Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Oligopoly Perloff Chapter 13

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Market Structure

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Nash Equilbrium Where each firm chooses the best action assuming that other firms do the same.

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Collusion Both firms could collude to earn higher profits. In collusion each firm has an incentive to cheat. Multiperiod game –Signalling –Punishment

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Punishment 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.

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved 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.

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Why do cartels fail

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved 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.

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Assumptions Two firms (duopoly). Identical products. Market only lasts one period.

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Deriving the Cournot Reaction Curve Shows one firms profit maximising output given the output of the other firm MC MRD p, $ per passenger q A, Thousand American Airlines passengers per quarter MR r D r D MC q U = p, $ per passenger q A, Thousand American Airlines passengers per quarter

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved American and United’s best response (reaction) curves Nash Equilibrium: Neither firm can increase profits by choosing another output level.

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved 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.

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Stackelberg decision tree American (4.6, 4.6) (3.8, 5.1) (2.3, 4.6) 48 Leader’s decisionFollower’s decisionProfits(π A,π U ) (5.1, 3.8) (4.1, 4.1) (2.0, 3.1) (4.6, 2.3) (3.1, 2.0) (0, 0) 96 United

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Stackelberg Graphical Model q A, Thousand American passengers per quarter q U = q A = 96 MR r D r D MC (a) Residual Demand American Faces q A, Thousand American passengers per quarter q U = q A = 96Q = 144 United’s best-response curve (b) United’s Best-Response Curve p, $ per passenger q u, Thousand United passengers per quarter

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved The effects of a subsidy on Cournot equilibrium MC 1 2 MR r D r D q A = e 2 e 1 United’s new best-response curve (MC = $99) United’s original best-response curve (MC = $147) American’s best-response curve (MC = $147) q u, Thousand United passengers per quarter q A, Thousand American passengers per quarter p, $ per passenger q U, Thousand United passengers per quarter

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Bertrand Equilibrium with undifferentiated products 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 Firm 2’s best-response curve Firm 1’s best-response curve 45° line e p 1, Price of Firm 1, $ per unit p 2, Price of Firm 2, $ per unit

Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Bertrand equilibrium with differentiated products Pepsi’s best-response curve (MC p = $5) Coke’s best-response curve (MC c = $14.50) Coke’s best-response curve (MC c = $5) p, Price of Pepsi, $ per unit e 1 e 2 p c, Price of Coke, $ per unit