Chapter 7.2 Oligopoly & Cartels Chapter 7.2 Oligopoly & Cartels

OLIGOPOLY We have looked at non-cooperative oligopolies; but noted their incentive to collude. Here we want to look at various possible collusion scenarios. Tacit collusion – –price leadership: dominant firm We have looked at non-cooperative oligopolies; but noted their incentive to collude. Here we want to look at various possible collusion scenarios. Tacit collusion – –price leadership: dominant firm

£ Q O D market Division of the market between leader and followers Dominant firm price leadership Leader assumes everyone else will act like a perfectly competitive firm once it sets price, by choosing output such that P=MC

£ Q O D market Division of the market between leader and followers Dominant firm price leadership So Supply curve for everybody else is just their MC curve And the leader takes this MC/supply curve as given

£ Q O S all other firms D market Division of the market between leader and followers Dominant firm price leadership What is left over for the market leader at each price ?

£ Q O S all other firms D market P1P1 P2P2 b Division of the market between leader and followers Dominant firm price leadership Above P 1 it gets nothing, below P 2 no competitors

£ Q O S all other firms D market D leader P1P1 P2P2 a b Division of the market between leader and followers Dominant firm price leadership Above P 1 it gets nothing, below P 2 no competitors P OF

£ Q O S all other firms D market D leader P1P1 P2P2 a b Division of the market between leader and followers Dominant firm price leadership What about at prices between P 1 and P 2 ? What if the price is P OF ? P OF Q OF

£ Q O S all other firms D market D leader P1P1 P2P2 a b Division of the market between leader and followers Dominant firm price leadership The “leftovers” represent demand curve for the leading firm P OF

£ Q O S all other firms D market D leader P1P1 P2P2 a b Division of the market between leader and followers Dominant firm price leadership The leader (of course!) maximises its profit subject to its demand curve

£ Q O S all other firms D market P1P1 P2P2 a b Division of the market between leader and followers Dominant firm price leadership To find optimal P and Q we consider, as usual, the MR, MC and AC curves.

£ Q O S all other firms D market D leader PLPL Determination of price and output MR leader MC leader QLQL l Dominant firm price leadership

£ Q O S all other firms D market D leader PLPL MR leader MC leader QLQL QTQT t l Determination of price and output Dominant firm price leadership

£ Q O S all other firms D market D leader PLPL MR leader MC leader QLQL QFQF QTQT f t l Determination of price and output Dominant firm price leadership Remember followers are a large group of smaller firms And Q T =Q L +Q F

£ Q O AR  D market Alternative Leadership: Price leader aiming to maximise profits for a given market share

£ Q O AR  D leader =40% of Market AR  D market Assume constant market share for leader Price leader aiming to maximise profits for a given market share

£ Q O MR leader AR  D leader AR  D market Price leader aiming to maximise profits for a given market share

£ Q O MC MR leader AR  D leader AR  D market Price leader aiming to maximise profits for a given market share

£ Q O PLPL MC MR leader AR  D leader QLQL l AR  D market Price leader aiming to maximise profits for a given market share

£ Q O AR  D market PLPL MC QTQT MR leader AR  D leader QLQL l t Price leader aiming to maximise profits for a given market share Remainder Q T -Q L divided up amongst other producers

OLIGOPOLY Tacit collusion – –price leadership: dominant firm – –price leadership: barometric   See Sloman. Just like the case where a leading firm has a constant market share. One firm chooses price given D, MR & MC, others follow. Tacit collusion – –price leadership: dominant firm – –price leadership: barometric   See Sloman. Just like the case where a leading firm has a constant market share. One firm chooses price given D, MR & MC, others follow.

