1. Oligopoly Overheads

2. Market Structure Market structure refers to all characteristics of a market that influence the behavior of buyers and sellers, when they come together to trade Market structure refers to all features of a market that affect the behavior and performance of firms in that market

3. Definition of a competitive agent competitive A buyer or seller (agent) is said to be competitive if the agent assumes or believes that the market price is given and that the agent's actions do not influence the market price We sometimes say that a competitive agent is a price taker

4. Common Market Structures Perfect (pure) competition Agents take prices as given Entry and exit barriers are minimal or nonexistent

5. Common Market Structures Monopoly (seller) or Monopsony (buyer) Firm sets price (faces market demand or supply curve) Entry and exit barriers result in the existence of one seller or one buyer

6. Common Market Structures Oligopoly Firm sets prices (faces residual demand) Entry and exit barriers result in the existence of few sellers or buyers

7. Common Market Structures Monopolistic competition Firm sets prices (faces residual demand) Entry and exit barriers are minimal

8. Strategic interdependence When individuals make decisions in environments characterized by strategic interdependence, the welfare of each decision maker depends not only on her own actions, but also on the actions of the other decision makers (firms). Moreover, the actions that are best for her to take may depend on what she expects the other firms to do

9. Formal definition of oligopoly Noncooperative oligopoly is a market structure where a small number of firms act independently, but are aware of each other's actions A noncooperative oligopoly is a market structure in which a small number of firms are strategically interdependent

10. Cooperative oligopoly is a market structure in which a small number of firms coordinate their actions to maximize joint profits

11. Oligopoly is an intermediate market structure in the sense that the firms are price makers as compared to the price takers of perfect competition, but because there are others firms in the market, the firm cannot act in the independent fashion of the monopolist

12. A duopoly is a market with only two firms, each selling the same or similar product Duopoly

13. Two firms with no additional entry A Duopoly Model Each firm produces a homogeneous product such that q 1 + q 2 = Q, where Q is industry output and q i is the output of the ith firm There is a single period of production & sales (zucchini) The market demand and inverse demand are linear

14. Demand

15. Marginal and average cost are constant and equal to $4.00

16. Monopoly solution Firm 1 is the only firm in the market Revenue is given by

17. Using the same intercept, twice the slope rule, marginal revenue is given by

18. If we set marginal revenue equal to marginal cost we can obtain the optimal level of q 1

19. If we substitute this into the demand equation we can find the market price

20. Profit for Firm 1 is given by revenue minus cost or

21. Zucchini Market Monopoly 0 5 10 15 20 25 30 0 246810121416 Quantity $ Demand/P MC MR

22. QPriceTRMRCostMCProfit 0.00 28.00 0.00 28.00 0.00 4.00 0.00 1.00 26.00 26.00 24.00 4.00 4.00 22.00 2.00 24.00 48.00 20.00 8.00 4.00 40.00 2.50 23.00 57.50 18.00 10.00 4.00 47.50 3.00 22.00 66.00 16.00 12.00 4.00 54.00 3.50 21.00 73.50 14.00 14.00 4.00 59.50 4.00 20.00 80.00 12.00 16.00 4.00 64.00 4.50 19.00 85.50 10.00 18.00 4.00 67.50 5.00 18.00 90.00 8.00 20.00 4.00 70.00 5.50 17.00 93.50 6.00 22.00 4.00 71.50 6.00 16.00 96.00 4.00 24.00 4.00 72.00 7.00 14.00 98.00 0.00 28.00 4.00 70.00 8.00 12.00 96.00 32.00 4.00 64.00 9.00 10.00 90.00 36.00 4.00 54.00 10.00 8.00 80.00 40.00 4.00 40.00 11.00 6.00 66.00 44.00 4.00 22.00 12.00 4.00 48.00 48.00 4.00 0.00 13.00 2.00 26.00 52.00 4.00 -26.00

