Download MicroEconomics Oligopoly

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MicroEconomics
Oligopoly
Presented by Students: João Pita
Francisco Vilhena da Cunha
Bruno Pereira
Jorge Oliveira
Master in Engineering Policy and Management of Technology
Oligopoly
The regimen of oligopoly is characterized
by a restricted number of agents on the
offer side and a large number on the
demand side.
The agents of the offer are in such number
that their market share allows each one of
them to affect the formation of prices and
from there affect other competitors.
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Oligopoly
This is, realistically, the regimen most
current in the not controlled economies.
Easiness of communications
Information
Transports
Technological competition
Selection of the most
capable firms
Automobile Market, Energy, Microprocessors, Photograph, etc
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Types of Oligopoly
- Cooperative Oligopoly
Implicit and explicit
agreements about prices,
amounts and types of product.
Eventual barriers to the
entrance of other companies in
the market
- Concorrencial
oligopoly
When the companies compete
between themself, having or
not in consideration the
reaction of the other
companies in the market.
- With indifferentiated
products
With identical prices and equally
available techniques of
production for all the companies
of the oligopoly - pure oligopoly
- With differentiated
products
- When the companies
differentiate its products, in
order to create a search that
specifically is directed them
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Cournot Model
•
Static Game: Players act simultaneously
•
Strategies: Any Price between 0 and infinity denoted p1 and p2
 Developed by Antoine Augustin Cournot in 1838
 In a two firm oligopoly (called a duopoly), if both firms set their output
levels assuming that the other firm’s strategic choice variable
(quantities in Cournot competition) is fixed, the equilibrium outcome is a
Cournot-Nash Non-cooperative Equilibrium.
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Cournot Model
Description:
Firm 1 excepts that firm 2 production will be y2e units of output,
Then decides to produce y1,
The total production will be
Y= y1+y2e
and market price
p(Y) = p( y1 + y2e )
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Properties of the Cournot-Nash
Equilibrium for Duopoly
 When the duopolists compete in quantities, we can compare the
outcome to both the monopoly and competitive outcomes.
 Each duopolist produces less than a monopolist in the same market
but together they produce more than the monopolist and less than
the amount two competitive firms would have produced with the
same cost structure and demand curves.
 The sum of the economic profits of each duopolist is less than the
economic profits of a monopoly in the same market.
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Cournot Model: Water’s Reaction
Curve
Firm 1
q1
(litres)
120
Water´s reaction curve
60
20
30
50
60
120
Firm 2
q2
(litres)
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Cournot Model
Firm 1
q1
(litres)
120
reaction curve
60
40
reaction curve
40
60
120
Firm 2
q2
(litres)
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Cournot Model
Firm 1
q1
(litres)
120
reaction curve
60
Cournot
Equilibrium
40
reaction curve
40
60
120
Firm 2
q2
(litres)
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Properties of the Cournot-Nash
Equilibrium for Duopoly
The profit-maximization problem
The optimal choice of firm 1 is y1 = f1(y2e )
This reaction function gives one firm’s optimal choice as a
function of its beliefs about the other firm’s choice.
For arbitrary values of y1e and y2e this won't happen - in
general firm 1´s optimal level of output, y1, will be
different from what firm 2 expects the output to be, y1e.
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Bertrand-Nash equilibrium
 Static Game: Players act simultaneously
 Strategies: Any Price between 0 and infinity denoted p1 and p2
 The Bertand equilibrium is a price level for each firm such that the firm´s
profits are maximized given the price level of the other firm.
Assuming that firms are selling identical products  Bertrand equilibrium is
the competitive equilibrium, where price equals marginal costs.
•
Consider that both firms are selling output at some price > marginal cost.
• Cutting its price by an arbitrarily small amount firm 1 can steal all of the
customers from firm 2.
Firm 2 can think the same way!
Any price higher than marginal cost cannot be an equilibrium
The only equilibrium is the competitive equilibrium
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Bertrand-Nash equilibrium
Graphical demonstration of Why P1=P2> MC is not a Nash Equilibrium
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Sequential Models
Companies act sequentially, as opposed to
simultaneously (Cournot and Bertrand models)
Competitors decisions are taken into account
Dominant player or Leader (first mover) and Follower –
anticipation strategy from the Leader
Perfect information: Follower has complete information
on Leader’s actions – Competitive Intelligence
Examples: IBM, Microsoft
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Sequential Models - Stackelberg
Stackelberg Model
 Heinrich Freiherr von Stackelberg
 1905 (Germany) – 1946 (Spain)
 Theory of competition
 Model
 Duopoly where both firms have market power with
undifferentiated products
 First model to assume asymmetries between companies
 Cournot-like competition on quantity/output followed by
Bertrand-like competition on price
 1st mover’s decision remains constant and follower
decides based on that (otherwise it’s a Cournot model)
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Sequential Models - Stackelberg
Firm 1 (leader) decides on quantity to produce (y1),
assuming that Firm 2 (follower) will react to maximise its
profits, producing y2:
 Total output: Y = y1 + y2 = f(y1)
 Equilibrium price P is a function of total output, Y
What will be the quantity produced by Firm 1 (Leader)?
Look forward and reason back
