Oligopoly ECO 230 J.F. O’Connor

Market Structures Perfect competition –Many firms and identical goods Monopolistic competition –Many firms and differentiated goods Oligopoly –Few firms and similar goods Monopoly –One firm

Duopoly Two sellers Example of water well Can show the alternatives with this example See Table 16

Monopoly Cartel

Cournot or Nash Equilibrium

Comparison Monopoly or joint profit maximizing cartel 60 units and TR=$3,600 Cournot-Nash Equilibrium 80 units, price $40, TE = $3,200 Jack 40 units and TR=$1,600 Jill same as Jack Socially Optimal Equilibrium 120 units, price=MC = $0

Impact of Competition Suppose a third person enters the water market Cournot-Nash equilibrium is now 90 units, price = $30, TR=$2,700 Jack 30 units and TR=$900 What about a fourth person entering? Conclusion: competition drives down price!

Compete or Cooperate This is the big issue for the oligopolist Cooperation (collusion) will always maximize joint profits Why not cooperate? Illegal in the U.S. (Sherman Act) Cartels tend to be difficult to organize and operate successfully (Why?)

Prisoners’ Dilemma Game theory studies behavior in case where strategy is important. How one participant does depends heavily on the actions of other individual participants. Prisoners’ dilemma is an example that demonstrates the fact that if each person looks after his individual interest, the result can be that both participants are worse off.

Bonnie&Clyde’s Dilemma Bonnie confessesBonnie stay silent Clyde confesses 8 years for Bonnie 8 years for Clyde 20 years for Bonnie 0 years for Clyde Clyde stays silent 0 years for Bonnie 20 years for Clyde 1 year for Bonnie 1 year for Clyde

Bonnie looks at her situation as follows: Suppose Clyde confesses: If I don’t confess, I get 20 years If I confess, I get 8 years Suppose Clyde stays silent: If I don’t confess, I get 1 years If I confess, I get 0 years Better option in both cases is to confess! Confessing is a dominant strategy for Bonnie Same is true for Clyde

Marlboro&Camel’s Dilemma Marlboro advertises Marlboro doesn’t advertise Camel advertises Marlboro $3 bil. Camel $3 bil. Marlboro $2 bil. Camel $5 bil. Camel does not advertise Marlboro $5 bil. Camel $2 bil. Marlboro $4 bil. Camel $4 bil.

Camel looks at its situation as follows: Suppose Malboro advertises: If we don’t, profit will be $2 bil. If we do, profit will be $3 bil. Suppose Marlboro does not advertise: If we don’t, profit will be $4 bil. If we do, profit will be $5 bil. Better option in both cases is to advertise! Advertising is a dominant strategy for Camel Also true for Marlboro, mutatis mutandis

Cartels OPEC Colombian Drug Cartel Mafia or Crime Syndicate Ivy League Schools Government enforced cartels: market intervention to raise prices!

Raise profits of participants by raising price away from competitive and toward monopoly levels Unstable because of internal conflict between individual and group interest Cheating is usually very profitable A viable cartel needs an effective enforcement mechanism or enforcer