oligopoly oligopoly is a market with few sellers selling similar or identical products. “few”...
TRANSCRIPT
OLIGOPOLY
Oligopoly is a market with few sellers selling similar or identical products. “Few” means morethan one, but not so many that each firm doesn’thave a substantial influence over market price.
OLIGOPOLY
Price Quantity (P) (Q)
10 0 9 1 8 2 7 3 6 4 5 5 4 6 3 7 2 8 1 9 0 10
The market demand for a product is given on the left. The technology for producing the product has zero fixedcost and constant marginal cost of $1.Then ATC=AVC=MC=1 for any firmregardless of size. We will consider three ways of organizing production(perfect competition, monopoly, andoligopoly), and examine the economic
OLIGOPOLY
Price Quantity (P) (Q)
10 0 9 1 8 2 7 3 6 4 5 5 4 6 3 7 2 8 1 9 0 10
efficiency of each.
PERFECT COMPETITION
Price Quantity (P) (Q)
10 0 9 1 8 2 7 3 6 4 5 5 4 6 3 7 2 8 1 9 0 10
Each perfectly competitive firm will produce where Ppc=MC=1, so that a total of Qpc=9 units will be produced. This is the socially optimal level of output. Each firm will have zero economic profit since ATC=MC=P, and (P-ATC) x Q = 0.
MONOPOLY
P Q TR MR
10 0 0 - 9 1 9 9 8 2 16 7 7 3 21 5 6 4 24 3 5 5 25 1 4 6 24 -1 3 7 21 -3 2 8 16 -5 1 9 9 -7 0 10 0 -9
The monopolist will producewhere P>MR=MC=1, whichoccurs at Qm=5 units of output. Monopoly price will be Pm=5, and monopoly profits will be (Pm-ATC) x Qm = (5-1)x5=20.
MONOPOLY
P Q TR MR
10 0 0 - 9 1 9 9 8 2 16 7 7 3 21 5 6 4 24 3 5 5 25 1 4 6 24 -1 3 7 21 -3 2 8 16 -5 1 9 9 -7 0 10 0 -9
$
Q
ATC=MCD
MR
Ppc=1
Pm=5
Qm= 5
Qpc=9
DEADWEIGHT LOSS
The perfectly competitiveindustry is efficient in allocating resources, while the
MONOPOLY
P Q TR MR
10 0 0 - 9 1 9 9 8 2 16 7 7 3 21 5 6 4 24 3 5 5 25 1 4 6 24 -1 3 7 21 -3 2 8 16 -5 1 9 9 -7 0 10 0 -9
$
Q
ATC=MCD
MR
Ppc=1
Pm=5
Qm= 5
Qpc=9
DEADWEIGHT LOSS
monopoly allocates too few resources producing a deadweight loss of
MONOPOLY
P Q TR MR
10 0 0 - 9 1 9 9 8 2 16 7 7 3 21 5 6 4 24 3 5 5 25 1 4 6 24 -1 3 7 21 -3 2 8 16 -5 1 9 9 -7 0 10 0 -9
$
Q
ATC=MCD
MR
Ppc=1
Pm=5
Qm= 5
Qpc=9
DEADWEIGHT LOSS
(1/2) x (Qpc-Qm) x (Pm-Ppc)=(1/2)(9-5)(4-1)=8.
DUOPOLY
P Q TR MR
10 0 0 - 9 1 9 9 8 2 16 7 7 3 21 5 6 4 24 3 5 5 25 1 4 6 24 -1 3 7 21 -3 2 8 16 -5 1 9 9 -7 0 10 0 -9
The special case of oligopoly,where there are only two firms, is called duopoly.Assume that the two firmsare identical. Then they canmaximize their combinedprofits by together producing the monopoly output of 5 andcharging the monopoly price
DUOPOLY
P Q TR MR
10 0 0 - 9 1 9 9 8 2 16 7 7 3 21 5 6 4 24 3 5 5 25 1 4 6 24 -1 3 7 21 -3 2 8 16 -5 1 9 9 -7 0 10 0 -9
of 5. If each of the duopolistsproduce 2.5 units of output,they will each have a profit of(P-ATC) x Q = (5-1) x 2.5=10.Then their combined profitwill be 20 -- the same as amonopolist’s profit. Whenfirms enter into an agreement about their production levels
DUOPOLY
and price to charge, this is called collusion, and thegroup of firms in the agreement is a cartel. Thena cartel may allocate resources in the same way asa monopoly. However there are often strong incentives for duopolists (oligopolists) to jointly produce a larger output than a monopolist. Whenduopoly firm A sees its competitor, firm B, producing 2.5 units of output, A can increase itsprofit by producing more than 2.5 units.
