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Title: Oligopoly%20and%20Monopolistic%20Competition


1
Chapter 13
  • Oligopoly and Monopolistic Competition

2
Key issues
  • 1. market structure
  • 2.game theory
  • 3.cooperative oligopoly models (cartels)
  • 4.Cournot model of noncooperative oligopoly
  • 5. Stackelberg model of noncooperative oligopoly
  • 6.monopolistic competition
  • 7.Bertrand model of noncooperative oligopoly

3
Market structures
  • markets differ according to
  • number of firms in market
  • ease of entry and exit
  • ability of firms to differentiate their products

4
Oligopoly
  • small group of firms in a market with substantial
    barriers to entry
  • because relatively few firms compete in such a
    market,
  • each firm faces a downward-sloping demand curve
  • each firm can set its price p gt MC
  • market failure inefficient (too little)
    consumption
  • each affects rival firms
  • typical oligopolists differentiate their products

5
Monopolistic competition
  • small or moderate number of firms
  • free entry
  • ? 0
  • p AC
  • usually products differentiated

6

7
Strategies and games
  • oligopolistic or monopolistically competitive
    firm use a
  • strategy
  • battle plan of actions (such as setting a price
    or quantity) it will take to compete with other
    firms
  • oligopolies engage in a
  • game
  • any competition between players (such as firms)
    in which strategic behavior plays a major role

8
Game theory
  • set of tools used by economists, political
    scientists, military analysts, and others to
    analyze decision making by players (such as
    firms) who use strategies
  • these analytic tools can be used to analyze
  • oligopolistic games
  • poker
  • coin-matching games
  • tic-tac-toe
  • elections
  • nuclear war

9
Firm's objective
  • obtain largest possible profit (or payoff) at
    games end
  • typically, one firm's gain comes at expense of
    other firms
  • each firm's profit depends on actions taken by
    all firms

10
Nash equilibrium
  • set of strategies is a Nash equilibrium if,
  • holding strategies of all other players (firms)
    constant,
  • no player (firm) can obtain a higher payoff
    (profit) by choosing a different strategy
  • in a Nash equilibrium, no firm wants to change
    its strategy because each firm is using its
  • best response
  • strategy that maximizes its profit given its
    beliefs about its rivals' strategies

11
Duopoly
  • consider single-period, duopoly, quantity-setting
    game
  • duopoly an oligopoly with two ("duo") firms

12
Airlines Example
  • American Airlines and United Airlines
  • compete for customers on flights between Chicago
    and Los Angeles

13
Notation
  • Q total number of passengers flown by both
    firms sum of
  • qA passengers on American Airlines
  • qU passengers on United Airlines

14
Firms act simultaneously
  • each firm selects a strategy that
  • maximizes its profit
  • given what it believes other firm will do
  • firms are playing
  • a noncooperative game of imperfect information
  • each firm must choose an action before observing
    rivals simultaneous actions

15

16
Dominant strategy
  • a strategy that strictly dominates all other
    strategies regardless of which actions rivals
    chose
  • in this Table 13.2 game, each firm has a dominant
    strategy
  • firm chooses its dominant strategy
  • where a firm has a dominant strategy, its belief
    about its rival's behavior is irrelevant

17
Noncooperative game
  • firms do not cooperate in a single-period game
  • In Nash equilibrium (qA qU 64), each firm
    earns 4.1 million (lt 4.6 million it would make
    if firms restricted their outputs to qA qU
    48)
  • sum of firms' profits is not maximized in this
    simultaneous choice, one-period game

18
Why don't firms cooperate?
  • don't cooperate due to a lack of trust
  • each firm can profitably use low-output strategy
    only if it trusts other firm!
  • each firm has a substantial profit incentive to
    cheat on a collusive agreement

19
Prisoners' dilemma game
  • all players have dominant strategies that lead
    to a profit (or other payoff) that is inferior to
    what they could achieve if they cooperated and
    played alternative strategies

20
Collusion in repeated games
  • in a single-period prisoners' dilemma game, firms
    produce more than they would if they colluded
  • why, then, are cartels frequently observed?
  • collusion is more likely in a multiperiod game
    single-period game played repeatedly
  • punishment not possible in a single-period game
    but possible in a multiperiod game

