Oligopoly

Question 1

What is an oligopoly?

Answer 1

Market dominated by a small number of big firms (mobile phone networks, video game consoles)

Question 2

Oligopoly assumptions

Answer 2

Sellers have market power and behave strategically
Buyers are price takers
Significant barriers to entry even in the long run

Question 3

Firms in an oligopoly can either compete or?

Answer 3

Collude

Question 4

What is collusion?

Answer 4

Coordinating setting prices or wuantjtjes

Question 5

What is a cartel?

Answer 5

A group of firms that cooperate to restrict competition

Question 6

Draw a cartel diagram

Question 7

Why don’t we see more cartels if they are so profitable?

Answer 7

Cartels are illegal and uncompetitive

Each cartel member has an incentive to produce more and increase its own profit at the expense of other cartel firms.

Question 8

Competition policy on Cartels

Answer 8

Cartels common until early 20th century
Since then all developed countries passed competition laws that limit or forbid cartels
Some firms caught breaking laws (UK milk cartel, 2007)
Some cartels operate beyond jurisdiction of competition authorities OPEC

Question 9

Forming and maintaining cartels is easier if:

Answer 9

Competition laws are only weakly enforced

Cartel can detect and punish cheating firms

Question 10

Detecting and punishing cheating firms is easier if:

Answer 10

• There is certainty regarding the colluding firm’s cost and revenue functions
• Easy to monitor rival’s output level and prices (harder if prices are negotiated with customers individually)
• There are higher entry barriers & fewer firms in market

Question 11

Product differentiation can make it ____ to cheat

Answer 11

Easier and harder

Question 12

How does product differentiation make it easier to cheat?

Answer 12

Punishment through overall increased production is less effective

Question 13

How does product differentiation make it harder to cheat?

Answer 13

Differentiation means lower profits from cheating
More complex agreements are needed

Question 14

How do oligopoly firms behave if they do not collude?

Answer 14

The Cournot model explains how oligopoly firms behave if simultaneously choose how much they produce

Question 15

What is the simplest possible case of non collusive firm behaviour (cournot)

Answer 15

Two identical firms.
Same cost functions & produce identical, undifferentiated products

• firms simultaneously choose quantities
• market only lasts for one period so each firm chooses its quantity only once

Question 16

Marginal revenue is based on…?

Answer 16

Residual demand curve

Question 17

How to obtain the Cournot equilibrium?

Answer 17

Finding the intersection of the two best response functions

Question 18

Why is the intersection of the two best-response curves an equilibrium?

Answer 18

At the intersection, each firm’s output choice is optimal given the choice of the other firm.

No firm has an incentive to deviate from its original choice

Equilibrium is a combination of output choices such that no firm can increase its profit by changing its output.

Cournot equilibrium = Nash equilibrium

Question 19

Draw the Nash equilibrium

Question 20

What was Joseph Bertrand’s criticism of the Cournot assumption that “firms choose quantity”

Answer 20

It’s more realistic to assume firms choose prices and then let consumers choose the quantity they wish to consume

Question 21

What is the Bertrand Model equilibrium called?

Answer 21

Bertrand or Nash-Bertrand equilibrium

Question 22

As with Nash-Cournot Equillbirium, in the Nash-Bertrand equilibrium:

Answer 22

• each firms choice is optimal given the choice of the other firm
• no firm has an incentive to deviate from its original choice

Question 23

Why is the Cournot equilibrium different from the Bertrand equilibrium?

Answer 23

In the Nash-Bertrand equilibrium, firms set p = MC & make 0 economic profits - so the outcome is very different!

Result doesn’t depend on number of firms. You always get P = MC

Question 24

The Nash Bertrand equilibrium’s output can be compared to the equilibrium in…?

Answer 24

Perfect competition

Question 25

What is the Bertrand Paradox?

Answer 25

The Bertrand paradox involves a situation where two companies competing on price end up setting the same low price, leading to a lack of differentiation. Despite having the opportunity to set higher prices and potentially earn more profit, they both choose to undercut each other, resulting in a scenario where prices converge to the lowest possible level, eliminating any competitive advantage.

Question 26

What are two main ways of resolving the Bertrand Paradox?

Answer 26

1. Most markets with homogenous goods, firm only seem to set price but really set quantity

• long production lead times in such markets
• once production plan made, output largely fixed
• firm adjusts price so all quantity produced is sold; but required price is determined by earlier output decision

Examples: steel, aluminium, oil

2. Product differentiation - in most market products are heterogenous

• can’t capture entire market by lowering ones price
• trade off between lower price & higher quantity
• price setting now leads to less extreme results: firms set P > MC

Examples; almost all consumer goods markets (explains why companies try so hard to differentiate themselves)

Question 27

Demand for differentiated products have two key features. What are they?

Answer 27

1. Demand decreases in own price and increases in competitor’s price
2. Firms don’t lose all sales if price is slightly higher than competitor price
   (Products are imperfect substitutes)

Question 28

Cournot model vs Bertrand Model

Answer 28

Cournot model explains how oligopoly firms behave if they simultaneously choose quantity

Bertrand model explains how they behave if they simultaneously choose prices