L22 Oligopoly

Market structure pall Market structures: Oligopoly – industry with 2 or more large sellers. Intermediate level of fixed cost Have market power (but smaller than monopoly) Also: oligopsony and bilateral oligopoly N 1 2 3-10 10-… Name pall

Oligopolies in practice Examples of oligopolies in the USA: - accounting & audit services, tobacco, beer, aircraft, military equipment, motor vehicle, film and music recording industries Inefficiency and regulation (Federal Trade Commission) Industry is legally recognized as oligopolistic 1. concentration ratio “big four”>40% (share of top 4 firms in the market) 2. HERFINDAHL-HIRSCHMAN I Moderately concentrated industries HHI>1000 Concentrated industry HHI>1800

IO - Models Strategic environment – harder than before Careful about timing and strategy Quantities - chosen simultaneously (Cournot) - leader and follower (Stackelberg) Prices (Bertrand) When goods are not homogenous - Monopolistic competition

Cournot Model - Assumptions Homogenous good 2 firms (duopoly) Aggregate supply Market price chosen simultaneously Cost function Maximize profit

Firm 1: Best response to

Best response: Geometry

Cournot-Nash Equilibrium: Cournot equilibrium : Output of each firm is a best response to the output of the other firm No firm has incentives to deviate, given production of the other firm.

Equilibrium (Example)

Nash Equilibrium: Geometry

Incentives to collude Are there profit incentives for both firms to “cooperate” by lowering their output levels? If yes than collusion. Firms that collude form a cartel. Good for firms, bad for consumers and efficiency (DWL) Under what condition cartels are stable?

Collusion

Collusion: Geometry

Incentives to collude In long run reputation helps! - see movie ``Informant’’ Cartels are hard to sustain if: Only short run interactions Imperfect monitoring of price Alternative: Mergers - Problem: Federal Trade Commission

Cournot with N firms