21
Supergame
  • if a single-period game is played repeatedly,
    firms engage in a
  • supergame
  • players strategies in this period may depend on
    rivals' actions in previous periods
  • in a repeated game, firm can influence its
    rival's behavior by
  • signaling
  • threatening to punish

22
Threat
  • suppose American announces to United that it will
    use the following two-part strategy
  • American produces smaller quantity each period as
    long as United does the same
  • if United produces larger quantity in period t,
    then American will produce larger quantity in
    period t 1and all subsequent periods
  • thus, if firms play same game indefinitely, they
    should find it easier to collude

23
Know number of periods
  • suppose firms know that they are going to play
    game for T periods
  • period T is like a single-period game, and all
    firms cheat
  • hence T-1 period is last interesting period
  • by same reasoning, they cheat in that period,
    etc.
  • cheating is less likely to occur if end period is
    unknown or there is no end

24
Insurance price wars
  • from 1984-1995, life insurance companies' prices
    were high and unchanging
  • in 1995, prices dropped 25 or more

25
Explanations for price war
  • 1. insurers knew that new Triple X regulations
    were expected to go into effect in 1996
  • regulations required insurers to raise reserves
    on term policies to cover future claims
  • were expected to boost rates on new policies by
    as much as 50
  • companies cut rates to attract new customers
    before higher rates took effect
  • 2. formal or informal agreement to keep prices
    high fell apart as end of original game approached

26
Cooperative oligopoly models
  • Adam Smith
  • "People of the same trade seldom meet
    together, even for merriment and diversion, but
    the conversation ends in a conspiracy against the
    public, or some contrivance to raise prices"

27
Cartels fail
  • luckily for consumers, cartels often fail
    because
  • each firm in a cartel has an incentive to cheat
    on the cartel agreement by producing extra output
  • governments forbid them

28
Historic cartels
  • in late nineteenth century, cartels (trusts)
    were legal and common in the United States
  • oil
  • railroads
  • sugar
  • tobacco
  • steel
  • J.D. Rockefeller

29
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30
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31
Laws against cartels
  • in response to trusts' high prices, Congress
    passed
  • Sherman Antitrust Act in 1890
  • Federal Trade Commission Act of 1914
  • these laws prohibit firms from explicitly
    agreeing to take actions that reduce competition,
    such as jointly setting price
  • these anti-cartel laws are called
  • antitrust laws in U.S.
  • competition policies in most other countries

32
Europe
  • over the last dozen years, the European
    Commission has been pursuing competition cases
    under laws that are similar to U.S. antitrust
    laws
  • recently the EC, the DOJ, and the FTC have become
    increasingly aggressive, prosecuting many more
    cases
  • following the U.S., which uses both civil and
    criminal penalties, the British government
    introduced legislation in 2002 to criminalize
    certain cartel-related conduct
  • EU uses only civil penalties, but its fines have
    increased dramatically, as have U.S. fines

33
Corporate Leniency Program
  • in 1993, DOJ introduced a new Corporate Leniency
    Program that guarantees that participants in
    cartels who blow the whistle will receive
    immunity from federal prosecution
  • as a consequence, DOJ has caught, prosecuted, and
    fined several gigantic cartels (e.g. Vitamins)
  • on Valentines Day, 2002, EC adopted a similar
    policy

34
Sothebys and Christies
  • Sothebys (established in 1744) and Christies
    (1776) are the two largest and most prestigious
    auction houses in the world
  • they control 90 of the 4 billion worldwide
    auction market
  • for most of the last two and a half centuries,
    they thrived
  • starting at least by 1993, when faced with poor
    business conditions, they started to collude,
    according to the U.S. Department of Justice (DOJ)

35
Auctions (cont.)
  • DOJ started investigating in 1997, but gained the
    necessary evidence in 2000, when Christies
    approached both DOJ and European Commission with
    proof that it had conspired with Sothebys to fix
    prices
  • Christies applied for leniency under the U.S.
    antitrust laws, effectively shopping its rival

