lecture on monopoli and oligopoli
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Kuliah 10
Monopoly andOligopoly
Monopoly andOligopoly
Chapter 10 Slide 2
Topik yg akan Dibicarakan
Monopoly
Monopoly Power
Sources of Monopoly Power
The Social Costs of Monopoly Power
Chapter 10 Slide 3
Topik yg akan Dibicarakan
Monopsony
Monopsony Power
Limiting Market Power: The AntitrustLaws (UU Anti Monopoli)
Chapter 10 Slide 4
Ingat: Perfect Competition
Review of Perfect Competition
P = LMC = LRAC
Normal profits or zero economic profits inthe long run
Large number of buyers and sellers
Homogenous product
Perfect information
Firm is a price taker
Ingat: Perfect Competition
Q Q
P PMarket Individual Firm
D S
Q0
P0 P0
D = MR = P
q0
LRACLMC
Chapter 10 Slide 6
Ciri-Ciri Struktur Pasar Monopoli
Monopoly
1) One seller - many buyers
2) One product (no good substitutes)
3) Barriers to entry
4) Price maker (price control andproduct)
Chapter 10 Slide 7
Monopoly
The monopolist is the supply-side of themarket and has complete control overthe amount offered for sale.
Profits will be maximized at the level ofoutput where marginal revenue equalsmarginal cost.
Chapter 10 Slide 8
Monopoly
Finding Marginal Revenue
As the sole producer, the monopolist workswith the market demand to determineoutput and price.
Assume a firm with demand:
P = 6 – Q or Qd= 6 - P
Chapter 10 Slide 9
Total, Marginal, and Average Revenue
$6 0 $0 --- ---
5 1 5 $5 $5
4 2 8 3 4
3 3 9 1 3
2 4 8 -1 2
1 5 5 -3 1
Total Marginal AveragePrice Quantity Revenue Revenue Revenue
P Q (TR=P.Q) MR AR
Chapter 10 Slide 10
Average and Marginal Revenue
Output0
1
2
3
$ perunit ofoutput
1 2 3 4 5 6 7
4
5
6
7
Average Revenue (Demand)
MarginalRevenue
Chapter 10 Slide 11
Monopoly
Observations
1) To increase sales the price must fall
2) MR < P
3) Compared to perfect competition
No change in price to change sales
MR = P
Chapter 10 Slide 12
Monopoly
Monopolist’s Output Decision
1) Profits maximized at the output levelwhere MR = MC
2) Cost functions are the same
MRMCor
MRMCQCQRQ
QCQRQ
0///
)()()(
Chapter 10 Slide 13
Maximizing Profit When MarginalRevenue Equals Marginal Cost
At output levels below MR = MC thedecrease in revenue is greater than thedecrease in cost (MR > MC).
At output levels above MR = MC theincrease in cost is greater than thedecrease in revenue (MR < MC)
The Monopolist’s Output DecisionThe Monopolist’s Output Decision
Chapter 10 Slide 14
Lostprofit
P1
Q1
Lostprofit
MC
AC
Quantity
$ perunit ofoutput
D = AR
MR
P*
Q*
Maximizing Profit When MarginalRevenue Equals Marginal Cost
P2
Q2
Chapter 10 Slide 15
Monopoly
An Example
CMC
QQCCost
2
50)( 2
The Monopolist’s Output DecisionThe Monopolist’s Output Decision
Chapter 10 Slide 16
Monopoly
An Example
RMR
QQQQPQR
QQPDemand
240
40)()(
40)(2
The Monopolist’s Output DecisionThe Monopolist’s Output Decision
Chapter 10 Slide 17
Monopoly
An Example
3010,When
10
2240
PQ
Q
QQorMCMR
The Monopolist’s Output DecisionThe Monopolist’s Output Decision
Chapter 10 Slide 18
Monopoly
An Example
By setting marginal revenue equal tomarginal cost, it can be verified that profit ismaximized at P = $30 and Q = 10.
