L22
Oligopoly
Market structure
Market structures:
N
1
2
3-10
10-…
Name
pall
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Oligopoly – industry with 2 or more large sellers.
Intermediate level of fixed cost
Have market power (but smaller than monopoly)
Also: oligopsony and bilateral oligopoly
Oligopolies in practice
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Examples of oligopolies in the USA:
- accounting & audit services, tobacco, beer, aircraft,
military equipment, motor vehicle, film and music
recording industries
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Inefficiency and regulation
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Federal Trade Commission
Oligopolies in practice
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Market share
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Industry is legally recognized as oligopolistic
1. concentration ratio “big four”>40%
(share of top 4 firms in the market)
Concentrated industry if CR>40%
2. HERFINDAHL-HIRSCHMAN Index (HHI)
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Moderately concentrated industries HHI>1000
Concentrated industry HHI>1800
IO - Models
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Strategic environment – harder than before
Careful about timing and strategy
Quantities
- yi chosen simultaneously (Cournot)
- leader and follower (Stackelberg)
Prices (Bertrand)
When goods are not homogenous - Monopolistic
competition
Cournot Model - Assumptions
 Homogenous
good
 2 firms (duopoly)
 Aggregate supply y  y1  y 2
p( y)  14  y
 Market price
 yi chosen simultaneously
 Cost function TC ( y i )  2 y i
 Maximize profit
Firm 1: Best response to y2
p ( y )  14  y ,
TC ( y )  2 y1
 1 ( y1 , y 2 )  p ( y1  y 2 ) y1  TC ( y1 ) 
Best response: Geometry
 1 ( y1 , y 2 )  (12  y 2 ) y1  y
1
R1 ( y 2 )  6  y 2
2
2
1
Cournot-Nash Equilibrium:
*
1
*
2
equilibrium y , y :
Output of each firm is a best response to
the output of the other firm
 Cournot
y  R1 ( y )
*
1
 No
*
2
y  R2 ( y )
*
2
*
1
firm has incentives to deviate, given
production of the other firm.
Equilibrium (Example)
p ( y1 )  14  y , TC  2 y
1
R1 ( y 2 )  6  y 2
2
1
R2 ( y1 )  6  y1
2
Nash Equilibrium: Geometry
Incentives to collude
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Are there profit incentives for both firms
to “cooperate” by lowering their output
levels?
If yes than collusion.
Firms that collude form a cartel.
Good for firms, bad for consumers and
efficiency (DWL)
Under what condition cartels are stable?
Collusion
p ( y1 )  14  y , TC  2 y
C o u rn o t
y  4, p ( y )  6,  i  12
*
i
Collusion: Geometry
Incentives to collude
 In
long run reputation helps!
- see movie ``Informant’’
 Cartels
are hard to sustain if:
– Only short run interactions
– Imperfect monitoring of price
 Alternative:
Mergers
- Problem: Federal Trade Commission
Cournot with N firms