36
Auctions (cont.)
  • DOJ charged that the pair
  • held meetings between top-level executives
  • exchanged confidential lists of super-rich
    clients
  • agreed to limit which customers received lower
    commissions
  • charged identical commission rates (a sliding
    scale up to 20) to other sellers who had little
    negotiation power
  • Sothebys paid a 45 million fine
  • the two auction houses agreed to pay more than
    512 million to former clients to settle lawsuits

37
Auctions (cont.)
  • A. Alfred Taubman, Sothebys former chairman and
    who still held a 21 share of stock and
    controlled 63 of its voting rights, was
    sentenced for price fixing to a year in prison
    and fined 7.5 million in 2002
  • Christies former chairman, Sir Anthony Tennant,
    lives in England has refused to come to the
    United States to face trial
  • however, days before Taubmans conviction, the
    European Commission brought charges against both
    auction houses

38
Why some cartels persist
  • 1. tacit collusion
  • 2. international cartels (OPEC) and cartels
    within certain countries operate legally
  • 3. illegal cartel believes it can avoid detection
    or punishment will be small

39
Why cartels form
  • members of cartel believe they can raise their
    profits by coordinating their actions

40
Why can cartels raise profits?
  • if a competitive firm is maximizing its profit,
    why should joining a cartel increase its profit?
  • competitive firm is already choosing output to
    maximize its profit
  • however, it ignores effect that changing its
    output level has on other firms' profits
  • cartel takes into account how changes in one
    firm's output affect cartel profits

41
Why cartels fail
  • cartels fail if noncartel members can supply
    consumers with large quantities of goods
    (example copper)
  • each member of a cartel has an incentive to cheat
    on cartel agreement

42
Figure 13.1 Competition Versus Cartel

(b) Market
(a) Firm
Price,
p
,
Price,
p
,
per unit
per unit
M
C
S
e
m
p
p
m
m
AC
e
p
p
c
c
c
MC
MC
m
m
Market demand
MR
q
q

q
Q
Q

c
m
m
c
Quantity,
q
, Units
Quantity,
Q
, Units
per year
per year
43
Solved problem
  • initially, all identical firms in a market
    collude
  • if some of these firms leave the cartel and act
    like price takers, how are consumers affected?

44
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45
Maintaining cartels
  • to maintain cartel, firms must
  • detect cheating
  • punish violators
  • keep its illegal behavior hidden from governments

46
Detection and enforcement
  • inspect each other's books (e.g., most-favored
    nation clauses)
  • governments report bids on
  • government contracts
  • divide market by region or by customers
  • mercury cartel (1928-1972) allocated
  • U.S. to Spain and Europe to Italy
  • use industry organizations to detect cheating
  • offer "low price" guarantees

47
Insurance price wars
  • life insurance companies' prices are normally
    stable and high
  • however, in 1995, companies dropped their prices
    substantially 25 or more
  • the previous price war 1981-3, when term
    insurance rates went from 4 to 1 per thousand
    dollars of coverage for a 35-year-old for a
    10-year plan

48
Cause of price war
  • theory 1 sparked by new insurance regulations
  • insurers knew in advance when these new
    regulations (Triple X) were expected to go into
    effect
  • new regulations required insurers raise reserves
    on term policies to cover future claims were
    expected to boost rates by as much as 50
  • companies were cutting rates to attract new
    customers before the higher rates took effect

49
Alternative theory
  • theory 2 (not necessarily incompatible view)
    a formal or informal agreement to keep prices
    high fell apart as the end of the original game
    approached

50
Government created cartels
  • American, European, and other governments
    established a cartel in 1944 that fixed prices
    for international airline flights and prevented
    competition
  • baseball teams exempted from some U.S. antitrust
    laws since 1922
  • Bud Selig, baseball's commissioner
  • The baseball antitrust exemption is
    protection for the fans.
  • automobiles

51
Automobile cartel
  • Reagan admin. negotiated 1981 voluntary export
    restraints (VER) Japanese auto manufacturers
    would reduce their auto exports to U.S.
  • Why would Japanese manufacturers voluntarily
    reduce their exports?
  • to avoid government quotas
  • to act like a cartel reducing sales to collusive
    level
  • when U.S. allowed VER agreements to lapse in
    1985, Japanese government wanted to continue to
    restrict exports

52
Auto cartel effects
  • stock market value of Japanese auto industry
    increased during VER period by 6.6 billion
  • VERs raised price of American cars by 5.4
    between 1981 and 1983
  • U.S. consumers lost 6.9 billion (1984) due to
    these export restrictions
  • using VER is foolish
  • foreign and domestic auto manufacturers capture
    cartel profits from higher prices
  • tariffs better for U.S.