OLIGOPOLY – –rules of thumb   AC mark-up pricingP=(1+.10)AC (firms somehow “agree” on a certain rate of profits).   Benchmark Pricing£9.99, £14,99, £19.99 – –rules of thumb   AC mark-up pricingP=(1+.10)AC (firms somehow “agree” on a certain rate of profits).   Benchmark Pricing£9.99, £14,99, £19.99 Tacit collusion

OLIGOPOLY Collusion and the law – –It may be difficult to prove that firms collude, especially if collusion is tacit. – –What is the difference between all firms agreeing a price and a price which is competitively set? Well, it is up to the right authorities to figure this out – typically they cannot prove anything unless it is REALLY bad. Collusion and the law – –It may be difficult to prove that firms collude, especially if collusion is tacit. – –What is the difference between all firms agreeing a price and a price which is competitively set? Well, it is up to the right authorities to figure this out – typically they cannot prove anything unless it is REALLY bad.

SUMMARY We have looked at various types of imperfect competition. Lack of competition is, as a general rule, bad for consumers. Against this speaks that monopolies in some cases tend to innovate more - though this is disputed. The law typically forbids monopolistic behavior, especially collusion, but it is not an easy matter to prove anyone’s guilt.

The remaining material in this presentation was not used in lectures though it is relevant for the classwork for weeks 9 & 10. Thus part of these assignments will consist in reading section 7.3 of Sloman. You will not be asked question about this material at the exam, however.

OLIGOPOLY Non-collusive oligopoly: the kinked demand curve theory – –assumptions of the model   If you drop price everyone will follow   If you raise price you are on your own Non-collusive oligopoly: the kinked demand curve theory – –assumptions of the model   If you drop price everyone will follow   If you raise price you are on your own

Suppose initially we have traditional diagram for firm £ Q O P1P1 Q1Q1 D MR MC But once equilibrium is established, if you raise price nobody follows you, and if you lower it everybody does

and below Q 1 it is steeper Kinked demand for a firm under oligopoly £ Q O P1P1 Q1Q1 D So above Q 1 Demand curve is now flatter MC

Kinked demand for a firm under oligopoly £ Q O P1P1 Q1Q1 D

£ Q O P1P1 Q1Q1 D So now firm faces the following demand curve

£ Q O P1P1 Q1Q1 D  AR a MR MR for the top part of the curve

£ Q O P1P1 Q1Q1 MR a b D  AR MR for the lower part of the curve?

£ Q O P1P1 Q1Q1 MR a b D  AR

Kinked Demand Curve Theory Why is this model important ? Because it helps to explain why we tend to observe relatively stable prices in oligopolistic industries Why is this model important ? Because it helps to explain why we tend to observe relatively stable prices in oligopolistic industries

£ Q O P1P1 Q1Q1 MR a b D  AR Stable price under conditions of a kinked demand curve To see this lets draw in the original D, MR and MC curve here.

£ Q O P1P1 Q1Q1 MR a b D  AR Stable price under conditions of a kinked demand curve To see this let’s draw in the original D, MR and MC curve here.

£ Q O P1P1 Q1Q1 MR a b D  AR Stable price under conditions of a kinked demand curve To see this lets draw in the original D, MR and MC curve here. Notice the original MC lies between points a and b

£ Q O P1P1 Q1Q1 MR a b D  AR Stable price under conditions of a kinked demand curve MC 1 MC 2 But what if MC changes?

£ Q O P1P1 Q1Q1 MR a b D  AR Stable price under conditions of a kinked demand curve MC 1 MC 2 So MC can vary a lot and price won’t change

OLIGOPOLY Non-collusive oligopoly: the kinked demand curve theory Offers a reason for stable prices besides collusion But other reasons why prices may be stable Prices may be costly to change Menu costs Non-collusive oligopoly: the kinked demand curve theory Offers a reason for stable prices besides collusion But other reasons why prices may be stable Prices may be costly to change Menu costs

OLIGOPOLY Oligopoly and the public interest – –advantages – –disadvantages – –difficulties in drawing general conclusions Advertising and the public interest Oligopoly and contestable markets Oligopoly and the public interest – –advantages – –disadvantages – –difficulties in drawing general conclusions Advertising and the public interest Oligopoly and contestable markets

