1. Today
Oligopoly Theory
Economic Experiment in Class

2. What happens when cartels won’t work?
Oligopoly

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

4. 2 Among Many Possibilities
Bertrand Equilibrium
Assumes firms primarily choose price, then sell quantity demanded
Cournot Equilibrium
Assumes firms primarily choose the quantity to produce, then let the market demand determine price.

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

6. What would you charge? What will the Bertrand equilibrium look like? PMC Q D

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

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

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

10. Cournot Equilibrium 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 D Q 33 67
100

11. Cournot Equilibrium-Profit
Profits will be made.
$53 MC D Q 33 67
100

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

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

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

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

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