24. Competitive Solution We set price (p) equal to marginal cost (MC) Notice that MC doesn’t depend on q i or Q

25. If we substitute p = 4 in the demand equation we obtain Profits will be zero

26. Zucchini Market Competition 0 5 10 15 20 25 30 0246810121416 Quantity $ Demand/P MC

27. If the two firms in this market were to coordinate their actions and maximize joint profit, Cooperative (collusive) oligopoly solution they would choose the monopoly output and price Such cooperative agreements are called cartels The two firms together would produce 6 units and charge a price of $16.00 The division of the output between the firms would have to negotiated between them

28. Noncooperative Oligopoly Joint profits maximized with Q = 6 and p = $16 Will this outcome occur?

29. Individual firm conjectures and market equilibrium Conjecture A supposition or guess Each firm makes a conjecture about the action of the other firm and then chooses its own action

30. Story Firm 1 conjectures that Firm 2 will produce 3 units Why?

31. Inverse demand given the conjecture

32. Revenue for Firm 1 given the conjecture

33. Marginal revenue is given by because

34. If we set marginal revenue equal to marginal cost we can obtain the optimal level of q 1

35. If Firm 2 produced 3 units, price would be

36. Profit for Firm 1 is given by revenue minus cost or

37. Profit for Firm 2 is given by Total profit for the two firms is $67.50 Monopoly profit was $72

38. Is Firm 2 happy? Is Firm 2 content? Is Firm 2 going to keep producing 3 units? Let’s See

39. Suppose Firm 2 conjectures that Firm 1 will produce 4.5 units

40. Inverse demand given the conjecture

41. Marginal revenue is given by because

42. If we set marginal revenue equal to marginal cost we can obtain the optimal level of q 2

43. If Firm 1 produces 4.5 units and Firm 2 produces 3.75 units, price will be

44. Profit for Firm 1 is given by

45. Profit for Firm 2 is given by Total profit for the two firms is $61.875 Monopoly profit was $72

46. Because Firm 2 is producing 3.75 and not 3 units Firm 1 will want to adjust its output level And then Firm 2 will want to change its output This silly game could go on forever

47. We can compute the best response for each firm given the action of the other firm to see this Other qq 1 *q 2 3.00 4.5004.500 3.25 4.3754.375 3.50 4.2504.250 3.75 4.1254.125 4.00 4.0004.000 4.25 3.8753.875 4.50 3.7503.750 4.75 3.6253.625 5.00 3.5003.500

48. What if Firm 1 conjectures that Firm 2 will bring 4 units to market? Firm 1 will bring 4 units to market! Other qq 1 *q 2 3.75 4.1254.125 4.00 4.0004.000 4.25 3.8753.875 4.50 3.7503.750

49. What if Firm 2 conjectures that Firm 1 will bring 4 units to market? Firm 2 will bring 4 units to market! Other qq 1 *q 2 3.75 4.1254.125 4.00 4.0004.000 4.25 3.8753.875 4.50 3.7503.750

50. Both firms are happy and content We have an equilibrium!!

51. 0 2 4 6 8 10 12 14 0246810121416 q2q2 q1q1 Zucchini Market Response Functions q1*q1* q2*q2* Graphically

52. A situation in which all economic actors (firms) interacting with one another choose their best strategy, given the strategies that all other actors have chosen, is called a Nash Equilibrium A market outcome is a Nash Equilibrium if no firm would find it beneficial to deviate from its output level provided that all other firms do not deviate from their output levels at this market outcome

53. The market outcome of this noncooperative oligopoly market is an output of 8 units with a price of $12.00. The output is lower than the competitive output but higher than the monopoly output The price is lower than the monopoly price but higher than the competitive one This is a result that holds generally

54. Monopoly66 --16$72$72-- Perfect Competition12? ?4$0$0$0 Cooperative Oligopoly6? ?16$72?? Noncooperative Oligopoly84412$64$32$32 TotalFirm 1Firm 2PTotal Firm 1Firm 2 Qq q B BB Results

55. Oligopoly and the number of firms Small number of firms  large price impact of individual Larger number of firms  less price impact As the number of firms in an oligopoly rises, the impact of any one firm on price falls As numbers keep getting larger, firms start to act more and more like price takers

56. The End