53
Entry and cartel success
  • barriers to entry help cartel limit competition
  • cartels with large number of firms rare (except
    professional associations)
  • Dept. of Justice price-fixing cases 1963-1972
  • only 6.5 involved 50 or more conspirators
  • average number of firms was 7.25
  • 48 involved 6 or fewer firms
  • cartels often fall apart after entry (mercury)

54
Bail bonds
  • Connecticut sets a maximum fee bail-bond
    businesses can charge for posting a given-size
    bond
  • how close price in a city is to legal maximum
    depends on number of firms

55
Town of active firms of maximum allowed fee
Plainville, Stamford, Wallingford 1 99
Meriden, New London 2 98
Norwalk 3 54
New Haven 8 64
Bridgeport 10 78
56
Mergers
  • if antitrust or competition laws prevent firms
    from colluding, they may try to merge
  • U.S. laws restrict ability of firms to merge if
    effect would be anticompetitive

57
Some mergers raise efficiency
  • efficiency due to greater scale
  • sharing trade secrets
  • closing duplicative retail outlets
  • Chase and Chemical banks merged in 1995
    closed or combined 7 branches in Manhattan
    located within 2 blocks of another branch

58
Airline mergers
  • government did not contest most airline mergers
    1985-1988
  • prices increased on routes served by firms that
    merged relative to those on routes without mergers

59
Soft drinks 1986 merger proposals
  • Coke, largest producer of carbonated soft drinks
    (38.6 of sales), tried to buy third largest, Dr
    Pepper (7.1)
  • Pepsi, second largest producer (27.4), tried to
    acquire fourth largest firm, Seven-Up Co. (6.3)
  • had these proposed mergers taken place, Coke's
    market share would have risen to 45.7 and
    Pepsi's to 33.7
  • combined share would have risen from 66.0 to
    79.4

60
FTC intervenes
  • Federal Trade Commission (FTC) opposed
    mergers, arguing that merger
  • would increase market shares of big firms
  • make entry of new firms more difficult
  • raise costs of other companies doing business in
    this market
  • ease "collusion among participants in the
    relevant markets"

61
Relevant market definition
  • Coca-Cola all beverages including tap water
  • Federal Judge Gesell carbonated soft drinks
    (based on cross-elasticities of demand)

62
Outcome
  • after Coke and Pepsi mergers blocked by FTC in
    1986
  • Dr Pepper Co. sold for 416 million to investor
    group (54 million less than Coke offered)
  • Seven-Up Co. sold for 240 million to another
    investment group (140 million less than
    Pepsico's bid)
  • lower values to others than to Coke and Pepsi is
    consistent with FTC's view that Coke and Pepsi
    would have gained market power through these
    mergers

63
Eventually
  • Dr Pepper and Seven-Up merged
  • by 1995 Dr Pepper/Seven-Up 11.5 of carbonated
    beverages market
  • Cadbury 5.5 Schweppes, Canada Dry, Crush,
    Sunkist, and AW (root beer) brands
  • Cadbury bought Dr Pepper/Seven-Up (17 of
    soft-drink market, and half non-cola part)
  • Coke 41, Pepsi 32
  • mergers increased share of top 3 firms
  • FTC's actions limited share of top 2 firms

64
Noncooperative oligopoly
  • many models of noncooperative oligopoly behavior
  • firms choose quantities
  • Cournot model
  • Stackelberg model
  • firms set prices Bertrand model

65
Cournot
  • Augustin Cournot introduced first formal model of
    oligopoly in 1838
  • oligopoly firms choose how much to produce at
    same time
  • as in prisoners' dilemma game, firms are playing
    noncooperative game of imperfect information
  • each firm chooses its output level before knowing
    what other firm will choose
  • firms may choose any output level they want

