Today n Oligopoly Theory n Economic Experiment in Class

What happens when cartels won’t work? Oligopoly

Theories of Oligopoly Behavior n There are several theories of oligopoly behavior. n Many seem to explain some industries. n None seem to explain all industries.

2 Among Many Possibilities n Bertrand Equilibrium – Assumes firms primarily choose price, then sell quantity demanded n Cournot Equilibrium – Assumes firms primarily choose the quantity to produce, then let the market demand determine price.

Bertrand Equilibrium n Firms simultaneously choose prices – ex: pre-printed catalogs. n Homogeneous product. n Perfect Information. n “Ties” split the market. n Simplification: – constant marginal costs – zero fixed costs. n What does the equilibrium look like?

What would you charge? Q D P What will the Bertrand equilibrium look like? MC

Bertrand Equilibrium Q D P The equilibrium price is equal to marginal cost. Profits are zero. Q* MC

Bertrand Equilibrium Explained n Unless there are zero profits, the firms will undercut each other to get more sales. n The result is like perfect competition, but here we have only a few firms. – Zero profits – P = MC (allocatively efficient)

Cournot Equilibrium n Firms choose quantities without knowing the other firm’s quantity choice. n Each firm sells its output for the highest price possible, given total market output. n Homogeneous product n Perfect Information n Same constant MC as above, zero fixed costs n Same market demand as above

Cournot Equilibrium Q D P In this example each firm would produce 33 1/3 units. (We will not study how this equilibrium is found.) Do these firms make profits in equilibrium? $53 MC

Cournot Equilibrium-Profit Q D P Profits will be made $53 MC

Overview of Cournot Equilibrium n Firms make positive profits. n There must be barriers to entry in order for these to last in the long run. n P > MC, so deadweight loss compared to the efficient quantity.

Oligopoly compared to Monopoly Q D MR P Monopoly produces the least, prices the highest, and earns the most profits. 67 $53 50 $70 Monopoly 2 firms, Cournot Bertrand 100 MC $20 Bertrand produces the most, has the lowest price, and earns zero profits. Cournot is in-between.

Cournot v. Bertrand n Bertrand indicates that without cooperation, the equilibrium is the same as in perfect competition. n The Bertrand equilibrium provides the efficient quantity of the good. n Cournot indicates that without cooperation, oligopolists can make profits as a monopolist does. n The Cournot equilibrium will result in too little being produced, compared to the efficient quantity.

Cournot v. Bertrand, Cont’d n Which is correct as a model of firm behavior? Probably neither. n Firms tend to say they act as price competitors, but market outcomes typically reflect a Cournot solution.

Coming Up n Externalities n In Class Today: – A series of experiments about oligopoly behavior.