Lesson 2.4 Flashcards
is being an oligopoly good and why?
yes, they generally have high profits
definition oligopoly
market with small number of firms
explain managers in oligopoly
considers reaction of rivals in pricing, managers are interdependent
3 reasons oligopolies can persist for years?
1) high entry barriers
2) government fiat
3) economies of scale
what is behaviour like in oligopoly
varies, more strategic
definition: cartel
when a collusive arrangement is made openly and formally
2 things cartels establish
1) uniform price for homogeneous product
2) distribution of sales across members
MC curve of cartel
If input prices do not increase as the cartel expands, the MC curve is horizontal summation of MC curves of individual firms
optimal price and output in oligopoly
choose quantity where MC curve cross MR to hit demand, go over to get price
what is price same as in oligopoly and what does it maximize?
Price is same as monopoly price. It maximizes profit earned by cartel
how do cartels allocate sales?
1) Cartel should allocate sales to members so MC of all members is equal (and in turn is equal to cartel MR). however sales are often allocated instead by levels of sales in past or extent of member’s productive capacity.
explain what should happen in allocation of sales in MC firm A > MC firm B
cartel can increase profit by transferring production from A to B, but unlikely to occur due to influence of members
what happens to demand curve if firms leave cartel?
demand curve shifts outward with price stable, demand curve becomes more elastic so firms can expand sales a lot with small reduction in price
when does profit increase for managers who leave cartel
If managers who leave cartel or secretly cheat, they would increase profit as long as rival managers do not do the same thing and cartel does not punish this behaviour
define price leadership
in oligopolistic industries, managers at one firm have significant market power and can set their price and rivals follow their lead
what market do small firms act as though they are in and what do managers act as?
Managers at the less dominant firms are price-takers. They act as if they are in a competitive market
supply curve for small firms
combined by horizontally summing their MC curve
formula for output and price of small firms
output where P = MC
demand curve for dominant firm
horizontal difference at each price between industry demand curve and supply curve for all small firms combined
output and price of dominant firm
total amount demanded - output supplied by small firms combined and price for dominant firm is where residual MR = MC
graph of output of small firm
total industry demand - output supplied by dominant firm
when is decision making simultaneous?
When firms produce identical products, and managers make their output decisions simultaneously without knowing decisions of others
what are managers who take action before others called?
first movers or market leaders
why do market leaders accelerate before others?
because of business acumen, they invent or patent a product or process, because they see opportunities others don’t, or because of luck
what does price competition result in?
Results in downward spiral of price cuts stopped only sometimes by constraint of MC
should managers do price competition and why/why not?
no, managers should never price below MC because then marginal revenue < marginal cost of the sale
market demand curve in collusion
cartel demand curve
cartel MC in collusion
horizontal summation of each firm’s MC curve
what market does cartel behave like?
monopoly
optimal price and output for cartel?
MC = MR
what happens in cournot scenario?
Competing on quantity (production capacity) to get higher profit relative to price
4 assumptions of cournot
1) Rival managers move simultaneously
2) Same view of market demand
3) Estimate each other’s cost functions
4) Choose profit maximizing output conditional on rival output is fixed (solution identical to game theory)
cournot - if firm A thinks firm B will abdicate market to them
Firm A should behave as monopolist and Set MR = MC and firm B produces 0
cournot - firm A thinks B will produce x units - where does A produce?
Firm A produces at most market demand demand - firm B output
cournot - firm A thinks B will produce x units - firm A demand curve
Firm A has a residual demand curve (market demand curve less what managers assume firm B produces)
cournot - firm A thinks B will produce x units - what happens if P =< MC?
firm produces nothing
definition: reaction function
a function that identifies for managers the profit-maximizing output to produce given output of rivals
cournot - firm A thinks B will produce x units - only way mangers can optimize profit
The only way manager can maximize profit, is if they stay on reaction functions
cournot - firm A thinks B will produce x units - profit compared to other competition
This profit is less than cartel but higher than if they compete on price
explain cournot equilibrium
Cournot equilibrium occurs when 2 firm’s reaction functions intersect. Both firm’s expectations of what the other firm will produce is consistent with their own expectations of optimal output. Output is the same
what happens if more than 2 entrants come into cournot situation
can bring significant price competition in the market, they erode market power of existing firms and generate downward pressure on price
what happens in stackelberg behaviour?