This can be seen graphically:
The Monopolist’s Output DecisionThe Monopolist’s Output Decision
Chapter 10 Slide 19
Quantity
$
0 5 10 15 20
100
150
200
300
400
50
R = 40Q-Q2
Profits () =-2Q2+40Q-50
t
t'
c
c’
Example of Profit Maximization
C = 50+Q2
Chapter 10 Slide 20
Example of Profit Maximization
Observations
Slope of rr’ = slope cc’and they are parallel at10 units
Profits are maximized at10 units
P = $30, Q = 10,TR = P x Q = $300
AC = $15, Q = 10,TC = AC x Q = 150
Profit = TR - TC
$150 = $300 - $150Quantity
$
0 5 10 15 20
100
150
200
300
400
50
R
C
Profits
t
t'
c
c
Chapter 10 Slide 21
Profit
AR
MR
MC
AC
Example of Profit Maximization
Quantity
$/Q
0 5 10 15 20
10
20
30
40
15
Chapter 10 Slide 22
Example of Profit Maximization
Observations
AC = $15, Q = 10,TC = AC x Q = 150
Profit = TR = TC = $300- $150 = $150 or
Profit = (P - AC) x Q =($30 - $15)(10) = $150
Quantity
$/Q
0 5 10 15 20
10
20
30
40
15
MC
AR
MR
ACProfit
Chapter 10 Slide 23
Monopoly
A Rule of Thumb for Pricing
We want to translate the condition thatmarginal revenue should equal marginalcost into a rule of thumb that can be moreeasily applied in practice.
This can be demonstrated using thefollowing steps:
Chapter 10 Slide 24
A Rule of Thumb for Pricing
PQ
QPE
Q
P
P
QPP
Q
PQPMR
Q
PQ
Q
RMR
d.3
.2
)(.1
Chapter 10 Slide 25
A Rule of Thumb for Pricing
d
d
EPPMR
EQP
PQ
1.5
1.4
Chapter 10 Slide 26
A Rule of Thumb for Pricing
D
DD
E11
MCP
EE
1PP
MCMR@maximizedis
1
.6
Chapter 10 Slide 27
= the markup over MC as apercentage of price (P-MC)/PdE
1.7
A Rule of Thumb for Pricing
8. The markup should equal theinverse of the elasticity of demand.
Chapter 10 Slide 28
A Rule of Thumb for Pricing
12$
75.
9
411
9
94
119
.
P
MCE
Assume
E
MCP
d
d
Chapter 10 Slide 29
Monopoly
Monopoly pricing compared to perfectcompetition pricing:
Monopoly
P > MC
Perfect Competition
P = MC
Chapter 10 Slide 30
Monopoly
Monopoly pricing compared to perfectcompetition pricing:
The more elastic the demand the closerprice is to marginal cost.
If Ed is a large negative number, price isclose to marginal cost and vice versa.
Chapter 10 Slide 31
Monopoly
Shifts in Demand
In perfect competition, the market supplycurve is determined by marginal cost.
For a monopoly, output is determined bymarginal cost and the shape of thedemand curve.
Chapter 10 Slide 32
D2
MR2
D1
MR1
Shift in Demand Leads toChange in Price but Same Output
Quantity
MC
$/Q
P2
P1
Q1= Q2
Chapter 10 Slide 33
D1
MR1
Shift in Demand Leads toChange in Output but Same Price
MC
$/Q
MR2
D2
P1 = P2
Q1 Q2Quantity
Chapter 10 Slide 34
Monopoly
Observations
Shifts in demand usually cause a changein both price and quantity.
A monopolistic market has no supplycurve.
Chapter 10 Slide 35
Monopoly
Observations
Monopolist may supply many differentquantities at the same price.
Monopolist may supply the same quantityat different prices.
Chapter 10 Slide 36
Monopoly
The Effect of a Tax
Under monopoly price can sometimes riseby more than the amount of the tax.
To determine the impact of a tax:
t = specific tax
MC = MC + t
MR = MC + t : optimal production decision
Chapter 10 Slide 37
Effect of Excise Tax on Monopolist
Quantity
$/Q
MC
D = AR
MR
Q0
P0 MC + tax
t
Q1
P1
P
Increase in P: P0P1 > increase in tax
Chapter 10 Slide 38
Question
Suppose: Ed = -2
How much would the price change?
