1 / 33

Industrial Organization

Industrial Organization. Market Power Oligopoly models (homogeneous products). Market Power. Empirical questions of interest: What gives rise to market power? Assumptions: Market power can be measured reliably (cost data) Causality can be established “SCP” approach

sumana
Download Presentation

Industrial Organization

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Industrial Organization Market Power Oligopoly models (homogeneous products)

  2. Market Power • Empirical questions of interest: • What gives rise to market power? • Assumptions: • Market power can be measured reliably (cost data) • Causality can be established • “SCP” approach • Is there market power? How much? • Cost data (i.e. market power) is unreliable • Use a lot theory and econometrics to infer unobserved cost (i.e. market power) • “Structural” approach

  3. Market Power • Empirical questions of interest: • What gives rise to market power? • Assumptions: • Market power can be measured reliably (cost data) • Causality can be established • “SCP” approach • Is there market power? How much? • Cost data (i.e. market power) is unreliable • Use a lot theory and econometrics to infer unobserved cost (i.e. market power) • “Structural” approach

  4. Structural Approach • “Structure”: • Theory • Start with oligopoly • Empirics: estimate theoretically meaningful parameters • Infer degree of market power

  5. Oligopoly Monopoly: No Rivals, full price control Oligopoly: Few firms, market price is affected but less than monopoly; this also affects rivals’ profits. Strategic environment: own strategy (and profits) depend on others’ strategies Perfect competition: Many firms, market price is unaffected by strategies. Not a strategic environment

  6. Oligopoly • Strategies: • Set prices • Set quantities • Popular models: • Cournot: quantity setting • Betrand: price setting • Stackelberg: price or quantity • Today: • Single period: a) Cournot, b) Betrand, c) Conjectural variation models • Later: • Repeated games (with collusion as equilibrium) Simultaneous Sequential

  7. Market Structures Perfect Competition P is given, choice of Q Imperfect Competition Oligopoly Decides P and Q given residual demand Duopoly Decides P and Q given residual demand Monopoly Decides P and Q given market demand Cooperation: Cartel/Collusion No-Cooperation Sequential Movements Leadership models Simultaneous movements Price Competition (Bertrand) or Quantity (Cournot) Repetitive interaction (∞)

  8. Cournot Model (1838) • Strategies are production levels • For now, assume 2 firms • What strategies should firm 1 use to choose output level? It depends on firm 1’ belief about firm 2’s behavior • Cournot: take rival’s choice as given

  9. Cournot (2 firms) $ B p=pM D1 (q2=0) D’ p’ D1 (q2=q2’) MC D MR Q q2’ q2’’ 1’s residual demand below MC: q1(q2’’)=0 q1(q2’) q1(q2=0)=qM

  10. Firm 1’s Reaction Function q2 q2’’ Optimal q1 given choice q2 Also known as “Reaction curve” or “best response” q2’ qM q1 q1(q2’)

  11. Cournot • Essence of Cournot Model: • Each firm treats output level of its competitor as given and then decides how much to produce • Each firm faces a residual demand curve • Reaction curve: describes optimal quantity choice given rival’s choice of quantity

  12. Cournot Equilibrium q2 q2, q1*(q2), is not a NE because firm 2 should reduce its output to increase profits r1 (q2) q2 NE: both choices are simultaneously optimal qM r2 (q1) q2*(q1*) qM q1 q1*(q2*) q1*(q2)

  13. Cournot: Algebra chain rule 1 0 This is the one of the Cournot assumptions

  14. Cournot: Algebra Additional profit of producing 1 more unit Reduced profit due to increased quantity • Cournot price < Monopoly price • Cournot profits (sum over all firms) < Monopoly profits • How is this related to the prisoner’s dilemma?

  15. Cournot: Algebra • Rewrite foc as: Market power is driven by market share

  16. Cournot • Joint profits are not maximized • Joint profit maximization happens when q1+q2=? And profits are ? • Not so realistic model: • Homogeneous products • Quantity competition • Simultaneous moves (one shot game, no equilibrium convergence)

  17. Bertrand: Price competition • Bertrand (1883): Who sets prices if not the firms? • Bertrand “conjecture” is similar to Cournot’s: rival’s price is taken as given (or fixed) • Consumers have perfect information • Firms have identical costs • Goods are homogeneous • No transportation costs • No capacity constraints

  18. Bertrand: example p1 Joint Profit Maximization π1=π2=5x10-5x3=35 10 • Assumptions: • 2 firms, MC1=MC2 • Unit demand, 10 consumers, each willing to pay a max of $10 • Lowest p captures the whole market, if tie, they split the market MC1=3 p2 MC2=3 10

  19. Bertrand: Example Joint Profit maximization π1=π2=5x10-5x3=35 (not an equilibrium) p1 10 • Strategies: price=[3,10] • Profit (πi): • (pi-3)x10 if pi<pj • (pi-3)x5 if pi=pj • 0 if pi>pj • Equilibrium: No incentive to change strategies Equilibrium: π1=π2=0 8 π1=0 π2=9x10-9x3=63 (not an equilibrium) MC1=3 45o p2 MC2=3 9 10

  20. Bertrand: More formally Why? A deviation must not be profitable pi>c means zero profit pi<c means negative profit

  21. Bertrand: Residual Demand r1(p2) p2 p2 Firm 2’ residual demand p1 r2(p1) MC2=3 q2 10 MC1=3 p1

  22. Bertrand Paradox • The perfectly competitive solution is found even in a highly concentrated market (2 firms) • It is hard to believe that firms in highly concentrated industries will not earn above normal profits • Solutions of the paradox: • Capacity constraints • Geographic differentiation (transportation costs) • Consumers have imperfect information • Product differentiation • Repetitive interaction

  23. So far… • Quantity setting firms (Cournot) • Price setting firms (Bertrand) • Conjecture or belief: “rival’s action is taken as given” • Bertrand, Cournot and Collusion can be “nested” in a more general model

  24. Conjectural Variation Model • 2 firms (n=2) “Conjecture”:

  25. n-firm Collusion and Bertrand • Symmetric case: q1=q2=…=qn n firms Collusion (monopoly): Bertrand:

  26. Conjectural variation: Elasticity

  27. Conjectural variation: Perceived MR MR • Oligopolist equates “perceived MR” with MC • Why “Perceived”: MR depends on conjecture about how firm 2 will react to a change in firm 1’s output

  28. Conjectural variation: Perceived MR p(Q) p(Q) Perceived MR of oligopolist Q “Weighted” MR: between monopolist’s MR and PC’s MR

  29. How is this done in practice? • Estimate supply and demand and infer from estimated parameters • Taking logs: Supply function (FOC optimality) Estimated constant Parameter of interest Demand estimate

  30. Conjectural Variation: Example “Perceived” MR

  31. Conjectural Variation: Example

  32. Criticisms of CV models • Conjectures are arbitrary • Certain values do not correspond to any theoretical model • Interpretation of CV models are implausible • Conjecture is a dynamic concept, but it is employed in a static (one-shot) framework • Firms do not update conjectures • Firms maximize PV of profits: choice of quantity/price today may not only affect today’s profits (this is a more general criticism)

  33. Popularity of CV Models • is known as “conduct parameter” • Why: Estimate of as an index of market power for the industry • Given criticism of conjectural variations, is not referred as CV in empirical analysis. Rather: index of market power

More Related