equilibrium, when no firm wants to change its behaviour unilaterally.
Explain the deep importance for the role of agreements between firms in a duopoly.
Collusion and cartelization- If firm A and Firm B cooperated to restrict output, they could drive prices higher and increase joint profits.
Self-enforcing agreements- Each firm’s self interest to abide by the agreement, assuming the other firm does the same.
Tacit agreements- Rely on mutual understanding and expectations rather than formal contracts.