66
Basic model
  • duopoly 2 firms (no other firms can enter)
  • firms sell identical products
  • market that lasts only 1 period (product or
    service cannot be stored and sold later)

67
Cournot model of airline market
  • duopoly United Airlines (UA) and American
    Airlines (AA) fly passengers between Chicago and
    Los Angeles
  • no possible entry (limited landing rights at both
    airports)

68
Cournot equilibrium
  • Nash equilibrium where firms choose quantities
  • set of quantities sold by firms such that,
    holding quantities of all other firms constant,
    no firm can obtain a higher profit by choosing a
    different quantity

69
Figure 13.2a American Airlines
Profit-Maximizing Output
(a) Monopoly
p
, per
passenger
339
243
MC
147
D
MR
0
339
169.5
96
q
, Thousand American Airlines
A
passengers per quarter
70
Figure 13.2b American Airlines
Profit-Maximizing Output
(b) Duopoly
p
, per
passenger
339
275
211
MC
147
q

64
U
r
r
MR
D
D
0
339
275
137.5
64
128
q
, Thousand American Airlines
A
passengers per quarter
71
Figure 13.3 American and Uniteds Best-Response
Curves
q
, Thousand United
U
passengers per quarter
192
American

s best-response curve
96
Cournot equilibrium
64
48
United
s best-response curve

0
192
96
64
q
, Thousand American
A
passengers per quarter
72
Figure 13.4a Duopoly Equilibria
(a) Equilibrium Quantities
q
, Thousand United
U
passengers per quarter
192
American

s best-response curve
Contract
curve
Price-taking equilibrium
96
Cournot equilibrium
64
Stackelberg equilibrium
48
Cartel
United

s best-response curve
equilibrium
0
192
96
64
48
q
, Thousand American passengers per quarter
A
73
Figure 13.4b Duopoly Equilibria
(b) Equilibrium Profits
p
, million profit
U
of United Airlines
9.2
Profit possibility frontier
Cartel profits
4.6
4.1
Cournot profits
2.3
Stackelberg
profits
American monopoly
profit
Price-taking profits
0
9.2
4.6
4.1
p
, million profit of American Airlines
A
74
Algebraic approach
  • estimate of linear market demand function is
  • Q(p) 339 p
  • linear residual demand facing AA is
  • qA Q(p) qU (339 p) qU ?
  • p 339 - qA - qU
  • slope of residual demand curve is ?p/?qA -1,
    so slope of MRr -2
  • MRr 339 - 2qA - qU

75
Calculus
  • linear residual demand facing AA is
  • p 339 - qA qU
  • so AAs revenue is
  • R 339qA - qA2 - qUqA
  • so AAs marginal revenue (using the Cournot
    assumption) is
  • MRr dR/dqA 339 2qA - qU

76
AA Maximizes profit
  • MRr 339 - 2qA - qU 147 MC
  • ? best-response function
  • qA 96 - ½ qU

77
Cournot equilibrium
  • intersection of best-response functions
  • qA 96 - ½ qU
  • qU 96 - ½ qA
  • solve by substituting
  • qA 96 - ½(96 - ½ qA)
  • ? qA 64
  • Q qA qU 128
  • p 339 Q 211

78
Solved problem
  • Math version of Solved Problem 13.1 in text.
  • Government charges American Airlines and United
    Airlines a specific tax of ? per passenger on the
    Los Angeles-Chicago route.
  • What is the new equilibrium number of passengers
    that each airline flies?
  • What's the equilibrium number if the tax is 30?

