Oligopoly Flashcards
What is an oligopoly?
Market dominated by a small number of big firms (mobile phone networks, video game consoles)
Oligopoly assumptions
Sellers have market power and behave strategically
Buyers are price takers
Significant barriers to entry even in the long run
Firms in an oligopoly can either compete or?
Collude
What is collusion?
Coordinating setting prices or wuantjtjes
What is a cartel?
A group of firms that cooperate to restrict competition
Draw a cartel diagram
Why don’t we see more cartels if they are so profitable?
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.
Competition policy on Cartels
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
Forming and maintaining cartels is easier if:
Competition laws are only weakly enforced
Cartel can detect and punish cheating firms
Detecting and punishing cheating firms is easier if:
- 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
Product differentiation can make it ____ to cheat
Easier and harder
How does product differentiation make it easier to cheat?
Punishment through overall increased production is less effective
How does product differentiation make it harder to cheat?
Differentiation means lower profits from cheating
More complex agreements are needed
How do oligopoly firms behave if they do not collude?
The Cournot model explains how oligopoly firms behave if simultaneously choose how much they produce
What is the simplest possible case of non collusive firm behaviour (cournot)
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
Marginal revenue is based on…?
Residual demand curve
How to obtain the Cournot equilibrium?
Finding the intersection of the two best response functions
Why is the intersection of the two best-response curves an equilibrium?
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
Draw the Nash equilibrium
What was Joseph Bertrand’s criticism of the Cournot assumption that “firms choose quantity”
It’s more realistic to assume firms choose prices and then let consumers choose the quantity they wish to consume
What is the Bertrand Model equilibrium called?
Bertrand or Nash-Bertrand equilibrium
As with Nash-Cournot Equillbirium, in the Nash-Bertrand equilibrium:
- each firms choice is optimal given the choice of the other firm
- no firm has an incentive to deviate from its original choice
Why is the Cournot equilibrium different from the Bertrand equilibrium?
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
The Nash Bertrand equilibrium’s output can be compared to the equilibrium in…?
Perfect competition
What is the Bertrand Paradox?
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.
What are two main ways of resolving the Bertrand Paradox?
- 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
- 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)
Demand for differentiated products have two key features. What are they?
- Demand decreases in own price and increases in competitor’s price
- Firms don’t lose all sales if price is slightly higher than competitor price
(Products are imperfect substitutes)
Cournot model vs Bertrand Model
Cournot model explains how oligopoly firms behave if they simultaneously choose quantity
Bertrand model explains how they behave if they simultaneously choose prices
