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Oligopoly Overheads

Oligopoly Overheads. Market Structure. Market structure refers to all characteristics of a market that influence the behavior of buyers and sellers, when they come together to trade. Market structure refers to all features of a market that affect

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Oligopoly Overheads

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  1. Oligopoly Overheads

  2. Market Structure Market structure refers to all characteristics of a market that influence the behavior of buyers and sellers, when they come together to trade Market structure refers to all features of a market that affect the behavior and performance of firms in that market

  3. Definition of a competitive agent A buyer or seller (agent) is said to be competitive if the agent assumes or believes that the market price is given and that the agent's actions do not influence the market price We sometimes say that a competitive agent is a price taker

  4. Common Market Structures Perfect (pure) competition Agents take prices as given Entry and exit barriers are minimal or nonexistent

  5. Common Market Structures Monopoly (seller) or Monopsony (buyer) Firm sets price (faces market demand or supply curve) Entry and exit barriers result in the existence of one seller or one buyer

  6. Common Market Structures Oligopoly Firm sets prices (faces residual demand) Entry and exit barriers result in the existence of few sellers or buyers

  7. Common Market Structures Monopolistic competition Firm sets prices (faces residual demand) Entry and exit barriers are minimal

  8. Strategic interdependence When individuals make decisions in environments characterized by strategic interdependence, the welfare of each decision maker depends not only on her own actions, but also on the actions of the other decision makers (firms). Moreover, the actions that are best for her to take may depend on what she expects the other firms to do

  9. Formal definition of oligopoly Noncooperative oligopoly is a market structure where a small number of firms act independently, but are aware of each other's actions A noncooperative oligopoly is a market structure in which a small number of firms are strategically interdependent

  10. Cooperative oligopoly is a market structure in which a small number of firms coordinate their actions to maximize joint profits

  11. Oligopoly is an intermediate market structure in the sense that the firms are price makers as compared to the price takers of perfect competition, but because there are others firms in the market, the firm cannot act in the independent fashion of the monopolist

  12. Duopoly A duopoly is a market with only two firms, each selling the same or similar product

  13. A Duopoly Model Two firms with no additional entry Each firm produces a homogeneous product such that q1 + q2 = Q, where Q is industry output and qi is the output of the ith firm There is a single period of production & sales (zucchini) The market demand and inverse demand are linear

  14. Demand

  15. Marginal and average cost are constant and equal to $4.00

  16. Monopoly solution Firm 1 is the only firm in the market Revenue is given by

  17. Using the same intercept, twice the slope rule, marginal revenue is given by

  18. If we set marginal revenue equal to marginal cost we can obtain the optimal level of q1

  19. If we substitute this into the demand equation we can find the market price

  20. Profit for Firm 1 is given by revenue minus cost or

  21. Demand/P MR MC Zucchini Market Monopoly 30 $ 25 20 15 10 5 0 0 2 4 6 8 10 12 14 16 Quantity

  22. QPriceTRMRCostMCProfit 0.00 28.00 0.00 28.00 0.00 4.00 0.00 1.00 26.00 26.00 24.00 4.00 4.00 22.00 2.00 24.00 48.00 20.00 8.00 4.00 40.00 2.50 23.00 57.50 18.00 10.00 4.00 47.50 3.00 22.00 66.00 16.00 12.00 4.00 54.00 3.50 21.00 73.50 14.00 14.00 4.00 59.50 4.00 20.00 80.00 12.00 16.00 4.00 64.00 4.50 19.00 85.50 10.00 18.00 4.00 67.50 5.00 18.00 90.00 8.00 20.00 4.00 70.00 5.50 17.00 93.50 6.00 22.00 4.00 71.50 6.00 16.00 96.00 4.00 24.00 4.00 72.00 7.00 14.00 98.00 0.00 28.00 4.00 70.00 8.00 12.00 96.00 32.00 4.00 64.00 9.00 10.00 90.00 36.00 4.00 54.00 10.00 8.00 80.00 40.00 4.00 40.00 11.00 6.00 66.00 44.00 4.00 22.00 12.00 4.00 48.00 48.00 4.00 0.00 13.00 2.00 26.00 52.00 4.00 -26.00

  23. Competitive Solution We set price (p) equal to marginal cost (MC) Notice that MC doesn’t depend on qi or Q

  24. If we substitute p = 4 in the demand equation we obtain Profits will be zero

  25. Demand/P MC Zucchini Market Competition 30 $ 25 20 15 10 5 0 0 2 4 6 8 10 12 14 16 Quantity

  26. Cooperative (collusive) oligopoly solution If the two firms in this market were to coordinate their actions and maximize joint profit, they would choose the monopoly output and price Such cooperative agreements are called cartels The two firms together would produce 6 units and charge a price of $16.00 The division of the output between the firms would have to negotiated between them

  27. Noncooperative Oligopoly Joint profits maximized with Q = 6 and p = $16 Will this outcome occur?

  28. Individual firm conjectures and market equilibrium Conjecture A supposition or guess Each firm makes a conjecture about the action of the other firm and then chooses its own action

  29. Story Firm 1 conjectures that Firm 2 will produce 3 units Why?

  30. Inverse demand given the conjecture

  31. Revenue for Firm 1 given the conjecture

  32. Marginal revenue is given by because

  33. If we set marginal revenue equal to marginal cost we can obtain the optimal level of q1

  34. If Firm 2 produced 3 units, price would be

  35. Profit for Firm 1 is given by revenue minus cost or

  36. Profit for Firm 2 is given by Total profit for the two firms is $67.50 Monopoly profit was $72

  37. Is Firm 2 happy? Is Firm 2 content? Is Firm 2 going to keep producing 3 units? Let’s See

  38. Suppose Firm 2 conjectures that Firm 1 will produce 4.5 units

  39. Inverse demand given the conjecture

  40. Marginal revenue is given by because

  41. If we set marginal revenue equal to marginal cost we can obtain the optimal level of q2

  42. If Firm 1 produces 4.5 units and Firm 2 produces 3.75 units, price will be

  43. Profit for Firm 1 is given by

  44. Profit for Firm 2 is given by Total profit for the two firms is $61.875 Monopoly profit was $72

  45. Because Firm 2 is producing 3.75 and not 3 units Firm 1 will want to adjust its output level And then Firm 2 will want to change its output This silly game could go on forever

  46. We can compute the best response for each firm given the action of the other firm to see this Other qq1*q2 3.00 4.500 4.500 3.25 4.375 4.375 3.50 4.250 4.250 3.75 4.125 4.125 4.00 4.000 4.000 4.25 3.875 3.875 4.50 3.750 3.750 4.75 3.625 3.625 5.00 3.500 3.500

  47. What if Firm 1 conjectures that Firm 2 will bring 4 units to market? Other qq1*q2 3.75 4.125 4.125 4.00 4.000 4.000 4.25 3.875 3.875 4.50 3.750 3.750 Firm 1 will bring 4 units to market!

  48. What if Firm 2 conjectures that Firm 1 will bring 4 units to market? Other qq1*q2 3.75 4.125 4.125 4.00 4.000 4.000 4.25 3.875 3.875 4.50 3.750 3.750 Firm 2 will bring 4 units to market!

  49. We have an equilibrium!! Both firms are happy and content

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