79
Answer
  • determine how the firms' best-response functions
    change due to the tax
  • AA sets its MRr equal to its MC (including the
    tax)
  • MRr 339 - 2qA - qU 147 ? MC
  • rearranging, AAs best-response function is
  • qA 96 - ?/2 - qU/2
  • similarly, UA's best-response function is
  • qU 96 - ?/2 - qA/2

80
Answer (cont.)
  • solve for the equilibrium quantities in terms of
    ?
  • substitute UA's best-response function into AA's
    and rearrange
  • qA (2/3)(96 ?/2) 64 ?/3
  • substitute for qa in UA's best-response function
  • qU 64 ?/3

81
Answer (cont.)
  • solve for the equilibrium quantities where ?
    30
  • qA qU 64 1/3? 54

82
European cigarette tax incidence
  • As with a monopoly, an oligopoly may pass through
    less or more than 100 of a tax to consumers
  • Delipalla and ODonnells (2001) estimate degree
    of pass-through to consumers from a specific tax
    on cigarettes
  • less than 100 in the Netherlands (67), Belgium
    (79), and Germany (82)
  • about 100 in Denmark, the United Kingdom,
    Portugal, and Ireland
  • extremely high in Italy (359), France (604),
    and Luxembourg (700)

83
Cournot equilibrium varies with number of firms
  • typical Cournot firm maximizes its profit
  • MR p(1 1/n?) MC
  • n? is elasticity of residual demand curve facing
    each firm
  • ? is market elasticity of demand
  • n is number of firms
  • Lerner index

84

85
Air ticket prices and rivalry
  • markup of price over marginal cost is much
    greater on routes in which one airline carries
    most of the passengers than on other routes
  • a single firm is the only carrier or the dominate
    carrier on 58 of all U.S. domestic routes
  • monopoly serves 18 of all routes
  • duopolies 19
  • three firms 16
  • four firms 13
  • five or more firms 35

86
Air ticket prices (cont.)
  • although nearly two-thirds of all routes have
    three or more carriers, one or two firms dominate
    virtually all routes
  • dominant firm has at least 60 of ticket sales
    by value but is not a monopoly
  • dominant pair if they collectively have at least
    60 of the market but neither firm is a dominant
    firm and three or more firms fly this route
  • all but 0.1 of routes have a monopoly (18), a
    dominant firm (40), or a dominant pair (42)

87
Air ticket prices (cont.)
  • (average price includes free frequent flier
    tickets and other below-cost tickets)
  • ticket price is
  • 2.1 x MC on average across all U.S. routes and
    market structures
  • 3.3 x MC for monopolies
  • 3.1 x MC for dominant firms
  • 1.2 x MC for dominant pairs
  • if there is a dominant pair, whether there are 4
    or 5 firms, price is between 1.3 x MC for a
    4-firm route and 1.4 x for a route with 5 or more
    firms

88
Stackelberg model
  • Cournot model both firms make their output
    decisions simultaneously
  • Heinrich von Stackelberg's model firms act
    sequentially
  • leader firm sets its output first
  • then its rival (follower) sets its output

89
Figure 13.5 Stackelberg Game Tree
Leader

s decision
Follower

s decision
Profits
(
p
,
p
)
A
U
48
(4.6, 4.6)
64
48
United
(3.8, 5.1)
96
(2.3, 4.6)
48
(5.1, 3.8)
64
64
American
United
(4.1, 4.1)
96
(2.0, 3.1)
48
(4.6, 2.3)
64
96
United
(3.1, 2.0)
96
(0, 0)
90
Figure 13.6 Stackelberg Equilibrium
(a) Residual Demand American Faces
p
, per
passenger
339
243
r
D
195
r
MR
MC
147
q

48
U
D
0
339
192
q

96
Q

144
A
q
, Thousand American passengers per quarter
A
(b) United

s Best-Response Curve
, Thousand United
q
U
passengers per quarter
96
q

48

United
s best-response curve
U
0
q

96
192
A
q
, Thousand American passengers per quarter
A
91
Question
  • when firms move simultaneously,
  • why doesn't AA announce it will produce
    Stackelberg-leader output,
  • so as to induce UA to produce the Stackelberg
    follower's output level?