Firm 1 knows that:
 It has influence over Firms2’s output and
 Firm 2 will react in order to maximise its profit
Leading to…
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Sequential Models - Stackelberg
Follower's profit-maximization problem
 Firm 2 will choose y2 in order to maximise its
profit, P2
 P2 = P(y1+y2)(y2) - w2(y2), where w2 is Firm 2’s unit
costs
 To Firm 2 and considering profit maximization:
• y1=constant and it will have to define y2 from:
• MR(y1,y2*)=MC(y2)  y2* = f2(y1)
 y2* = f2(y1): Firm 2 reaction function
• y2* is a function of Firm 1’s decision
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Sequential Models - Stackelberg
Follower's profit-maximization problem
y2
P2 max
(Monopolist)
Isoprofit lines – Firm 2
y2 = f2(y’1)
Reaction Curve f2(y1)
y’1
y1
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Sequential Models - Stackelberg
Leader’s Problem
 Assuming Firm 2’s reaction to its output, Firm 1
now aims at maximizing it profit:
P1 = P[y1+f(y1)](y1) - w1(y1), since y2 = f(y1)
 Leader knows that his actions influence the
output choice of the follower,
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Sequential Models - Stackelberg
Stackelberg model - Equilibrium
Mathematical deduction: http://josemata.org/ee/17/stackelberg2/
y2
Reaction Curve Firm 1
Isoprofit lines – Firm 1
Cournot Equilibrium
Stackelberg Equilibrium
y*2
Reaction Curve Firm 2 f2(y1)
y*1
y1
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Sequential Models - Stackelberg
Stackelberg model compared
Price
Bertrand < Stackelberg < Cournot
Competitive < Stackelberg < Monopoly
Total Output
Monopoly < Stackelberg < Competitive
Cournot < Stackelberg < Bertrand
Consumer Surplus
Cournot < Stackelberg < Bertrand
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Sequential Models - Stackelberg
Identifying the leader
Stackelberg model based on Cournot with an
anticipation strategy from one of the companies on
setting its output
The model doesn’t explain what is the asymmetry
neither in what it is based on
There can be several reasons, e.g.:
 Company already in the market and new entrant
• 1st can decide on the installed capacity
• If installed capacity irreversible, 2nd can assume capacity of
the 1st as an input for decision
 Depending on fixed costs, 2nd may not be able to enter
the market (monopoly)
 If seond enters the market  Stackelberg model
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Collusion Model
Types of Cooperative Behaviour
When firms agree to cooperate in order to restrict output and
raise prices, their behaviour is called collusion.
•Tacit collusion occurs when firms act without explicit
agreement to achieve the cooperative outcome. Can take the
form of a verbal ‘gentleman’s agreement’ to fix prices and output.
• Explicit collusion occurs when firms ostensibly agree to
maintain their joint-profit-maximizing output. Cartels -- such
as DeBeers and OPEC -- are obvious examples.
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Factors that affect the ability to
collude:
 Number and size distribution of sellers
Similar  easier to collude
 Product heterogeneity
Homogeneous  easier to collude
 Cost structures
Similar  easier to collude
 Size and frequency of orders
Frequent smaller  easier to collude
 Secrecy and retaliation
Less secrecy, easier retaliation  easier to collude
 Social structure of the industry
Social interaction  easier to collude
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Tacit Collusion
Price Leader (Barometric Firm)
Largest, dominant, or lowest cost firm in the
industry
Demand curve is defined as the market
demand curve less supply by the followers
Followers
Take market price as given and behave as
perfect competitors
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Price Leadership
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Oligopoly isn’t a problem unless it
becomes a Cartel
 Cartel – a formal or informal agreement among
firms in an oligopolistic industry
 Cartel members may agree on such issues as
prices, total industry output, market shares, and
division of profits
 Cartels or collusive agreements are illegal in
most cases.
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Cartels
OPEC
Colombian Drug Cartel
Mafia or Crime Syndicate
Ivy League Schools
Government enforced cartels: market
intervention to raise prices!
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Cartel as a Monopolist
D is the market
demand curve, MR
the associated
marginal revenue
curve, and MC the
horizontal sum of
the marginal cost
curves of cartel
members (assuming
all firms in the
market join the
cartel).
Cartel profits are
maximized when the
industry produces
quantity Q and
charges price p.
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Some illegal Cartels get caught:
 Electrical equipment manufacturers in the 1950s
 Pharmaceutical companies more recently
Some don’t…
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Cheating
Perhaps the biggest obstacle to keeping the cartel
running smoothly is the powerful temptation to cheat
on the agreement
By offering a price slightly below the established
price, a firm can usually increase its sales and
economic profit
Because oligopolists usually operate with excess
capacity, some cheat on the established price
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How can either of the firms be sure
that the other firm isn’t cheating on
their agreement, and selling the
product for lower price?
“BEAT ANY PRICE”
One way is to offer to beat any
price a costumer can find. That way,
the costumer report any attempt to
cheat on the collusive arrangement
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OPEC Illustrates Cartel Difficulties
 Incentive to Cheat
Cheating increases individual profits
Cheating decreases cartel profits
 Different Members Have Different Goals
High prices encourage substitutes
Supply expansion by non-members
Development of alternative products
More important to some members than to others
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OPEC
and CIPEC
OPEC is the Organization of Petroleum Exporting Countries




