Chapter 7.2 Oligopoly & Cartels Chapter 7.2 Oligopoly & Cartels
OLIGOPOLY Last day, saw non-co-operative ologopolies and noted incentive to collude. Here we want to look at varies possible collusion scenarios: Tacit collusion – –price leadership: dominant firm Last day, saw non-co-operative ologopolies and noted incentive to collude. Here we want to look at varies 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 setting their 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 So leader takes their 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 So what is left over for the market leader at each price Notice reverse strategic thinking
£ 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 price were P OF, what would other firms supply? 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 But leftovers represent demand curve for lead 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 So now leader obviously 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 So need to draw in 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 Like case where firm has constant market share. One firm chooses price given D, MR & MC, others follow Tacit collusion – –price leadership: dominant firm – –price leadership: barometric Like case where firm has constant market share. One firm chooses price given D, MR & MC, others follow
OLIGOPOLY – –rules of thumb AC pricingP=(1+.10)AC Benchmark Pricing£9.99, £14,99, £19.99 Benchmark on Advertising and/or design Recent implicit criticism by Virgin of BA by advertising 4 engine planes – –rules of thumb AC pricingP=(1+.10)AC Benchmark Pricing£9.99, £14,99, £19.99 Benchmark on Advertising and/or design Recent implicit criticism by Virgin of BA by advertising 4 engine planes Tacit collusion –price leadership: dominant firm –price leadership: barometric Tacit collusion –price leadership: dominant firm –price leadership: barometric
OLIGOPOLY Collusion and the law – –Can be difficult to prove – –What is the difference between all agreeing a price and one-price competitively set? Collusion and the law – –Can be difficult to prove – –What is the difference between all agreeing a price and one-price competitively set? Tacit collusion –price leadership: dominant firm –price leadership: barometric –Rules of thumb Tacit collusion –price leadership: dominant firm –price leadership: barometric –Rules of thumb
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 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 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 – –– don’t believe personally 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 – –– don’t believe personally
The remaining material in this presentation was not used in lectures though it is relevant for the classwork for weeks 9 &10 Please see section 7.3 of Sloman for more information
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