L22
Oligopoly
Market structure
Market structures:
N
1
2
3-10
10-…
Name
pall
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
Examples of oligopolies in the USA:
- accounting & audit services, tobacco, beer, aircraft,
military equipment, motor vehicle, film and music
recording industries
Inefficiency and regulation
Federal Trade Commission
Oligopolies in practice
Market share
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)
Moderately concentrated industries HHI>1000
Concentrated industry HHI>1800
IO - Models
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
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
0