Effect of Excise Tax on Monopolist
Chapter 10 Slide 39
Answer
What would happen to profits?
tax.theby twiceincreasesPrice
22)(2
toincreasesIf
22If
11
tMCtMCP
tMCMC
MCPE
E
MCP
d
d
Effect of Excise Tax on Monopolist
Chapter 10 Slide 40
Monopoly Power
Scenario:
Four firms with equal share (5,000) of amarket for 20,000 toothbrushes at a priceof $1.50.
Quantity10,000
2.00
QA
$/Q $/Q
1.50
1.00
20,000 30,000 3,000 5,000 7,000
2.00
1.50
1.00
1.40
1.60
At a market priceof $1.50, elasticity of
demand is -1.5.
MarketDemand
The Demand for Toothbrushes
The demand curve for Firm Adepends on how much
their product differs, andhow the firms compete.
At a market priceof $1.50, elasticity of
demand is -1.5.
Quantity10,000
2.00
QA
$/Q $/Q
1.50
1.00
20,000 30,000 3,000 5,000 7,000
2.00
1.50
1.00
1.40
1.60
DA
MRA
MarketDemand
Firm A sees a much moreelastic demand curve due tocompetition--Ed = -.6. Still
Firm A has some monopolypower and charges a price
which exceeds MC.
MCA
The Demand for Toothbrushes
Chapter 10 Slide 43
Monopoly Power
Measuring Monopoly Power
In perfect competition: P = MR = MC
Monopoly power: P > MC
Chapter 10 Slide 44
Monopoly Power
Lerner’s Index of Monopoly Power
L = (P - MC)/P
The larger the value of L (between 0 and1) the greater the monopoly power.
L is expressed in terms of Ed
L = (P - MC)/P = -1/Ed
Ed is elasticity of demand for a firm, notthe market
Chapter 10 Slide 45
Monopoly Power
Monopoly power does not guaranteeprofits.
Profit depends on average cost relativeto price.
Question:
Can you identify any difficulties in using theLerner Index (L) for public policy?
Chapter 10 Slide 46
Monopoly Power
The Rule of Thumb for Pricing
Pricing for any firm with monopoly power
If Ed is large, markup is small
If Ed is small, markup is large
dE
MCP
11
Elasticity of Demand and Price Markup
$/Q $/Q
Quantity Quantity
AR
MR
MR
AR
MC MC
Q* Q*
P*
P*
P*-MC
The more elastic isdemand, the less the
markup.
Chapter 10 Slide 48
Markup Pricing:Supermarkets to Designer Jeans
Supermarkets
MC.above11%-10aboutsetPrices
storesindividualfor3.
productSimilar2.
firmsSeveral1.
.5
)(11.19.01.11
.4
10
MCMCMC
P
Ed
Chapter 10 Slide 49
Convenience Stores
MC.above25%aboutsetPrices
3.
thematesdifferentieConvenienc2.
tssupermarkethanpricesHigher1.
.5
)(25.18.0511
.4
5
MCMCMC
P
Ed
Markup Pricing:Supermarkets to Designer Jeans
Chapter 10 Slide 50
Convenience stores have moremonopoly power.
Question:
Do convenience stores have higher profitsthan supermarkets?
Markup Pricing:Supermarkets to Designer Jeans
Convenience StoresConvenience Stores
Chapter 10 Slide 51
Designer jeans
Ed = -3 to -4
Price 33 - 50% > MC
MC = $12 - $18/pair
Wholesale price = $18 - $27
Markup Pricing:Supermarkets to Designer Jeans
Designer JeansDesigner Jeans
The Pricing ofPrerecorded Videocassettes
1985 1999
Title Retail Price($) Title Retail Price($)
Purple Rain $29.98 Austin Powers $10.49Raiders of the Lost Ark 24.95 A Bug’s Life 17.99Jane Fonda Workout 59.95 There’s Something
about Mary 13.99The Empire Strikes Back 79.98 Tae-Bo Workout 24.47An Officer and a Gentleman 24.95 Lethal Weapon 4 16.99Star Trek: The Motion Picture 24.95 Men in Black 12.99Star Wars 39.98 Armageddon 15.86
What Do You Think?
