Chapter 7 2 Oligopoly Cartels OLIGOPOLY We have

Chapter 7. 2 Oligopoly & Cartels

OLIGOPOLY • We have looked at non-cooperative oligopolies; but noted their incentive to collude. Here we want to look at various possible collusion scenarios. • Tacit collusion – price leadership: dominant firm

Dominant firm price leadership £ Leader assumes everyone else will act like a perfectly competitive firm once it sets price, by choosing output such that P=MC Dmarket O Q Division of the market between leader and followers

Dominant firm price leadership £ So Supply curve for everybody else is just their MC curve And the leader takes this MC/supply curve as given Dmarket O Q Division of the market between leader and followers

Dominant firm price leadership £ Sall other firms What is left over for the market leader at each price ? Dmarket O Q Division of the market between leader and followers

Dominant firm price leadership £ P 1 Sall other firms Above P 1 it gets nothing, below P 2 no competitors Dmarket P 2 O b Q Division of the market between leader and followers

Dominant firm price leadership £ P 1 Sall other firms Above P 1 it gets nothing, below P 2 no competitors a POF Dleader P 2 O Dmarket b Q Division of the market between leader and followers

Dominant firm price leadership £ P 1 Sall other firms What about at prices between P 1 and P 2? a POF Dleader b P 2 O Dmarket What if the price is POF ? QOF Q Division of the market between leader and followers

Dominant firm price leadership £ P 1 Sall other firms a POF Dleader P 2 O The “leftovers” represent demand curve for Dmarket the leading firm b Q Division of the market between leader and followers

Dominant firm price leadership £ P 1 Sall other firms a Dleader P 2 O The leader (of course!) maximises its profit subject to its demand curve Dmarket b Q Division of the market between leader and followers

Dominant firm price leadership £ P 1 Sall other firms To find optimal P and Q we consider, as usual, the MR, MC and AC curves. a Dmarket P 2 O b Q Division of the market between leader and followers

Dominant firm price leadership £ PL MCleader Sall other firms l Dmarket Dleader MRleader O QL Determination of price and output Q

Dominant firm price leadership £ PL MCleader l Sall other firms t Dmarket Dleader MRleader O QL QT Determination of price and output Q

Dominant firm price leadership £ PL MCleader l f Sall other firms Remember followers are a large group of smaller firms t Dmarket And QT=QL+QF Dleader MRleader O QL QF QT Determination of price and output Q

Alternative Leadership: Price leader aiming to £ maximise profits for a given market share AR = D market O Q

Price leader aiming to maximise profits for a given market share £ Assume constant market share for leader AR = D market AR = D leader =40% of Market O Q

Price leader aiming to maximise profits for a given market share £ AR = D market AR = D leader MR leader O Q

Price leader aiming to maximise profits for a given market share £ MC AR = D market AR = D leader MR leader O Q

Price leader aiming to maximise profits for a given market share £ MC PL l AR = D market AR = D leader MR leader O QL Q

Price leader aiming to maximise profits for a given market share £ MC PL l t Remainder QT-QL divided up amongst other producers AR = D market AR = D leader MR leader O QL QT Q

OLIGOPOLY • Tacit collusion – price leadership: dominant firm – price leadership: barometric ²See Sloman. Just like the case where a leading firm has a constant market share. One firm chooses price given D, MR & MC, others follow.

OLIGOPOLY • Tacit collusion – rules of thumb ²AC mark-up pricing P=(1+. 10)AC (firms somehow “agree” on a certain rate of profits). ²Benchmark Pricing £ 9. 99, £ 14, 99, £ 19. 99

OLIGOPOLY • Collusion and the law – It may be difficult to prove that firms collude, especially if collusion is tacit. – What is the difference between all firms agreeing a price and a price which is competitively set? Well, it is up to the right authorities to figure this out – typically they cannot prove anything unless it is REALLY bad.

SUMMARY We have looked at various types of imperfect competition. Lack of competition is, as a general rule, bad for consumers. Against this speaks that monopolies in some cases tend to innovate more - though this is disputed. The law typically forbids monopolistic behavior, especially collusion, but it is not an easy matter to prove anyone’s guilt.

The remaining material in this presentation was not used in lectures though it is relevant for the classwork for weeks 9 & 10. Thus part of these assignments will consist in reading section 7. 3 of Sloman. You will not be asked question about this material at the exam, however.

