2. Chapter 7.2 Oligopoly & Cartels Chapter 7.2 Oligopoly & Cartels

3. 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

4. £ 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

5. £ 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

6. £ 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

7. £ 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

8. £ 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

9. £ 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

10. £ 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

11. £ 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

12. £ 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

13. £ 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

14. £ 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

15. £ 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

16. £ Q O AR  D market Alternative Leadership: Price leader aiming to maximise profits for a given market share

17. £ 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

18. £ Q O MR leader AR  D leader AR  D market Price leader aiming to maximise profits for a given market share

19. £ Q O MC MR leader AR  D leader AR  D market Price leader aiming to maximise profits for a given market share

20. £ 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

21. £ 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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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

28. Kinked demand for a firm under oligopoly £ Q O P1P1 Q1Q1 D

29. £ Q O P1P1 Q1Q1 D So now firm faces the following demand curve

30. £ Q O P1P1 Q1Q1 D  AR a MR MR for the top part of the curve

31. £ Q O P1P1 Q1Q1 MR a b D  AR MR for the lower part of the curve?

32. £ Q O P1P1 Q1Q1 MR a b D  AR

33. 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

34. £ 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.

35. £ 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.

36. £ 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

37. £ 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?

38. £ 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

39. 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

42. 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

43. 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

44. PRICE DISCRIMINATION Meaning of price discrimination Types of price discrimination – –first degree Meaning of price discrimination Types of price discrimination – –first degree

45. O P1P1 D 200 P Q First-degree price discrimination

46. O P1P1 D 200 P Q First-degree price discrimination

47. 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

48. 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

49. Third-degree price discrimination P Q O P1P1 D 200

50. O P1P1 D P2P2 150200 P Q Third-degree price discrimination

51. 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

52. 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

53. Profit-maximising output under third-degree price discrimination OOO DXDX MR X (a) Market X

54. OOO DXDX DYDY MR X MR Y (a) Market X (b) Market Y Profit-maximising output under third-degree price discrimination

55. 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

56. 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

57. 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

58. OOO DXDX DYDY MR X MR Y MR T MC 5 3000 (a) Market X (b) Market Y (c) Total (markets X + Y) Profit-maximising output under third-degree price discrimination

59. OOO DXDX DYDY MR X MR Y MR T MC 5 10003000 (a) Market X (b) Market Y (c) Total (markets X + Y) Profit-maximising output under third-degree price discrimination

60. OOO DXDX DYDY MR X MR Y MR T MC 5 1000 2000 3000 (a) Market X (b) Market Y (c) Total (markets X + Y) Profit-maximising output under third-degree price discrimination

61. OOO DXDX DYDY MR X MR Y MR T MC 5 9 1000 2000 3000 (a) Market X (b) Market Y (c) Total (markets X + Y) Profit-maximising output under third-degree price discrimination

62. OOO DXDX DYDY MR X MR Y MR T MC 5 9 7 1000 2000 3000 (a) Market X (b) Market Y (c) Total (markets X + Y) Profit-maximising output under third-degree price discrimination

63. 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

64. 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

65. 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

66. 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