Should producers lower the price ofvideocassettes to increase sales andrevenue?
The Pricing ofPrerecorded Videocassettes
Chapter 10 Slide 54
Sources of Monopoly Power
Why do some firm’s have considerablemonopoly power, and others have littleor none?
A firm’s monopoly power is determinedby the firm’s elasticity of demand.
Chapter 10 Slide 55
Sources of Monopoly Power
The firm’s elasticity of demand isdetermined by:
1) Elasticity of market demand
2) Number of firms
3) The interaction among firms
Chapter 10 Slide 56
The Social Costs of Monopoly Power
Monopoly power results in higher pricesand lower quantities.
However, does monopoly power makeconsumers and producers in theaggregate better or worse off?
Chapter 10 Slide 57
BA
Lost Consumer Surplus
DeadweightLoss
Because of the higherprice, consumers lose
A+B and producergains A-C.
C
Deadweight Loss from Monopoly Power
Quantity
AR
MR
MC
QC
PC
Pm
Qm
$/Q
Chapter 10 Slide 58
Rent Seeking
Firms may spend to gain monopoly power
Lobbying
Advertising
Building excess capacity
The Social Costs of Monopoly Power
Chapter 10 Slide 59
The incentive to engage in monopolypractices is determined by the profit tobe gained.
The larger the transfer from consumersto the firm, the larger the social cost ofmonopoly.
The Social Costs of Monopoly Power
Chapter 10 Slide 60
Example
1996 Archer Daniels Midland (ADM)successfully lobbied for regulationsrequiring ethanol be produced from corn
Question
Why only corn?
The Social Costs of Monopoly Power
Chapter 10 Slide 61
Price Regulation
Recall that in competitive markets, priceregulation created a deadweight loss.
Question:
What about a monopoly?
The Social Costs of Monopoly Power
Chapter 10 Slide 62
AR
MR
MCPm
Qm
AC
P1
Q1
Marginal revenue curvewhen price is regulatedto be no higher that P1.
If left alone, a monopolistproduces Qm and charges Pm.If price is lowered to P3 output
decreases and a shortage exists.
For output levels above Q1 ,the original average and
marginal revenue curves apply.
If price is lowered to PC outputincreases to its maximum QC and
there is no deadweight loss.
Price Regulation
$/Q
Quantity
P2 = PC
Qc
P3
Q3 Q’3
Any price below P4 resultsin the firm incurring a loss.
P4
Chapter 10 Slide 63
Natural Monopoly
A firm that can produce the entire output ofan industry at a cost lower than what itwould be if there were several firms.
The Social Costs of Monopoly Power
Chapter 10 Slide 64
Regulating the Priceof a Natural Monopoly
$/Q
Natural monopolies occurbecause of extensiveeconomies of scale
Quantity
Chapter 10 Slide 65
MC
AC
AR
MR
$/Q
Quantity
Setting the price at Pr
yields the largest possibleoutput;excess profit is zero.
Qr
Pr
PC
QC
If the price were regulate to be PC,the firm would lose money
and go out of business.
Pm
Qm
Unregulated, the monopolistwould produce Qm and
charge Pm.
Regulating the Priceof a Natural Monopoly
Chapter 10 Slide 66
Regulation in Practice
It is very difficult to estimate the firm's costand demand functions because theychange with evolving market conditions
The Social Costs of Monopoly Power
Chapter 10 Slide 67
Regulation in Practice
An alternative pricing technique---rate-of-return regulation allows the firms to set amaximum price based on the expected rateor return that the firm will earn.
P = AVC + (D + T + sK)/Q, whereP = price, AVC = average variable cost
D = depreciation, T = taxes
s = allowed rate of return, K = firm’s capitalstock
The Social Costs of Monopoly Power
Chapter 10 Slide 68
Regulation in Practice
Using this technique requires hearings toarrive at the respective figures.