OLIGOPOLY • Non-collusive oligopoly: the kinked demand curve theory – assumptions of the model ² If you drop price everyone will follow ² If you raise price you are on your own

Suppose initially we have traditional diagram for firm £ But once equilibrium is established, if you raise price nobody follows you, and if you lower it everybody does MC P 1 MR O Q 1 D Q

Kinked demand for a firm under oligopoly £ So above Q 1 Demand curve is now flatter and below Q 1 it is steeper MC P 1 D O Q 1 Q

Kinked demand for a firm under oligopoly £ P 1 D O Q 1 Q

Kinked demand for a firm under oligopoly £ So now firm faces the following demand curve P 1 D O Q 1 Q

£ MR for the top part of the curve P 1 MR a O Q 1 D = AR Q

£ MR for the lower part of the curve? P 1 a D = AR b O Q 1 Q MR

£ P 1 a D = AR b O Q 1 Q MR

Kinked Demand Curve Theory • Why is this model important ? • Because it helps to explain why we tend to observe relatively stable prices in oligopolistic industries

Stable price under conditions of a kinked demand curve £ To see this lets draw in the original D, MR and MC curve here. P 1 a D = AR b O Q 1 Q MR

Stable price under conditions of a kinked demand curve £ To see this let’s draw in the original D, MR and MC curve here. P 1 a D = AR b O Q 1 Q MR

Stable price under conditions of a kinked demand curve £ To see this lets draw in the original D, MR and MC curve here. Notice the original MC lies between points a and b P 1 a D = AR b O Q 1 Q MR

Stable price under conditions of a kinked demand curve £ But what if MC changes? MC 2 P 1 MC 1 a D = AR b O Q 1 Q MR

Stable price under conditions of a kinked demand curve £ So MC can vary a lot and price won’t change MC 2 P 1 MC 1 a D = AR b O Q 1 Q MR

OLIGOPOLY • Non-collusive oligopoly: the kinked demand curve theory • Offers a reason for stable prices besides collusion • But other reasons why prices may be stable • Prices may be costly to change • Menu costs

OLIGOPOLY • Oligopoly and the public interest – advantages – disadvantages – difficulties in drawing general conclusions • Advertising and the public interest • Oligopoly and contestable markets

PRICE DISCRIMINATION • Meaning of price discrimination • Types of price discrimination – first degree

First-degree price discrimination P P 1 D O 200 Q

First-degree price discrimination P P 1 D O 200 Q

PRICE DISCRIMINATION • Meaning of price discrimination • Types of price discrimination – first degree – second degree

PRICE DISCRIMINATION • Meaning of price discrimination • Types of price discrimination – first degree – second degree – third degree

Third-degree price discrimination P P 1 D O 200 Q

Third-degree price discrimination P P 2 P 1 D O 150 200 Q

PRICE DISCRIMINATION • Meaning of price discrimination • Types of price discrimination – first degree – second degree – third degree • Conditions necessary for price discrimination to operate

PRICE DISCRIMINATION • Profit-maximising prices and output under price discrimination – first degree – third degree

Profit-maximising output under third-degree price discrimination DX O O MRX (a) Market X O

Profit-maximising output under third-degree price discrimination DY DX O MRY O O MRX (a) Market X (b) Market Y

Profit-maximising output under third-degree price discrimination DY DX O MRY O MRT O MRX (a) Market X (b) Market Y (c) Total (markets X + Y)

Profit-maximising output under third-degree price discrimination MC DY DX O MRY O MRT O MRX (a) Market X (b) Market Y (c) Total (markets X + Y)

Profit-maximising output under third-degree price discrimination MC DY DX O MRY O O MRX (a) Market X MRT (b) Market Y 3000 (c) Total (markets X + Y)

Profit-maximising output under third-degree price discrimination MC 5 DY DX O MRY O O MRX (a) Market X MRT (b) Market Y 3000 (c) Total (markets X + Y)

Profit-maximising output under third-degree price discrimination MC 5 DY DX O 1000 MRY O O MRX (a) Market X MRT (b) Market Y 3000 (c) Total (markets X + Y)

Profit-maximising output under third-degree price discrimination MC 5 DY DX O 1000 MRY O MRX (a) Market X 2000 (b) Market Y MRT O 3000 (c) Total (markets X + Y)

Profit-maximising output under third-degree price discrimination MC 9 5 DY DX O 1000 MRY O MRX (a) Market X 2000 (b) Market Y MRT O 3000 (c) Total (markets X + Y)

Profit-maximising output under third-degree price discrimination MC 9 7 5 DY DX O 1000 MRY O MRX (a) Market X 2000 (b) Market Y MRT O 3000 (c) Total (markets X + Y)

PRICE DISCRIMINATION • Profit-maximising prices and output under price discrimination – first degree – third degree • Advantages to the firm

PRICE DISCRIMINATION • Profit-maximising prices and output under price discrimination – first degree – third degree • Advantages to the firm • Price discrimination and the public interest

PRICE DISCRIMINATION • Profit-maximising prices and output under price discrimination – first degree – third degree • Advantages to the firm • Price discrimination and the public interest – advantages

PRICE DISCRIMINATION • Profit-maximising prices and output under price discrimination – first degree – third degree • Advantages to the firm • Price discrimination and the public interest – advantages – disadvantages