chapter 7.2 oligopoly & cartels chapter 7.2 oligopoly & cartels

Chapter 7.2Oligopoly & CartelsChapter 7.2Oligopoly & Cartels

OLIGOPOLYOLIGOPOLY

• We have looked at non-cooperative

oligopolies; but noted their incentive to

collude. Here we want to look at various

possible collusion scenarios.

• Tacit collusion

– price leadership: dominant firm

• We have looked at non-cooperative

oligopolies; but noted their incentive to

collude. Here we want to look at various

possible collusion scenarios.

• Tacit collusion

Dmarket

Division of the market between leader and followersDivision of the market between leader and followers

Dominant firm price leadershipDominant firm price leadership

Leader assumes everyone else will act

like a perfectly competitive firm once it sets price, by choosing output such that P=MC

Dmarket

So Supply curve for everybody else is just

their MC curve

And the leader takes this MC/supply curve as

Sall other firms

Dmarket

What is left over for the

market leader at each price ?

Sall other firms

Dmarket

Above P1 it gets nothing, below P2 no competitors

Sall other firms

DmarketDleader

Above P1 it gets nothing, below P2 no competitorsPOF

Sall other firms

DmarketDleader

What about at prices between

P1 and P2?

What if the price is POF ?

Sall other firms

DmarketDleader

The “leftovers” represent

demand curve for the leading

Sall other firms

DmarketDleader

The leader (of course!)

maximises its profit subject to

its demand curve

Sall other firms

Dmarket

To find optimal P and Q we

consider, as usual, the MR,

MC and AC curves.

Sall other firms

Dmarket

Dleader

Determination of price and outputDetermination of price and output

MRleader

MCleader

Sall other firms

Dmarket

Dleader

MRleader

MCleader

Sall other firms

Dmarket

Dleader

MRleader

MCleader

QL QFQT

Remember followers are a large group of smaller firms

And QT=QL+QF

AR D market

Alternative Leadership: Price leader aiming to Alternative Leadership: Price leader aiming to maximise profits for a given market sharemaximise profits for a given market share

AR D leader

=40% of Market

AR D market

Assume constantmarket share

for leader

Price leader aiming to maximise profitsPrice leader aiming to maximise profitsfor a given market sharefor a given market share

MR leader

AR D leader

AR D market

MR leader

AR D leader

AR D market

MR leader

AR D leader

AR D market

AR D market PL

MR leader

AR D leader

Remainder QT-QL divided up

amongst other producers

OLIGOPOLYOLIGOPOLY

• Tacit collusion

– price leadership: barometric

See Sloman. Just like the case where a

leading firm has a constant market share. One

firm chooses price given D, MR & MC, others

follow.

• Tacit collusion

– price leadership: barometric

See Sloman. Just like the case where a

leading firm has a constant market share. One

firm chooses price given D, MR & MC, others

follow.

OLIGOPOLYOLIGOPOLY

– rules of thumb

AC mark-up pricing P=(1+.10)AC (firms

somehow “agree” on a certain rate of profits).

Benchmark Pricing £9.99, £14,99, £19.99

– rules of thumb

AC mark-up pricing P=(1+.10)AC (firms

somehow “agree” on a certain rate of profits).

Benchmark Pricing £9.99, £14,99, £19.99

• Tacit collusion• Tacit collusion

OLIGOPOLYOLIGOPOLY

• Collusion and the law

– It may be difficult to prove that firms collude,

especially if collusion is tacit.

– What is the difference between all firms

agreeing a price and a price which is

competitively set? Well, it is up to the right

authorities to figure this out – typically they

cannot prove anything unless it is REALLY bad.

• Collusion and the law

– It may be difficult to prove that firms collude,

especially if collusion is tacit.

– What is the difference between all firms

agreeing a price and a price which is

competitively set? Well, it is up to the right

authorities to figure this out – typically they

cannot prove anything unless it is REALLY bad.

SUMMARYSUMMARY

We have looked at various types of imperfect We have looked at various types of imperfect competition.competition.

Lack of competition is, as a general rule, bad Lack of competition is, as a general rule, bad for consumers. Against this speaks that for consumers. Against this speaks that monopolies in some cases tend to innovate monopolies in some cases tend to innovate more - though this is disputed.more - though this is disputed.

The law typically forbids monopolistic The law typically forbids monopolistic behavior, especially collusion, but it is not behavior, especially collusion, but it is not an easy matter to prove anyone’s guilt.an easy matter to prove anyone’s guilt.