The hearing process creates a regulatorylag that may benefit producers (1950s &60s) or consumers (1970s & 80s).
Question
Who is benefiting in the 1990s?
The Social Costs of Monopoly Power
Chapter 10 Slide 69
Struktur Pasar Oligopoli
OLIGOPOLY ?
Chapter 10 Slide 70
Ciri-Ciri Pasar Oligopoli
Characteristics
Small number of firms
Product differentiation may or may not exist
Barriers to entry
Price Setter/Price Leadership
Chapter 10 Slide 71
Contoh Oligopoly
Contoh di AS
Automobiles
Steel
Aluminum
Petrochemicals
Electrical equipment
Computers
Contoh diIndonesia
Industri Semen
Industri Otomotif
Industri Kacalembaran
Industri Rokok
Industri CPO
Chapter 10 Slide 72
Oligopoly
The barriers to entry are:
Natural
Scale economies
Patents
Technology
Name recognition
Chapter 10 Slide 73
Oligopoly
The barriers to entry are:
Strategic action
Flooding the market
Controlling an essential input
Chapter 10 Slide 74
Oligopoly
Management Challenges
Strategic actions
Rival behavior
Question
What are the possible rival responses to a10% price cut by Ford?
Chapter 10 Slide 75
Oligopoly
Equilibrium in an Oligopolistic Market
In perfect competition, monopoly, andmonopolistic competition the producers didnot have to consider a rival’s responsewhen choosing output and price.
In oligopoly the producers must considerthe response of competitors whenchoosing output and price.
Chapter 10 Slide 76
Oligopoly
Equilibrium in an Oligopolistic Market
Defining Equilibrium
Firms doing the best they can and haveno incentive to change their output orprice
All firms assume competitors are takingrival decisions into account.
Chapter 10 Slide 77
Oligopoly
Nash Equilibrium
Each firm is doing the best it can givenwhat its competitors are doing.
Chapter 10 Slide 78
Oligopoly
The Cournot Model
Duopoly
Two firms competing with each other
Homogenous good
The output of the other firm is assumedto be fixed
Chapter 10 Slide 79
MC1
50
MR1(75)
D1(75)
12.5
If Firm 1 thinks Firm 2 will produce75 units, its demand curve is
shifted to the left by this amount.
Firm 1’s Output Decision
Q1
P1
What is the output of Firm 1if Firm 2 produces 100 units?
D1(0)
MR1(0)
If Firm 1 thinks Firm 2 willproduce nothing, its demand
curve, D1(0), is the marketdemand curve.
D1(50)MR1(50)
25
If Firm 1 thinks Firm 2 will produce50 units, its demand curve is
shifted to the left by this amount.
Chapter 10 Slide 80
Oligopoly
The Reaction Curve
A firm’s profit-maximizing output is adecreasing schedule of the expectedoutput of Firm 2.
Chapter 10 Slide 81
Firm 2’s ReactionCurve Q*2(Q2)
Firm 2’s reaction curve shows how much itwill produce as a function of how much
it thinks Firm 1 will produce.
Reaction Curvesand Cournot Equilibrium
Q2
Q1
25 50 75 100
25
50
75
100
Firm 1’s ReactionCurve Q*1(Q2)
x
x
x
x
Firm 1’s reaction curve shows how much itwill produce as a function of how much
it thinks Firm 2 will produce. The x’scorrespond to the previous model.
In Cournot equilibrium, eachfirm correctly assumes how
much its competitors willproduce and thereby
maximize its own profits.
CournotEquilibrium
Chapter 10 Slide 82
Oligopoly
Questions
1) If the firms are not producing at theCournot equilibrium, will they adjustuntil the Cournot equilibrium isreached?
2) When is it rational to assume that itscompetitor’s output is fixed?