Firm firm A chooses and commits to a capacity decision based on knowledge of rival’s reaction function, firm B needs to maximize their profit by following their reaction function.
stackelberg - what happens if you have power to move first and what is this called?
your profit will be higher than in cournot. you have first-mover advantage.
what is optimal strategy/behaviour in oligopoly?
depends on what adversary does
stackelberg - which cost structure firm gains most by moving first?
low cost structure
when is price competition a lose-lose situation?
if there is no differentiation between market products
profit in price competition with no differentiation
0
explain bertrand model
competing on price without it being lose-lose
price firms charge in bertrand model and why?
Both firms charge same price because differentiation efforts create similar impacts on demand of others
which generates higher profits: bertrand or collusion?
collusion
entry of other competitors in bertrand?
reduces prices
why are price sticky in cournot?
managers move firm toward optimum price and stay there so price is sticky
where else are prices sticky besides cournot?
Prices are also sticky for markets with stable cost and demand, or where they are anticipated and where managers have been competing for several years
sticky price with slightly differentiated product - demand curve of market
Demand curve of market is kinked at current market price
sticky price with slightly differentiated product - demand curve with prices higher than current market price
demand is very elastic (but not perfectly because differentiated products are not perfect substitutes) because if 1 firm increases price, rival firms will not follow
sticky price with slightly differentiated product - demand curve with prices less than current market price
demand is very inelastic since price cut made by one firm will be followed by rival firms so they can protect sales level
at prices less than current market price, demand is inelastic, what does this make managers reluctant to do and why
This makes firms reluctant to reduce prices since rivals would follow and this would not increase sales
what does kink in demand curve result in?
Kink in demand curve results in kink in MR. this means MC can rise or fall considerably before profit maximization conditions fall. This makes profit maximized price and quantity stable.
optimal price and quantity with kinked demand curve
at kind in demand curve
with bertrand model, how to find optimal price and quantity
find TR of one firm, differentiate TR with respect to Price of firm, set to 0 and solve for Price of firm. Do the same for other firm. This gives bertrand reaction functions for price of both firms. Substitute one in for the other to get optimal price. optimal quantity is the same for both firms too
with cartel, how to find optimal price and quantity?
Q = qa + qb, then price is the same, so find dTR/dP and set to 0 to find Price.
dominant firm, how to find optimal price and quantity with demand curve of small firm
1) demand curve for dominant firm = market demand curve - small firm demand curve; price is the same
2) find TR of dominant firm
3) find MR of dominant firm
4) set MR dominant firm = MC dominant firm to find Price
dominant firm, how to find optimal price and quantity with TC of small firm
1) find MC of small firm
2) MC of small firm = P
3) rearrange for Q of small firm
4) multiply Q by number of small firms
5) demand of dominant firm = market demand - demand of small firms
6) set MR dominant firm = MC dominant firm
remember how do we find MR?
dTR/dQ NOT dP
in collusion, and 1 firm has higher MC, how much does each firm produce
firm with lower MC produces everything
explain economies of scale
costs decrease as output expands
what does it mean when cartel member cheats?
overproduce and thereby increase profit
how to find reaction function of firm
set MC firm = P
kink demand curve - changes in MC that do not move above or below vertical section of MR curve implication
do not cause optimal level of output or price to change
price competition - highest and lowest price manager will accept
highest price is P = a - bQ (Q = q1+q2), highest price is a - 1. lowest price is c+1 where MC = c + q
price competition - formula to solve
find P = a - bQ (set Q = q1 + q2) then set P = MC1 and solve for q1 and then do the same for q2
perfectly competitive market, optimal price and output
choose P and Q where demand=supply (MC = demand)
if 2 companies collude over compete, what can customers expect?
higher prices and lower quantities offered
collusion - find max joint profts
Q*P - TC1 - TC2
2 ways to solve for collusion
1) set Q = q/n in individual MC curve to get total MC
2) sum MCi, where it is solved for qi to get MC
stackelberg - formula
firm A is first mover, then find firm B reaction function, substitute firm B reaction function into demand curve. next find MR and solve for firm A output
