Download Econ_111-10-13

Oligopoly Continued
Convert the Multi-Plant Monopoly into an Oligopoly
To maximize profits, two conditions must be satisfied when a firm has two plants:
Marginal costs of each plant must be equal: MCA = MCB
Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB
MCA
MCB
MCA
MCB
100
100
100
80
80
80
60
60
60
40
40
40
20
20
20
qA
50
100
qA = 50 MCA = $60
D
MR
Q
qB
50
100 150 200
qB = 100 MCB = $60
50
100 150 200 200
qA + qB = = 150 MR = $60
Owner retires and gives Plant A to his son Adam and Plant B to his daughter Beth
Adam’s Firm
Beth’s Firm
Total Production
qA = 50
qB = 100
Q = 150
MR = 60


MCA = $60
MCB = $60
P = $90
P = $90
Preview
To cheat or not to cheat? If a firm believes that the other firm(s) will
not retaliate, the firm has an incentive to cheat.
retaliate aggressively, the firm does not have an incentive to cheat.
As cheating and retaliation occurs:
The joint profits of the firms fall.
Consumer surplus rises.
The gain in consumer surplus exceeds the loss in joint profits. Society as a whole
becomes better off.
Conflicting Interests of an Oligopolies and Cartels: Collective versus Individual
It is in the collective interests of the firms in an industry to establish a cartel to
maximize their joint profits by reducing production below the competitive level.
But, if a cartel is established it may be in the individual interests of each firm to cheat
on the cartel agreement by producing more to increase its individual profit.
Scenario 1: No retaliation - Adam cheats and Beth does not retaliate?
Quantity
Slope of Demand Curve = .20
Adam Beth Joint
Price
To clear the market the quantity
demanded must increase by 1 unit.
Tomorrow
51
100 151
89.80
Today
50
100 150
90.00
The price must fall by .20, from
$90.00 to $89.80.
MCA = $60.00
Adam’s
Adam’s
Quantity
Price
Total Revenue = Price  Quantity
Tomorrow:
Today:
51
50
Question: What does
Adam’s marginal
revenue (MRA) equal?
Does Adam have an
incentive to cheat if
Beth does not
retaliate?
Yes
89.80
89.8051
89.80(1 + 50)
= 89.80 +
90.00
89.8050
90.0050
Adam’s Marginal Revenue = 89.80 + 89.8050  90.0050
= 89.80 +
(89.80  90.00)50
= 89.80 +
(.20)50


TR tends to rise by 89.80,
TR tends to fall by 10.00,
the price, as a consequence
as a consequence of the
of the additional unit sold.
lower price.


Output Effect
Price Effect


MRA = Adam’s Marginal Revenue
=
89.80

10.00
= $79.80
Adam produces one more unit of output and Beth does not retaliate: qA: 50  51
qB = 100
P: $90.00  $89.80
Adam’s Profit
qA: 50  51 Increased by 1
MRA = $79.80
MR = Change in total revenue resulting
from a one unit change in production
Adam’s Profit

Up by $19.80
 Lab 18.1
Quantity
Total Revenue
Total Cost
Profit
Cons Surplus
=
MCA = $60.00
MC = Change in total cost resulting
from a one unit change in production
TR

TC
Produce 1


more unit
Up by $79.80 Up by $60.00
Joint Profit Maximization
Firm A
Firm B
Joint
50
100
150
4,500
9,000
3,000
5,000
1,500
4,000
Firm A Cheats
Firm B Does Not Retaliate
Firm A
Firm B
Joint
51
100
151
4,580
8,980
3,060
5,000
1,520
3,980
2,250
Consumer surplus increases by 22
2,372
Scenario 2: 1-For-1 Retaliation – Adam Cheats and Beth Retaliates
Quantity
Slope of Demand Curve = .20
Adam Beth Joint
Price
To clear the market the quantity
demanded must increase by 2 units.
Tomorrow
51
101 152
89.60
Today
50
100 150
90.00
The price must fall by .40, from
$90.00 to $89.60.
MCA = $60.00
Adam’s
Adam’s
Quantity
Price
Total Revenue = Price  Quantity
Tomorrow:
51
89.60
89.6051
89.60(1 + 50)
= 89.60 +
89.6050
50
90.00
90.0050
Today:
Question: What does
Adam’s marginal
revenue (MRA) equal?
Does Adam still have
an incentive to cheat?
Yes
Adam’s Marginal Revenue = 89.60 + 89.6050  90.0050
= 89.60 +
(89.60  90.00)50
= 89.60 +
(.40)50


TR tends to rise by 89.60,
TR tends to fall by 20.00,
the price, as a consequence
as a consequence of the
of the additional unit sold.
lower price.