Chapter 10 Slide 83
Oligopoly
An Example of the Cournot Equilibrium
Duopoly
Market demand is P = 30 - Q where Q =Q1 + Q2
MC1 = MC2 = 0
The Linear Demand CurveThe Linear Demand Curve
Chapter 10 Slide 84
Oligopoly
An Example of the Cournot Equilibrium
Firm 1’s Reaction Curve
111 )30(Revenue,Total QQPQR
122
11
1211
30
)(30
QQQQ
QQQQ
The Linear Demand CurveThe Linear Demand Curve
Chapter 10 Slide 85
Oligopoly
An Example of the Cournot Equilibrium
12
21
11
21111
2115
2115
0
230
MCMR
QQQRMR
CurveReactions2'Firm
CurveReactions1'Firm
The Linear Demand CurveThe Linear Demand Curve
Chapter 10 Slide 86
Oligopoly
An Example of the Cournot Equilibrium
1030
20
10)2115(2115
21
1
1
QP
QQQ
Q
QQ 2:mEquilibriuCournot
The Linear Demand CurveThe Linear Demand Curve
Chapter 10 Slide 87
Duopoly Example
Q1
Q2
Firm 2’sReaction Curve
30
15
Firm 1’sReaction Curve
15
30
10
10
Cournot Equilibrium
The demand curve is P = 30 - Q andboth firms have 0 marginal cost.
Chapter 10 Slide 88
Oligopoly
MCMRMR
QQRMR
QQQQPQR
and15Qwhen0
230
30)30( 2
Profit Maximization with CollusionProfit Maximization with Collusion
Chapter 10 Slide 89
Oligopoly
Contract Curve
Q1 + Q2 = 15
Shows all pairs of output Q1 and Q2 thatmaximizes total profits
Q1 = Q2 = 7.5
Less output and higher profits than theCournot equilibrium
Profit Maximization with CollusionProfit Maximization with Collusion
Chapter 10 Slide 90
Firm 1’sReaction Curve
Firm 2’sReaction Curve
Duopoly Example
Q1
Q2
30
30
10
10
Cournot Equilibrium15
15
Competitive Equilibrium (P = MC; Profit = 0)
CollusionCurve
7.5
7.5
Collusive Equilibrium
For the firm, collusion is the bestoutcome followed by the Cournot
Equilibrium and then thecompetitive equilibrium
Chapter 10 Slide 91
First Mover Advantage--The Stackelberg Model
Assumptions
One firm can set output first
MC = 0
Market demand is P = 30 - Q where Q =total output
Firm 1 sets output first and Firm 2 thenmakes an output decision
Chapter 10 Slide 92
Firm 1
Must consider the reaction of Firm 2
Firm 2
Takes Firm 1’s output as fixed andtherefore determines output with theCournot reaction curve: Q2 = 15 - 1/2Q1
First Mover Advantage--The Stackelberg Model
Chapter 10 Slide 93
Firm 1
Choose Q1 so that:
122
1111 30
0
Q- Q- QQPQR
MC, MCMR
0MRtherefore
First Mover Advantage--The Stackelberg Model
Chapter 10 Slide 94
Substituting Firm 2’s Reaction Curvefor Q2:
5.7and15:0
15
21
1111
QQMR
QQRMR
211
112
111
2115
)2115(30
QQQQR
First Mover Advantage--The Stackelberg Model
Chapter 10 Slide 95
Conclusion
Firm 1’s output is twice as large as firm 2’s
Firm 1’s profit is twice as large as firm 2’s
Questions
Why is it more profitable to be the firstmover?
Which model (Cournot or Shackelberg) ismore appropriate?
First Mover Advantage--The Stackelberg Model
Chapter 10 Slide 96
Price Competition
Competition in an oligopolistic industrymay occur with price instead of output.
The Bertrand Model is used to illustrateprice competition in an oligopolisticindustry with homogenous goods.
Chapter 10 Slide 97
Price Competition
Assumptions
Homogenous good
Market demand is P = 30 - Q whereQ = Q1 + Q2
MC = $3 for both firms and MC1 = MC2 =$3
Bertrand ModelBertrand Model
Chapter 10 Slide 98
Price Competition
Assumptions
The Cournot equilibrium:
Assume the firms compete with price, notquantity.