92
Answer
  • when firms move simultaneously, UA doesn't
    view AA's warning that it will produce a large
    quantity as a credible threat
  • not in AAs best interest to produce large
    quantity
  • because AA cannot be sure that UA believes threat
    and reduce its output, AA produces Cournot level
  • when one firm moves first, its threat to produce
    large quantity is credible because it has already
    committed to producing large quantity

93
Monopolistic competition
  • market structure in which firms
  • have market power
  • are price setters
  • firms enter if there is a profit opportunity (?
    0)
  • monopolistically competitive equilibrium
  • MR MC p AC
  • (demand curve tangent to AC curve)

94
Figure 13.8 Monopolistically Competitive
Equilibrium
p
, per unit
AC
MC
p


AC
p
r
MR



MC
r
r
MR
D
q
, Units per year
q
95
Figure 13.9a Monopolistic Competition Among
Airlines
(a) Two Firms in the Market
p
, per
if F 2.3 million
passenger
300
275
p
1.8 million
211
183
AC
MC
147
r
D
for 2 firms
r
MR
for 2 firms
275
137.5
64
0
q
, Thousand passengers
per quarter
96
Figure 13.9b Monopolistic Competition Among
Airlines
(b) Three Firms in the Market
p
, per
passenger
300
243
195
AC
147
MC
r
D
for 3 firms
r
MR
for 3 firms
243
121.5
48
0
q
, Thousand passengers
per quarter
97
Number of firms
  • number of firms in equilibrium is smaller,
  • greater economies of scale
  • less market demand at each price
  • fewer monopolistically competitive firms,
  • less elastic is each firms residual demand curve
    at equilibrium
  • higher fixed cost

98
Fixed cost and number of firms
  • fixed costs determine number of firms
  • AC 147 F/q
  • smallest quantity at which AC curve reaches its
    minimum called
  • full capacity, or
  • minimum efficient scale
  • monopolistically competitive equilibrium in
    downward-sloping section of AC curve, so
    monopolistically competitive firm operates at
    less than full capacity in LR

99
Bertrand
  • firms set price instead of quantity
  • changes equilibrium
  • (unlike monopoly, choice of quantity vs. price
    matters)

100
Figure 13.10 Bertrand Equilibrium with Identical
Products
p
, Price of Firm 2,
2
Firm 1
s best-response curve

per unit
10
Firm 2

s best-response curve
e
5
45

line
0
5
10
9.99
p
, Price of Firm 1, per unit
1
101
Figure 13.11 Bertrand Equilibrium with
Differentiated Products
p
, Price of Coke,
c
per unit
25
Pepsi

s best-response
curve (
MC
5)
Coke

s best-response
p
curve (
MC
14.50)
c
e
2
18
e
Coke

s best-response
1
13
curve (
MC
5)
c
0
25
13
14
p
, Price of Pepsi, per unit
p
102
1. Market structure
  • prices, profits, and quantities in a market
    equilibrium depend on the market's structure
  • all firms maximize profit by setting MR MC
  • oligopolies and monopolistically competitive
    firms are price setters face downward-sloping
    demand curves
  • oligopoly entry blocked
  • monopolistic competition free entry

103
2. Game theory
  • set of tools used to analyze conflict and
    cooperation between firms
  • each firm forms a strategy or battle plan of the
    actions to compete with other firms
  • firms' set of strategies is a Nash equilibrium
    if,
  • holding the strategies of all other firms
    constant,
  • no firm can obtain a higher profit by choosing a
    different strategy

104
3. Cooperative oligopoly models
  • with collusion, firms collectively produce
    monopoly output and earn monopoly profit
  • each individual firm has an incentive to cheat on
    a cartel arrangement so as to raise its own
    profit even higher

105
4. Cournot model of noncooperative oligopoly
  • if oligopoly firms act independently, market
    output and firms' profits lie between competitive
    and monopoly levels
  • Cournot model each oligopoly firm sets its
    output simultaneously
  • Cournot (Nash) equilibrium each firm produces
    its best-response output given rivals outputs
  • as number of Cournot firms increases, Cournot
    equilibrium price, quantity, and profits approach
    price-taking levels

106
5. Stackelberg model of noncooperative oligopoly
  • Stackelberg leader chooses its output first
  • then its rivals - Stackelberg followers choose
    outputs
  • leader produces more and earns a higher profit
    than followers

107
6. Monopolistic competition
  • monopolistically competitive firms are price
    setters MR MC, so p gt MC
  • there's free entry p AC
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