The remaining material in this The remaining material in this presentation was not used in lectures presentation was not used in lectures though it is relevant for the classwork though it is relevant for the classwork for weeks 9 & 10. Thus part of these for weeks 9 & 10. Thus part of these assignments will consist in reading assignments will consist in reading

section 7.3 of Sloman. You will not be section 7.3 of Sloman. You will not be asked question about this material at asked question about this material at

the exam, however.the exam, however.

OLIGOPOLYOLIGOPOLY

• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model

If you drop price everyone will followIf you raise price you are on your own

• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model

If you drop price everyone will followIf you raise price you are on your own

Suppose initially we have traditional diagram for firmSuppose initially we have traditional diagram for firm

But once equilibrium is established, if you raise price nobody follows you, and

if you lower it everybody does

and below Q1 it is steeper

Kinked demand for a firm under oligopolyKinked demand for a firm under oligopoly

So above Q1 Demand curve is now flatter

Kinked demand for a firm under oligopolyKinked demand for a firm under oligopoly

So now firm faces the following demand curve

MR for the top part of the curve

MR for the lower part of the curve?

Kinked Demand Curve Theory

• Why is this model important ?

• Because it helps to explain why we tend to observe relatively stable prices in oligopolistic industries

• Why is this model important ?

• Because it helps to explain why we tend to observe relatively stable prices in oligopolistic industries

Stable price under conditions of a kinked demand curveStable price under conditions of a kinked demand curve

To see this lets draw in the original

D, MR and MC curve here.

To see this let’s draw in the original

To see this lets draw in the original

Notice the original MC lies between

points a and b

But what if MC changes?

So MC can vary a lot and price won’t change

OLIGOPOLYOLIGOPOLY

• Non-collusive oligopoly: the kinked demand curve theory

• Offers a reason for stable prices besides collusion

• But other reasons why prices may be stable

• Prices may be costly to change

• Menu costs

• Non-collusive oligopoly: the kinked demand curve theory

• Offers a reason for stable prices besides collusion

• But other reasons why prices may be stable

• Prices may be costly to change

• Menu costs

OLIGOPOLYOLIGOPOLY

• Oligopoly and the public interest

– advantages

– disadvantages

– difficulties in drawing general conclusions

• Advertising and the public interest

• Oligopoly and contestable markets

• Oligopoly and the public interest

– advantages

– disadvantages

– difficulties in drawing general conclusions

• Advertising and the public interest

• Oligopoly and contestable markets

PRICE DISCRIMINATIONPRICE DISCRIMINATION

• Meaning of price discrimination

• Types of price discrimination

– first degree

First-degree price discriminationFirst-degree price discrimination

– first degree

– second degree

– first degree

– second degree

– first degree

– second degree

– third degree

– first degree

– second degree

– third degree

Third-degree price discriminationThird-degree price discrimination

150 200

Third-degree price discriminationThird-degree price discrimination

– first degree

– second degree

– third degree

• Conditions necessary for price discrimination to operate

– first degree

– second degree

– third degree

• Conditions necessary for price discrimination to operate

• Profit-maximising prices and output under price discrimination

– first degree

– third degree

– first degree

– third degree

Profit-maximising output underProfit-maximising output underthird-degree price discriminationthird-degree price discrimination

(a) Market X

(a) Market X (b) Market Y

MRY MRT

(a) Market X (b) Market Y (c) Total

(markets X + Y)

MRY MRT

(markets X + Y)

MRY MRT

(markets X + Y)

MRY MRT

(markets X + Y)

MRY MRT

1000 3000

(markets X + Y)

MRY MRT

1000 2000 3000

(markets X + Y)

MRY MRT

1000 2000 3000

(markets X + Y)

MRY MRT

1000 2000 3000

(markets X + Y)

– first degree

– third degree

• Advantages to the firm

– first degree

– third degree

– first degree

– third degree

• Price discrimination and the public interest

– first degree

– third degree

– first degree

– third degree

– advantages

– first degree

– third degree

– advantages

– first degree

– third degree

– advantages

– disadvantages

– first degree

– third degree

– advantages

– disadvantages

chapter 7.2 oligopoly & cartels chapter 7.2 oligopoly & cartels

market leader

d market price leader

d leaderqlltprice leader

d market plmcqtmr leaderar

constant market share

given market share q

d leaderar

competitive firm

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