PRICE DISCRIMINATION Meaning of price discrimination Types of price discrimination – –first degree Meaning of price discrimination Types of price discrimination – –first degree

O P1P1 D 200 P Q First-degree price discrimination

O P1P1 D 200 P Q First-degree price discrimination

PRICE DISCRIMINATION Meaning of price discrimination Types of price discrimination – –first degree – –second degree Meaning of price discrimination Types of price discrimination – –first degree – –second degree

PRICE DISCRIMINATION Meaning of price discrimination Types of price discrimination – –first degree – –second degree – –third degree Meaning of price discrimination Types of price discrimination – –first degree – –second degree – –third degree

Third-degree price discrimination P Q O P1P1 D 200

O P1P1 D P2P P Q Third-degree price discrimination

PRICE DISCRIMINATION Meaning of price discrimination Types of price discrimination – –first degree – –second degree – –third degree Conditions necessary for price discrimination to operate Meaning of price discrimination Types of price discrimination – –first degree – –second degree – –third degree Conditions necessary for price discrimination to operate

PRICE DISCRIMINATION Profit-maximising prices and output under price discrimination – –first degree – –third degree Profit-maximising prices and output under price discrimination – –first degree – –third degree

Profit-maximising output under third-degree price discrimination OOO DXDX MR X (a) Market X

OOO DXDX DYDY MR X MR Y (a) Market X (b) Market Y Profit-maximising output under third-degree price discrimination

OOO DXDX DYDY MR X MR Y MR T (a) Market X (b) Market Y (c) Total (markets X + Y) Profit-maximising output under third-degree price discrimination

OOO DXDX DYDY MR X MR Y MR T MC (a) Market X (b) Market Y (c) Total (markets X + Y) Profit-maximising output under third-degree price discrimination

OOO DXDX DYDY MR X MR Y MR T MC 3000 (a) Market X (b) Market Y (c) Total (markets X + Y) Profit-maximising output under third-degree price discrimination

OOO DXDX DYDY MR X MR Y MR T MC (a) Market X (b) Market Y (c) Total (markets X + Y) Profit-maximising output under third-degree price discrimination

OOO DXDX DYDY MR X MR Y MR T MC (a) Market X (b) Market Y (c) Total (markets X + Y) Profit-maximising output under third-degree price discrimination

OOO DXDX DYDY MR X MR Y MR T MC (a) Market X (b) Market Y (c) Total (markets X + Y) Profit-maximising output under third-degree price discrimination

OOO DXDX DYDY MR X MR Y MR T MC (a) Market X (b) Market Y (c) Total (markets X + Y) Profit-maximising output under third-degree price discrimination

OOO DXDX DYDY MR X MR Y MR T MC (a) Market X (b) Market Y (c) Total (markets X + Y) Profit-maximising output under third-degree price discrimination

PRICE DISCRIMINATION Profit-maximising prices and output under price discrimination – –first degree – –third degree Advantages to the firm Profit-maximising prices and output under price discrimination – –first degree – –third degree Advantages to the firm

PRICE DISCRIMINATION Profit-maximising prices and output under price discrimination – –first degree – –third degree Advantages to the firm Price discrimination and the public interest Profit-maximising prices and output under price discrimination – –first degree – –third degree Advantages to the firm Price discrimination and the public interest

PRICE DISCRIMINATION Profit-maximising prices and output under price discrimination – –first degree – –third degree Advantages to the firm Price discrimination and the public interest – –advantages Profit-maximising prices and output under price discrimination – –first degree – –third degree Advantages to the firm Price discrimination and the public interest – –advantages

PRICE DISCRIMINATION Profit-maximising prices and output under price discrimination – –first degree – –third degree Advantages to the firm Price discrimination and the public interest – –advantages – –disadvantages Profit-maximising prices and output under price discrimination – –first degree – –third degree Advantages to the firm Price discrimination and the public interest – –advantages – –disadvantages