Bertrand ModelBertrand Model
$81firmsbothfor
12$P
Chapter 10 Slide 99
Price Competition
How will consumers respond to aprice differential? (Hint: Considerhomogeneity)
The Nash equilibrium:
P = MC; P1 = P2 = $3
Q = 27; Q1 & Q2 = 13.5
Bertrand ModelBertrand Model
0
Chapter 10 Slide 100
Price Competition
Why not charge a higher price to raiseprofits?
How does the Bertrand outcome compare tothe Cournot outcome?
The Bertrand model demonstrates theimportance of the strategic variable (priceversus output).
Bertrand ModelBertrand Model
Chapter 10 Slide 101
Price Competition
Criticisms
When firms produce a homogenous good,it is more natural to compete by settingquantities rather than prices.
Even if the firms do set prices and choosethe same price, what share of total saleswill go to each one?
It may not be equally divided.
Bertrand ModelBertrand Model
Chapter 10 Slide 102
Price Competition
Price Competition with DifferentiatedProducts
Market shares are now determined not justby prices, but by differences in the design,performance, and durability of each firm’sproduct.
Chapter 10 Slide 103
Price Competition
Assumptions
Duopoly
FC = $20
VC = 0
Differentiated ProductsDifferentiated Products
Chapter 10 Slide 104
Price Competition
Assumptions
Firm 1’s demand is Q1 = 12 - 2P1 + P2
Firm 2’s demand is Q2 = 12 - 2P1 + P1
P1 and P2 are prices firms 1 and 2charge respectively
Q1 and Q2 are the resulting quantitiesthey sell
Differentiated ProductsDifferentiated Products
Chapter 10 Slide 105
Price Competition
Determining Prices and Output
Set prices at the same time
202-12
20)212(
20$:1Firm
212
11
211
111
PPPP
PPP
QP
Differentiated ProductsDifferentiated Products
Chapter 10 Slide 106
Price Competition
Determining Prices and Output
Firm 1: If P2 is fixed:
12
21
2111
413
413
0412
'
PP
PP
PPP
curvereactions2'Firm
curvereactions1'Firm
pricemaximizingprofits1Firm
Differentiated ProductsDifferentiated Products
Chapter 10 Slide 107
Firm 1’s Reaction Curve
Nash Equilibrium in Prices
P1
P2
Firm 2’s Reaction Curve
$4
$4
Nash Equilibrium
$6
$6
Collusive Equilibrium
Chapter 10 Slide 108
The Kinked Demand Curve
$/Q
Quantity
MR
D
If the producer lowers price thecompetitors will follow and the
demand will be inelastic.
If the producer raises price thecompetitors will not and the
demand will be elastic.
Chapter 10 Slide 109
The Kinked Demand Curve
$/Q
D
P*
Q*
MC
MC’
So long as marginal cost is in thevertical region of the marginal
revenue curve, price and outputwill remain constant.
MR
Quantity
Chapter 10 Slide 110
Implications of the Prisoners’Dilemma for Oligopolistic Pricing
Price Signaling
Implicit collusion in which a firm announcesa price increase in the hope that otherfirms will follow suit
Price Signaling & Price LeadershipPrice Signaling & Price Leadership
Chapter 10 Slide 111
Implications of the Prisoners’Dilemma for Oligopolistic Pricing
Price Leadership
Pattern of pricing in which one firmregularly announces price changes thatother firms then match
Price Signaling & Price LeadershipPrice Signaling & Price Leadership
Chapter 10 Slide 112
Implications of the Prisoners’Dilemma for Oligopolistic Pricing
The Dominant Firm Model
In some oligopolistic markets, one largefirm has a major share of total sales, and agroup of smaller firms supplies theremainder of the market.
The large firm might then act as thedominant firm, setting a price thatmaximized its own profits.
Chapter 10 Slide 113
Price Setting by a Dominant Firm
Price
Quantity
D
DD
QD
P*
At this price, fringe firmssell QF, so that total
sales are QT.
