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Oligopoly

Oligopoly. Perloff Chapter 13. Market Structure. Nash Equilbrium. Where each firm chooses the best action assuming that other firms do the same. Both firms could collude to earn higher profits. In collusion each firm has an incentive to cheat. Multiperiod game Signalling Punishment.

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Oligopoly

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  1. Oligopoly Perloff Chapter 13

  2. Market Structure

  3. Nash Equilbrium Where each firm chooses the best action assuming that other firms do the same.

  4. Both firms could collude to earn higher profits. In collusion each firm has an incentive to cheat. Multiperiod game Signalling Punishment Collusion

  5. American produces 48 as long as United does. If United produces 64, American will do the same in all subsequent periods. Increase profits for one period outweighed by reduced profits in all subsequent periods. But the argument breaks down if there is a know stopping point. Punishment

  6. (a) Firm (b) Market Price, p, $ per unit Price, p, $ 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 m c m c Quantity, q , Units Quantity, Q , Units per year per year Why do Cartels Form • Each firm in competition only considers the effects of its own actions on price. • In a Cartel the collective actions of all firms are considered.

  7. (a) Firm (b) Market Price, p, $ per unit Price, p, $ 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 m c m c Quantity, q , Units Quantity, Q , Units per year per year Why do cartels fail

  8. Models of Non-cooperative Oligopoly • Firms cannot set both price and quantity. • Cournot model. • Firms simultaneously set quantity. • Stackelberg model. • Firms set quantities sequantially. • Bertrand model. • Firms set prices.

  9. Assumptions • Two firms (duopoly). • Identical products. • Market only lasts one period.

  10. 339 339 275 243 211 p, $ per passenger p, $ per passenger 147 MC 147 MC q = 64 U r r MR D D MR D 0 64 137.5 275 339 128 q , Thousand American Airlines 96 0 169.5 339 q , Thousand American Airlines A A passengers per quarter passengers per quarter Deriving the Cournot Reaction Curve Shows one firms profit maximising output given the output of the other firm

  11. 192 qu, Thousand Unitedpassengers per quarter American ’ s best-response curve 96 Cournot equilibrium 64 48 United ’ s best-response curve 0 64 96 192 q , Thousand American A passengers per quarter American and United’s best response (reaction) curves Nash Equilibrium: Neither firm can increase profits by choosing another output level.

  12. Stackelberg model • One firm is the leader: • They are able to choose their output before the other firm (the follower) • Leader realises that once it sets it ouput, the follower will use its reaction curve to determine its output.

  13. Stackelberg decision tree Leader ’ s decision Follower ’ s decision Profits ( π , π ) A U 48 (4.6, 4.6) 48 64 (3.8, 5.1) United 96 (2.3, 4.6) 48 (5.1, 3.8) 64 64 American (4.1, 4.1) United 96 (2.0, 3.1) 48 (4.6, 2.3) 96 64 (3.1, 2.0) United 96 (0, 0)

  14. (a) Residual Demand American Faces 339 Stackelberg Graphical Model p, $ per passenger 243 r D 195 r MR MC 147 q = 48 U D 0 q = 96 Q = 144 192 339 A q , Thousand American passengers per quarter A (b) United ’ s Best-Response Curve qu, Thousand Unitedpassengers per quarter 96 q = 48 U United ’ s best-response curve 0 q = 96 192 A q , Thousand American passengers per quarter A

  15. 339 275 q = 64 A 1 147 MC 2 MC 99 r r MR D D 0 64 88 137.5 275 339 The effects of a subsidy on Cournot equilibrium 192 p, $ per passenger American ’ s best-response curve ( MC = $147) qu, Thousand Unitedpassengers per quarter 120 e 2 96 88 United ’ s original best-response curve ( MC = $147) e 64 1 United ’ s new best-response 48 curve ( MC = $99) 0 48 64 96 192 240 q , Thousand United q , Thousand American U A passengers per quarter passengers per quarter

  16. Bertrand Equilibrium with undifferentiated products p2, Price of Firm 2, $ per unit Firm 1 ’ s best-response curve • Price setting • MC=AC=$5 for both • Suppose firm 1 sets p=$10 • Firm 2 will set p=$9.99 • If firm 1 sets p=$5 • Firm 2 sets p=0 10 Firm 2 ’s best-response curve e 5 45 ° line 0 5 9.99 10 p , Price of Firm 1, $ per unit 1

  17. Bertrand equilibrium with differentiated products 25 Pepsi ’ s best-response curve ( MC = $5) Coke ’ s best-response p curve ( MC = $14.50) c e 2 pc, Price of Coke, $ per unit 18 e Coke ’ s best-response 1 13 curve ( MC = $5) c 0 13 14 25 p , Price of Pepsi, $ per unit

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