Oligopoly Models Cornout Bertrand Chamberlin Cartels Lecture 28

Consider the following game between Roger and Chris. It is played one shot, simultaneously and non-cooperatively. CHRIS ROGER Left Right Top 10, 2 22, 2 Middle 20, 20 10, 20 Bottom 10, 5 5, 20

3 Different Models of Oligopoly u Cournot u Bertrand u Chamerberlin

#1 Cournot-Nash Duopoly Structure A Non-Cooperative Outcome in Quantities u u u Pioneered by Antoine Augustin Cournot, circa 1838. Duopoly an oligopoly of 2 firms. Firms selling identical spring water. Firms have identical cost functions. Firms decide how many units to put on the market – Choice variables are q 1 and q 2 u Market then determines the price: – PD = f(Q) where Q=q 1+q 2 u So…, GIVEN the quantity your rival is putting on the market, the more you put on the market, the lower the price for both of you, and vice versa. u Solve for a Nash Equilibrium in quantities.

#2 Bertrand-Nash Duopoly Structure A Non-cooperative Outcome in Prices u u u Pioneered by Joseph Louis Francois Bertrand, circa 1883. Duopoly an oligopoly of 2 firms. Firms selling identical spring water. Firms have identical cost functions. Firms decide what price to post on the market. What each firm sells depends on their own price along with their rival’s price: q 1 D = g(P 1 , P 2) and q 2 D = h(P 1 , P 2) u u u If P 1 < P 2 everyone buys from firm 1 If P 1 > P 2 everyone buys from firm 2 Solve for a Nash Equilibrium in prices.

#3 Edward Chamberlin Duopoly Structure A Cooperative Outcome (Collusion) u u u u circa 1930’s The duopolists can do better than the Non-Cooperative Equilibrium – Bertrand or Cournot. So far, because the equilibrium is non-cooperative, we have ruled out the possibility of collusion between the two firms. Collusion means that the firms explicitly and/or implicitly cooperate in choosing a market output and the division of output between them. (Note, if they set the output level, then the market sets the price. ) If the duopolists collude & divide the market privately, they produce the monopoly quantity and divide the monopoly economic profits. Since the monopoly economic profits are more than the sum of the duopoly profits, the duopolists are better off if they collude. When we allow the possibility of collusion the game can turn out differently. It’s no longer a Non-Cooperative game. Chamberlin suggested duopolists would tacitly collude in this way. – conscious parallelism

Cournot vs. Bertrand vs. Chamberlin u When N=1 – All three produce the simple monopoly solution. u When N > 1 but not that large – Chamberlin gets you the monopoly solution, still. – Cournot gets you something between monopoly and the perfectly competitive solution. – Bertrand gets you the perfectly competitive solution. u When N large enough – Chamberlin breaks down. – Cournot converges to the perfectly competitive solution. – Bertrand still gets you the perfectly competitive solution.

So What Oligopoly Model Is The One? u u Depends on the particular industry. Requires lots of investigation and appeals to empirical information. – Does profit look to be positive? – Does price appear to be greater than or equal to marginal cost? u Different markets require using different models of oligopoly behavior.

Edward Chamberlin Duopoly: Does Conscious Parallelism Really Happen? u With only a couple/few identical firms, and homogeneous output, this might be expected. w/o collusion suppose you get the Cournot-Nash Joint Profit w/ collusion you get/want “Collusive Monopoly” Joint Profit u However, when firms have different cost structures… w/o collusion suppose you get the Cournot-Nash Joint Profit w/ collusion you get/want “Collusive Monopoly” Joint Profit

If Conscious Parallelism Fails, Can a Cartel Succeed? mc. Iran mc. SA marginal costcartel Demandcartel marginal revenuecartel

Collusion Story With a Cornell Connection #1 u Quoting… The Justice Department last week (back then) sued the eight Ivy League colleges and MIT, plus "various other. . . co-conspirators, " for allegedly violating the Sherman Antitrust Act "by illegally conspiring to restrain price competition on financial aid" to prospective undergraduate students. …The Ivy League colleges signed a consent decree that settles the suit against them. MIT declined to sign. …aides refused to say how the suit would affect the rest of the reported group of 57 colleges which have been under investigation since 1989. In the decree, the Ivy League defendants--Brown, Columbia, Cornell, Dartmouth, Harvard, Princeton, the University of Pennsylvania and Yale--agree that they will no longer collude or conspire on financial aid. They also agreed not to discuss or agree on future tuition or faculty salary increases. – MIT BALKS, Ivies Settle Antitrust Suit on Aid, By Kenneth D. Campbell – From Tech. Talk, Published by the MIT News Office at the Massachusetts Institute of Technology, Cambridge, Mass. May 29, 1991 u MIT Agrees to Settle Antitrust Suit, U. S. Says – December 23, 1993, http: //articles. latimes. com/1993 -12 -23/news/mn-4834_1_financial-aid-policy i>clicker question: Do you buy the MIT argument that price fixing was good for the students and their families? A. YES! B. Nope.

Collusion Story With a Cornell Connection #2 u The Archer Daniels Midland (ADM) investigation has been characterized by the Department of Justice, Antitrust Division, as one of the largest criminal antitrust cases in United States history. Since August 1996, at least seven cases were filed (back then) against eight companies and ten individuals charging price fixing and allocating sales volumes of lysine and/or citric acid worldwide. u Lysine, a $600 million a year industry (back then), is used by farmers as a feed additive to ensure proper growth of poultry and swine. Citric acid, a $1. 2 billion a year industry (back then), is a flavor additive and preservative produced from various sugars and is found in soft drinks, processed foods, detergents, and pharmaceutical and cosmetic products. Eight corporate defendants and six individual defendants pled guilty and were fined in excess of $190 million. Most of the defendants were from overseas. u In October 1996, ADM was sentenced to pay a $100 million fine for its participation in the lysine and citric acid conspiracies. At the time, it was the largest criminal fine ever imposed in an antitrust case. On September 17, 1998, three former ADM executives were convicted of participating in the lysine conspiracy following a nine-week trial. This trial was one of the Antitrust Division's highest profile and most successful criminal cases in its history. u Mark Whitacre was key. He was the guy who was the ADM informant and even served jail time, for this and other crimes…. – Cornell connection: he earned a Ph. D. in Nutritional Biochemistry from Cornell University (1983). u There is a book (among others) entitled The Informant by Kurt Eichenwald that chronicles what happened. It was turned into a movie, The Informant, a dark comedy thriller film, starring Matt Damon.

IO-Summary: Can You Fill This Table In?

The End - Amen u u u Study hard. Use the class web pages – stay informed. Work loads of problems. Eat well. Take a walk once in a while. Get some sleep. Don’t survive on And last but not least. . Thanks to YOU ALL for a great semester!! And thanks to the TAs for all their hard work. Best of luck on all your finals. I’m looking for good things from you all in our final!!