DUOPOLY
QB QA Q P TRA MRA TCA PROFIT
2.5 0.5 3 7 3.5 - 0.5 32.5 1.5 4 6 9 5.5 1.5 7.52.5 2.5 5 5 12.5 3.5 2.5 102.5 3.5 6 4 14 1.5 3.5 10.52.5 4.5 7 3 13.5 -0.5 4.5 92.5 5.5 8 2 11 -1.5 5.5 5.52.5 6.5 9 1 6.5 -4.5 6.5 02.5 7.5 10 0 0 -6.5 7.5 -7.5
If B continues toproduce and sell2.5 units, A can increase profitsto 10.5 by selling
3.5 units of output. Price will fall to 4 so that B’sprofit will now be (P-ATC)xQ=(4-1)x2.5=7.5, adecrease of 2.5. Therefore, when A increases itssales, B’s profit is affected. Similarly, if B changes
DUOPOLY
the quantity that it sells, A’s profit will change.Therefore the two firms are interdependent.When each firm believes that the other will produce and sell 2.5 units, each has the incentiveto produce and sell 3.5 units to increase theirprofit. However, when each firm produces 3.5units, total output is 7 and market price is 3. Theneach firm’s profit is (P-ATC)xQ=(3-1)X3.5=7. Each firm does worse than when they each produce 2.5.
DUOPOLY
Firm A 2.5 3.5 2.5Firm B 3.5
10 10.5
10 7.5
7.5 7
10.5 7
The table at the left summarizes the results ofthe two duopolists’ actions.A’s profits for each outputpair is given in the upper right of each cell; B’s profit
for each output pair is in the lower left of each cell. When B sells 2.5 and A sells 3.5, A’s profit is 10.5and B’s profit is 7.5.
GAME THEORY
Since the duopolists’ actions affect each other, theymust develop strategies for deciding how muchoutput to produce. Strategic decision making canbe conveniently analyzed using game theory. Anelementary game is known as the prisoners’ dilemma.
PRISONERS’ DILEMMA
Butch Remain Silent Confess
RemainSundance Silent
Confess
5 years 0 years
5 years 20 years20 years 10 years
0 years 10 years
Each prisonerwill get a 5year sentenceif they bothremain silent.However, eachhas an
incentive to confess and have their sentence reduced to 0 years. But if both confess, they will
PRISONERS’ DILEMMA
Butch Remain Silent Confess
RemainSundance Silent
Confess
5 years 0 years
5 years 20 years20 years 10 years
0 years 10 years
both be worseoff than if theyboth remainsilent. Theactions of eachwill have not only an effect
on themselves, but also on the other. The resultsof their actions are interdependent. If Butch
PRISONERS’ DILEMMA
Butch Remain Silent Confess
RemainSundance Silent
Confess
5 years 0 years
5 years 20 years20 years 10 years
0 years 10 years
confesses andSundanceremains silent,Sundance’ssentence willincrease from 5 to 20 years.
DUOPOLY
Firm A 2.5 3.5 2.5Firm B 3.5
10 10.5
10 7.5
7.5 7
10.5 7
The duopolists’ game issimilar to the prisoners’dilemma. Each has an incentive to choose an action that is not jointly optimal. The actions of
each duopolist has an effect on the profits of the other.
OPEC
Founded in 1960, the Organization of Petroleum Exporting Countries (OPEC) is a cartel of 11 countries that collectively produce about 75% of the world’s oil. Periodically, the cartel assigns production quotas to each of its members to limit production in order to increase price and profits of its members. The cartel has no legal means of enforcing the production quotas. They are simplyaccepted by mutual consent. When price is high,
OPEC
each country has an incentive to increase itsproduction to increase its own profits. But whena number of countries increase production, pricewill fall and so will the OPEC members’ profits.In fact the history of OPEC has seen output quotasraise petroleum (and gasoline) prices, only to havesome members eventually cheat on the agreement.Saudi Arabia (which is an OPEC member) has attempted to penalize the cheaters by flooding the
OPEC
world market with oil, and driving down worldprice and the profits of oil producers. The idea that Saudi Arabia is attempting to convey is that countries who cheat will be “punished” with lowprices and profits when they do not follow theirproduction quotas. Repeatedly playing this gameOPEC members should eventually learn that thebest strategy to play is to adhere to their productionquotas.