Output Effect
Price Effect


MRA = Adam’s Marginal Revenue
=
89.60

20.00
= $69.60
Adam produces one more unit of output and Beth does retaliate: qA: 50  51
qB = 101
P: $90.00  $89.60
Adam’s Profit
qA: 50  51 Increased by 1
MRA = $79.80
MR = Change in total revenue resulting
from a one unit change in production
Adam’s Profit

Up by $9.60
 Lab 18.1
Quantity
Total Revenue
Total Cost
Profit
Cons Surplus
=
MCA = $60.00
MC = Change in total cost resulting
from a one unit change in production
TR

TC
Produce 1


more unit
Up by $69.60 Up by $60.00
Joint Profit Maximization
Firm A
Firm B
Joint
50
100
150
4,500
9,000
3,000
5,000
1,500
4,000
Firm A Cheats
Firm B Retaliates 1-For-1
Firm A
Firm B
Joint
51
101
152
4,570
9,050
3,060
5,060
1,510
3,990
2,250
Consumer surplus increases by 60
2,310
Scenario 3: 3-For-1 Retaliation – Adam Cheats and Beth Retaliates Aggressively
Quantity
Slope of Demand Curve = .20
Adam Beth Joint
Price
To clear the market the quantity
demanded must increase by 4 units.
Tomorrow
51
103 154
89.20
Today
50
100 150
90.00
The price must fall by .80, from
$90.00 to $89.20.
MCA = $60.00
Adam’s
Adam’s
Quantity
Price
Total Revenue = Price  Quantity
Tomorrow:
51
89.20
89.2051
89.20(1 + 50)
= 89.20 +
89.2050
Today:
50
Question: What does
Adam’s marginal
revenue (MRA) equal?
Does Adam have an
incentive to cheat?
No
90.00
90.0050
Adam’s Marginal Revenue = 89.20 + 89.2050  90.0050
= 89.20 +
(89.20  90.00)50
= 89.20 +
(.80)50


TR tends to rise by 89.20,
TR tends to fall by 40.00,
the price, as a consequence
as a consequence of the
of the additional unit sold.
lower price.


Output Effect
Price Effect


MRA = Adam’s Marginal Revenue
=
89.20

40.00
= $49.20
Adam produces one more unit of output and Beth does retaliate: qA: 50  51
qB = 101
P: $90.00  $89.60
Firm A Cheats
Joint Profit Maximization
Firm B Retaliates 3-For-1
Firm A
Firm B
Joint
Firm A
Firm B
Joint
Quantity
50
100
150
51
103
154
Total Revenue
4,500
9,000
4,549
9,188
Total Cost
3,000
5,000
3,060
5,182
Profit
1,500
4,000
5,500
1,489
4,006
5,495
Cons Surplus
 Lab 18.2
2,250
2,372
Consumer surplus increases by 122
Change from Joint Profit Maximization
Firm A Firm B
Joint
Consumer
Net
Profit
Profit
Profit
Surplus
Firm A Cheats
Firm B Retaliates 3-For-1
11
+6
5
+122
+117
Firms: Joint profit falls.
Adam’s profit falls; Adam has no incentive to cheat.
Consumers: Consumer Surplus rises.
The increase in consumer surplus is greater than the fall in joint profits. Society as a
whole (firms and consumers together) is better off.
Summary
Change from Joint Profit Maximization
Firm A
Firm B
Joint
Consumer Society as a
Profit
Profit
Profit
Surplus
Whole
Firm A Cheats
+20
Firm B Does Not Retaliate
Firm A Cheats
+10
Firm B Retaliates 1-For-1
Firm A Cheats
11
+6
5
+122
+117
Firm B Retaliates 3-For-1
To cheat or not to cheat? If a firm believes that the other firm(s) will
not retaliate, the firm has an incentive to cheat.
retaliate aggressively, the firm does not have an incentive to cheat.
As cheating and retaliation occurs:
The joint profits of the firms fall.
Consumer surplus rises.
The gain in consumer surplus exceeds the loss in joint profits. Society as a whole becomes
better off.
Conflicting Interests of an Oligopolies and Cartels: Collective versus Individual
It is in the collective interests of the firms in an industry to establish a cartel to maximize
their joint profits by reducing production below the competitive level.
But, if a cartel is established it may be in the individual interests of each firm to cheat on
the cartel agreement by producing more to increase its individual profit.
Question: What might affect a firm’s temptation to cheat?
Government regulation.
Personal ties.
Threat of retaliation.
Role of the Government
Antitrust legislation: Broadly speaking antitrust legislation is designed to prevent
a firm from becoming a monopoly
or
an oligopoly from colluding and acting as a cartel.
Regulation
Airline Deregulation Act: In 1978, Congress passed and President Carter signed the Airline
Deregulation Act. This act phased in the deregulation of the industry:
1981 - CAB lost authority over domestic routes
1983 - CAB lost authority over airline prices
1984 - CAB was disbanded
Year
1970
1978
1980
1985
1986
1987
1988
1989
Real Price (Price adjusted for inflation)
(Cents per passenger mile)
15.5
13.0
13.7
11.4
10.2
10.0
10.4
10.6