Scribd Logo
Upload

Welcome to Scribd!

  • 120 views

    Basic Concepts Oligopoly

    Uploaded by

    shikhakhandelia1992
    Oligopoly is a market structure with only a few sellers selling either identical or differentiated products. Firms in an oligopoly are interdependent and recognize that the actions of any one firm can impact the profits of others. While colluding firms could maximize profits by setting a monopoly price, each firm is incentivized to cheat by cutting prices. As a result, oligopoly prices and output typically fall between the competitive and monopoly outcomes.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd

    Basic Concepts Oligopoly

    Uploaded by

    shikhakhandelia1992
    120 views18 pages
    Oligopoly is a market structure with only a few sellers selling either identical or differentiated products. Firms in an oligopoly are interdependent and recognize that the actions of any one firm can impact the profits of others. While colluding firms could maximize profits by setting a monopoly price, each firm is incentivized to cheat by cutting prices. As a result, oligopoly prices and output typically fall between the competitive and monopoly outcomes.

    Original Description:

    oligopoly

    Copyright

    © Attribution Non-Commercial (BY-NC)

    Available Formats

    PPT, PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    Oligopoly is a market structure with only a few sellers selling either identical or differentiated products. Firms in an oligopoly are interdependent and recognize that the actions of any one firm can impact the profits of others. While colluding firms could maximize profits by setting a monopoly price, each firm is incentivized to cheat by cutting prices. As a result, oligopoly prices and output typically fall between the competitive and monopoly outcomes.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    120 views18 pages

    Basic Concepts Oligopoly

    Uploaded by

    shikhakhandelia1992
    Oligopoly is a market structure with only a few sellers selling either identical or differentiated products. Firms in an oligopoly are interdependent and recognize that the actions of any one firm can impact the profits of others. While colluding firms could maximize profits by setting a monopoly price, each firm is incentivized to cheat by cutting prices. As a result, oligopoly prices and output typically fall between the competitive and monopoly outcomes.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 18

    Oligopoly

    Basic Concepts

    Four market model

    Oligopoly

    Pure Monopolistic Competition Competition

    Pure Monopoly

    Market Structure Continuum

    Oligopoly
    Definition:
    an industry with only a few sellers selling an identical or differentiated product.

    Product may be identical


    aluminum crude oil

    or product may be differentiated


    Automobile cigarettes

    possible explanation for the formation of oligopolies


    In oligopoly the size of the minimum efficient scale is large relative to market demand. Typical LAC in Oligopoly
    LAC2 LAC3
    LAC1

    Demand
    Output

    Characteristics of Oligopoly
    A few characteristics of oligopoly: small number of rival firms (highly concentrated
    markets) The actions of any one seller in the market can have a large impact on the profits of all the other sellers.

    firms are interdependent Each seller is large enough to influence price means each seller faces a downward sloping demand curve substantial economies of scale Usually high barriers to entry

    Economies of scale

    Long run average cost

    Unit Cost

    Quantity per year

    Barriers to Entry
    Structural
    The cost advantage over entrants because of
    Economies of scale Economies of scope Control over key input Government regulations

    Strategic
    The action of incumbents that may deter entry
    Over investment in capacity Limit pricing

    Price and Output Under Oligopoly


    Because of interdependence and diversity No general theory exists for price and output under oligopoly. If the firms operated independently, they would drive down the price to the per unit cost of production. If the firms colluded perfectly, the price would rise to the monopoly price. The outcome is usually between these two extremes.

    Price and Output Under Oligopoly


    If oligopolists compete with one another, price cutting drives price down to PC, and expands total output to QC . In contrast, perfect cooperation among firms leads to a higher price PM and a smaller market output of QM. Due to the difficulty to perfectly collude, when firms try to coordinate their activity, price is typically between PC and PM and output between QM and QC.
    Profits to oligopoly with perfect collusion.

    PM PC

    MR
    QM

    LRAC = LRMC Demand

    QC

    Incentive to Collude
    Firms would be better off cooperating and jointly maximizing their profits However, each firm has an incentive to cheat by lowering price because the demand curve facing each firm is more elastic than the market demand curve. This conflict makes collusive agreements difficult to maintain.

    Gaining from Cheating


    Using industry demand Di and marginal revenue MRi, oligopolists maximize their joint profit where MRi = MC at output Qi and price Pi . Demand facing each firm df (where no other firms cheat) would be much more elastic than industry demand Di . The firm maximizes its profit where MRf = MC by expanding output to qf and lowering its price to Pf from Pi

    Pi

    Industry MC MRi Di

    Pi

    Firm MC df

    Pf
    MRf qf

    Qi

    Gaining from Cheating


    Using industry demand Di and marginal revenue MRi, oligopolists maximize their joint profit where MRi = MC at output Qi and price Pi . Demand facing each firm df (where no other firms cheat) Individual firms have would be much more elastic than industry demand Di . an its profit where MR = MC by The firm maximizes intensive to fcheat expanding output tocutting price to to Pf from Pi by qf and lowering its price

    Pi

    expand out put Industry


    Pi

    Firm MC df

    Pf
    MC MRi Di MRf qf

    Qi

    Nash Equilibrium
    The Nash equilibrium is a non-cooperative equilibrium - each firm makes the decision that gives it the maximum possible profit, given the actions of its competitors. As demonstrated, this does not produce a monopoly outcome. Only if firms can prevent entry by potential new firms and collude with existing firms can they realize a monopoly outcome.

    Strategic Behavior
    Strategic behavior is firm behavior that takes into account the market power and reactions of other firms in the industry

    Collusive Strategy
    Repeated interaction provides opportunities for firms to learn and deploy an array of strategies to enforce collusion. These include: tit-for-tat and trigger
    strategies

    Tit-for-tat strategy: firm colludes in current period only if other firm colluded in previous period; otherwise choose not to collude, e.g. price war. Trigger strategy: firm colludes if the other firm colludes, but reverts to Nash equilibrium strategy in every future period if the other firm chooses not to collude.

    Collusive Strategy
    Since each firm learns that it makes a larger profit by sticking to collusion, both firms do so and the monopoly outcome prevails. This outcome results from each firm responding rationally to the credible threat of the other firm to inflict damage if the agreement to collude is broken.

    Types of Collusive Arrangements


    A collusive agreement can be overt or tacit Overt agreements can take the form of a cartel which are formal arrangements to fix prices, divide up or share the market or limit competition. Tacit agreements are less formal arrangements and can take the form of a verbal gentlemans agreement to fix prices and output.

    Obstacles to Collusion
    As the number of firms in an oligopolistic market increases, the likelihood of effective collusion declines. When it is difficult to detect cheating (secret price cuts), effective collusion is less likely. Low entry barriers also make effective collusion less likely because profit attracts additional rivals. Unstable demand conditions lead to honest differences among firms about the size of shares and price that maximizes total profit. Rigorous enforcement of antitrust law makes collusion potentially more costly.

    You might also like