CIPEC is the French acronym for Int’l Council of Copper Exporting Countries
Why has OPEC been successful in raising its price, but CIPEC has not?
OPEC as a dominant firm
Price
MCnon-opec
P1
Oil Market
Popec
Pcomp
MCopec
P2
Dmkt
MRopec
Q
Qfringeopec
Qtotal
Output
Qc+c
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OPEC and CIPEC
 CIPEC (Chile, Peru, Zambia, Zaire)
 MCCIPEC is not much less than MCnon-
Price
Copper Market
cipec
 Why has OPEC been successful in
raising its price, but CIPEC has not?
 CIPEC as a dominant firm
 Why can’t CIPEC increase
P1
copper prices much?
Pcipec
 D for copper is more elastic
Pcomp
(aluminum is a good substitute)
 Comp’ve supply more elastic
P2
than for oil (if P rises, simply go
to scrap heap)
 Successful cartel needs relatively
inelastic D.
MCnon-cipec
MCcipec
Dmkt
MRopec
Q
Qfringecipec
Qtotal
Qc+c
Output
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Obstacles to Collusion
Demand and cost differences between
firms.
Higher numbers of firms, particularly if a
number of firms outside collusive
agreement.
Incentives to cheat.
Recession.
Legislative obstacles: Trade Practices
Law.
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OLIGOPOLY MODELS
COMPARISON OF THE SOLUTIONS
One firm leads by setting its output, and the other firm
follows. When the leader chooses an output, it will take
Stackelberg
(Quantity-leader) into account how the follower will respond
Cournot
(Price-leader)
One firm sets its price and the firm chooses how much
it wants to supply at that price. Again the leader has to
take into account the behavior of the follower when it
takes its decision
Bertrand
(Simultaneous
price setting)
Each firm chooses its prices given its beliefs about the
price that the other firm will choose. The only
equilibrium price is the competitive equilibrium
Collusion
(Cartel)
A number of firms colluding to restrict output and to
maximize industry profit. A cartel will typically be
unstable in the sense that each firm will be tempted to
sell more than its agreed upon output if it believes that
the other firms will not respond
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Sweezy Model
- It tries to explain the rigidity of
the price, many times
observed in oligopolistc
markets;
P
- If a companie increases its
price, the other companies will
not, making the first one to
lose its customers;
- On the other hand, if a
company lower the prices, the
other companies also will
lower the price, for that it will
not have advantage to do that.
mC’
mC
mR
D
Q
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Conclusions - Balance in the Long
Run
 Profits, equilibrium or damage
 In the long run, the oligopolist will leave the industry if has no
profits.
 It prepares its company to present the very best level of
production in the long run.
 If it will have some profits, other companies will try to enter in
the sector, if the entrance will not be restricted.
 Competition based on strategy, quality, product project,
advertisement, services, innovation
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Bibliography

Lipsey & Chrystal

Mata, José, “Economia da empresa”, Fund. Calouste Gulbenkian, Lisboa, 2nd edition, 2002

Mata, José in http://josemata.org/ee, 2006

Pindyck, Robert S., Rubinfield, Daniel L., “Microeconomics”, 5th edition, ch. 12, pgs. 429 to 451

Samuelson

Salvatore, Dominick, “Microeconomy”, Schaum, MacGraw-Hill, 1984

Sousa, Alfredo de, “Análise Económica”, Universidade Nova de Lisboa, Faculdade de Economia,
1988

“The Home of Economics on the Internet” in www.tutor2u.net, 2006

Varian, Hal R., “Intermediate Microeconomics”, 6th edition, ch. 26, pgs. 459 to 479