P1
QF QT
P2
MCD
MRD
SF The dominant firm’s demandcurve is the difference between
market demand (D) and the supplyof the fringe firms (SF).
Chapter 10 Slide 114
Cartels
Characteristics
1) Explicit agreements to set output andprice
2) May not include all firms
Chapter 10 Slide 115
Cartels
Examples ofsuccessful cartels
OPEC
InternationalBauxiteAssociation
Mercurio Europeo
Examples ofunsuccessful cartels
Copper
Tin
Coffee
Tea
Cocoa
Characteristics
3) Most often international
Chapter 10 Slide 116
Cartels
Characteristics
4) Conditions for success
Competitive alternative sufficientlydeters cheating
Potential of monopoly power--inelasticdemand
Chapter 10 Slide 117
Cartels
Comparing OPEC to CIPEC
Most cartels involve a portion of the marketwhich then behaves as the dominant firm
Chapter 10 Slide 118
The OPEC Oil Cartel
Price
Quantity
MROPEC
DOPEC
TD SC
MCOPEC
TD is the total world demandcurve for oil, and SC is the
competitive supply. OPEC’sdemand is the difference
between the two.
QOPEC
P*
OPEC’s profits maximizingquantity is found at the
intersection of its MR andMC curves. At this quantity
OPEC charges price P*.
Chapter 10 Slide 119
Cartels
About OPEC
Very low MC
TD is inelastic
Non-OPEC supply is inelastic
DOPEC is relatively inelastic
Chapter 10 Slide 120
The OPEC Oil Cartel
Price
Quantity
MROPEC
DOPEC
TD SC
MCOPEC
QOPEC
P*
The price without the cartel:•Competitive price (PC) where
DOPEC = MCOPEC
QC QT
Pc
Chapter 10 Slide 121
The CIPEC Copper Cartel
Price
Quantity
MRCIPEC
TD
DCIPEC
SC
MCCIPEC
QCIPEC
P*PC
QC QT
•TD and SC are relatively elastic•DCIPEC is elastic•CIPEC has little monopoly power•P* is closer to PC
Chapter 10 Slide 122
Cartels
Observations
To be successful:
Total demand must not be very priceelastic
Either the cartel must control nearly allof the world’s supply or the supply ofnoncartel producers must not be priceelastic
Chapter 10 Slide 123
The Cartelizationof Intercollegiate Athletics
Observations
1) Large number of firms (colleges)
2) Large number of consumers (fans)
3) Very high profits
Chapter 10 Slide 124
Question
How can we explain high profits in acompetitive market? (Hint: Think cartel andthe NCAA)
The Cartelizationof Intercollegiate Athletics
Chapter 10 Slide 125
The Milk Cartel
1990s with less government support,the price of milk fluctuated more widely
In response, the government permittedsix New England states to form a milkcartel (Northeast Interstate DairyCompact -- NIDC)
Chapter 10 Slide 126
The Milk Cartel
1999 legislation allowed dairy farmers inNortheastern states surrounding NIDCto join NIDC, 7 in 16 Southern states toform a new regional cartel.
Soy milk may become more popular.
Chapter 10 Slide 127
Summary
In a monopolistically competitivemarket, firms compete by sellingdifferentiated products, which are highlysubstitutable.
In an oligopolistic market, only a fewfirms account for most or all ofproduction.
Chapter 10 Slide 128
Summary
In the Cournot model of oligopoly, firmsmake their output decisions at the sametime, each taking the other’s output asfixed.
In the Stackelberg model, one firm setsits output first.
Chapter 10 Slide 129
Summary
The Nash equilibrium concept can alsobe applied to markets in which firmsproduce substitute goods and competeby setting price.
Firms would earn higher profits bycollusively agreeing to raise prices, butthe antitrust laws usually prohibit this.
Chapter 10 Slide 130
Summary
The Prisoners’ Dilemma creates pricerigidity in oligopolistic markets.
Price leadership is a form of implicitcollusion that sometimes gets aroundthe Prisoners Dilemma.
In a cartel, producers explicitly colludein setting prices and output levels.
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