L22 Oligopoly

Market structure Market structures: u Oligopoly – industry with 2 or more large sellers. u Intermediate level of fixed cost u Have market power (but smaller than monopoly) u Also: oligopsony and bilateral oligopoly pall N … Name

Oligopolies in practice u Examples of oligopolies in the USA: - accounting & audit services, tobacco, beer, aircraft, military equipment, motor vehicle, film and music recording industries u Inefficiency and regulation u Federal Trade Commission

Oligopolies in practice u Market share u Industry is legally recognized as oligopolistic 1. concentration ratio “big four”>40% (share of top 4 firms in the market) v Concentrated industry if CR>40% 2. HERFINDAHL-HIRSCHMAN Index (HHI) v Moderately concentrated industries HHI>1000 v Concentrated industry HHI>1800

IO - Models u Strategic environment – harder than before u Careful about timing and strategy u Quantities - chosen simultaneously (Cournot) - leader and follower (Stackelberg) u Prices (Bertrand) u When goods are not homogenous - Monopolistic competition

Cournot Model - Assumptions u Homogenous good u 2 firms (duopoly) u Aggregate supply u Market price u chosen simultaneously u Cost function u Maximize profit

Firm 1: Best response to

Best response: Geometry

u Cournot equilibrium : Output of each firm is a best response to the output of the other firm u No firm has incentives to deviate, given production of the other firm. Cournot-Nash Equilibrium:

Equilibrium (Example)

Nash Equilibrium: Geometry

Incentives to collude u Are there profit incentives for both firms to “cooperate” by lowering their output levels? u If yes than collusion. u Firms that collude form a cartel. u Good for firms, bad for consumers and efficiency (DWL) u Under what condition cartels are stable?

Collusion

Collusion: Geometry

Incentives to collude u In long run reputation helps! - see movie ``Informant’’ u Cartels are hard to sustain if: –Only short run interactions –Imperfect monitoring of price u Alternative: Mergers - Problem: Federal Trade Commission

Cournot with N firms