Week 9 - Oligopoly and Monopolistic Competition Flashcards
Oligopoly
A market with many buyers and few sellers.
There is no clear amount of firms where a market becomes/ stops being an oligopoly.
Cartel
A cartel is a group of independent market participants who collude with each other in order to improve their profits and dominate the market.
Why do cartels work
Cartels give market power to the firms in the market by reducing competition, allowing the firms to raise prices and keep sales, earning the firms more profit than they otherwise would.
Why are cartels unstable
Originally firms are selling at the same price and sharing profits however one firm could lower their price and sell more to get all the sales from being the cheapest product, massively increasing their profit.
What are 2 models that analyse how firms compete in oligopoly
The Cournot model and Bertrand model.
Cournot model
A model for an oligopolist market where firms choose output levels, allowing the market to determine price.
The Cournot model is generally used for a duopoly but can be generalised for oligopoly.
What does the Cournot model assume
Firms products are highly substitutable products.
Firms have the same technology and face the same input costs.
There are constant unit costs and straight line market demand curve.
What is the reaction curve
A curve used in duopoly to decide the output a firm should have to maximise profits, given the output of another firm.
What are Qpc and Qm
Qpc is the perfectly competitive output. If the other firm’s output is Qpc, the best response is to produce nothing.
Qm is the monopolist output. If the other firm’s output is 0, the best response is the monopolist output.
What is Cournot equilibrium
The intersection of two firms reaction function where neither firm has an incentive to change their output.
Output for Cournot equilibrium is below perfect equilibrium but above monopolist industries.
Why does Cournot equilibrium have allocative inefficiency
Firms earn supernormal profit (profit is positive), but not as much as they could earn if they were to collude (effectively becoming a monopoly).
How can you find Cournot equilibrium algebraically
- Substitute price function into profit function to eliminate price from the profit function
- Re-arrange profit function by expanding brackets and simplifying
- Find maximum profit by differentiating profit with respect to q1, setting equal to 0
- Solve for q1 to find firm 1’s reaction function
- Swap q1 and q2 in q1’s reaction function to find firm 2’s reaction function (can do this as the two firms are identical)
- Solve equations simultaneously to find q1* and q2*
Bertrand model
A model for an oligopolist market where firms decide on price, allowing the market to decide on output levels.
Undercutting
Bertrand pricing means that firms have the opportunity to price just below their rivals to steal the whole market.
Undercutting is possible as long as price does not fall below marginal cost as this would mean they are making a loss.
Bertrand paradox
The Bertrand paradox is a paradox that occurs when firms constantly undercut each other until both firms are selling at marginal cost meaning neither is making any profit.
It is paradoxical because oligopolies are expected to earn profit because of limited competition and it reflects the outcome of perfect competition, even though only two firms exist.
Why is the Bertrand paradox unlikely to happen in the real world.
Firms cannot keep decreasing prices as this increases output and firms have capacity constraints.
Firms are likely to try and differentiate their product to have other attractive features instead of or as well as low prices.
Firms understand that the short term gains from undercutting leads to falling profits in the longer term.
Monopolistic competition
A market where there are many buyers and many sellers, and
sellers can differentiate their products.
Demand curves have a downwards slope.
Short vs long run monopolistic competition
Firms have profits in the short run however due to lack of entry barriers, firms will see the profits being made and join the market.
However as more firms join, profits have to be shared between more firms leading to 0 profit in the long run.
Is monopolistic competition efficient
It is an inefficient market structure because it has less surplus than the surplus in perfect competition.
Sources of market power
Exclusive control over important inputs
Patents and copyrights
Government licences or franchises
Economies of scale (Natural monopolies)
Network economies
