Oligopoly Flashcards
3 main characteristics?
Small number of firms
Identical or differentiated product
Barriers to entry
Define interdependence?
When a firm’s actions wrt price and output can be strategically countered by one or more other firms in the industry and vice versa
4 assumptions for kinked demand curve model?
Few firms
Homogenous products
Firms know market demand
Each firm believes that its rivals will match any price cut, but will not match any price increase
Explain the kinked demand curve?
Firm is at equilibrium price and quantity
If they increase price, other firms won’t follow suit tf demand curve is elastic (if they raise price they will lose lots of customers)
If they decrease price, rivals match price change tf they enter price war tf demand curve is quite in elastic (they don’t gain many customers from a price reduction)
Describe what the kinked demand curve graph looks like for all components (AR, MC, MR)
AR - flatter at top, steeper at bottom
MR - flatter at top, JUMP down at price equilibrium, steeper at bottom
MC - anywhere between the ‘jump’ area
Where is profit maximisation when MC is anywhere between the jump?
Profit maximisation will be at p1q1 where the kink on the demand curve is
What is price rigidity and how is it explained?
Firms in an oligopoly are reluctant to change their prices even if their costs change
Explained by the fact that the MC can be anywhere in the ‘jump’ without affecting the profit maximising price and output
4 assumptions for cournot model of duopoly?
Two firms
Identical products
Firms know market demand
Each firm must decide how much to produce and they make the decision at the same time
Explain the cournot mechanism?
See notes
What is the reaction function?
The relationship between a firm’s profit maximising output and the output it thinks it’s rivals will produce
What happens at cournot equilibrium and where is it?
Each firm optimally chooses the output that the other firm expects it to produce therefore once they discover each other’s choices neither firm has any incentive to change output level (at the profit maximising point)
5 assumptions for Bertrand model?
Duopoly Homogenous products Firms know market demand Identical costs Each firm must know what price to charge and the firms make their decisions at the same time
Read through info and learn graph for Bertrand
Now
Where is the Bertrand equilibrium?
Where AVC(b) = AVC(a)
What does the Bertrand equilibrium represent?
The only point at which neither of the firms will undercut each other
Define tacit collusion?
Unagreed collusion between firms in an oligopoly
How can tacit collusion work?
By having a price setting ‘leader’ in the market
What are the two types of ‘leader’?
Dominant firm
Barometric firm
What is a dominant firm?
When there’s one large and many small firms, large firm sets price and others follow (tf act as price takers like in PC)
How does the dominant firm decide how much to produce?
They set a price, see how much quantity the other firms provide then they supply the rest
Referring to the diagram in L12:
How much demand does the dominant firm face and why at p1?
If they set the price at p1, the small firms will supply the whole market therefore they will face no demand
Referring to the diagram in L12:
Why do the two demand curves merge below p2?
Because at p2 only the dominant firm can supply due to cost advantage
See and learn simple price leadership model and normal price leadership model
Now
What is the difference between the simple and normal price leadership models?
The simple model assumes constant market share for leader therefore the demand curves do not merge at low prices
What is a barometric firm?
A ‘reliable’ firm that does not need to dominate the industry
2 simple ways for firms to tacitly collude?
1) average cost pricing: firms simple add a certain % on top of their AVC
2) price benchmarks: certain prices are typically used - tf if costs rise a firm may change their prices from £19.99 to £24.99 (from one benchmark to another)
What is a cartel?
A formal collusive agreement (can agree on prices, output, planned obsolescence)
What is planned obsolescence?
A product with an artificially limited life
How are cartels modelled?
Like a monopoly (act as though single firm) (see diagram)
Why do firms in a cartel often get tempted to cheat?
Since the industry acts as a monopoly, they operate where MC=MR and split the quantities between them accordingly.
However, by looking at the diagram of one firm in a cartel, they will often make more profit by cutting their prices or expanding their output - tending themselves towards their MC=MR point
How does the MR curve for the industry(whole cartel) look on the diagram for a single one of those firms in the cartel?
It is horizontal since the price is fixed
What is the pricing strategy for a firm modelling with a kinked demand curve?
Maintain current price unless competitors lower theirs; if they do the firm will lower their price by the same amount
What is the pricing strategy for a firm modelling with a Bertrand model?
They will set their price just below their competitors so long as they can stay in business (not fall below AVC)
3 elements of a game?
2 rational players
List of possibly actions available
List of payoffs available
What is a maximin strategy?
The strategy of choosing the action whose worst possible outcome is the least bad
What is a maximal strategy?
The strategy of choosing the action that has the best possible outcome
What is a dominant strategy?
A strategy that is optimal no matter what the opponent does
What is a Nash equilibrium?
A payoff point where neither firm has any incentive to change strategy (no gain from changing their strategy given the other firms choice)
What is the ‘tit-for-tat’ strategy?
A strategy in which players mimic their opponent’s last move on each successive move
