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Today. Oligopoly Theory Economic Experiment in Class. What happens when cartels won’t work?. Oligopoly. Theories of Oligopoly Behavior. There are several theories of oligopoly behavior. Many seem to explain some industries. None seem to explain all industries. 2 Among Many Possibilities.

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Today

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  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? P What will the Bertrand equilibrium look like? MC Q D

  7. Bertrand Equilibrium P 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 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? P $53 MC D Q 67 33 100

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

  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.

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