Oligopoly Lecture 2 Economics 121 Spring 2006 Joseph Farrell Briefly The Midterm Most people did well as I intended What if you re an exception Jenny will discuss in section Office hours Pick up your exam at end of lecture Friday is drop add date Enrollment bureaucracy 1 Recall Cournot model When the assumptions make sense Capacity that s cheap to use once built Expecting price responses that preserve rivals planned output levels Conjectural variation How we solved it Residual demand elasticity is e s Then easy algebra Cournot Intuitive Results Continuum between competition and monopoly High concentration close to monopoly Symmetric case high concentration small N Low concentration close to perfect competition Decreasing returns to decreases in concentration Of course depends on measuring scale 2 Cournot and Concentration Herfindahl index of concentration Relates to weighted average gross margin industry average profit rate on sales H e Predict concentrated industries more profitable on average comparing industries Expect cleaner results if allow for e as well as H Inside an industry predict larger firms more profitable High shares go with low MC general formula linear demand case Other Simple Oligopoly Models Other conjectural variations in prices Price setting oligopoly Price matching Other conjectural variations in quantity 3 Price setting static models Eschew conjectural variation Game theoretic purity Is this sensible Undifferentiated Bertrand Two firms each sets a price One shot static game Lower price gets whole market Split it if equal Examples Near examples Analysis with constant unit costs Perhaps differing between firms Drastic and non drastic cost differences 4 Undifferentiated Bertrand II Analysis with economies of scale Average cost or marginal cost How fixed costs affect price contrary to the Econ 101 slogan Recall free entry equilibrium CP page 76 Capacity limits Concentration and Competition Cournot High concentration may signal that there s little competition Causes of high concentration in Cournot Few firms high concentration by definition Asymmetric MCs most efficient firms face little competition so dominate market Undifferentiated Bertrand Fierce competition may causally increase concentration 5 Stackelberg Model CP Stackelberg in quantity First mover advantage Commit to being aggressive rival backs off Why would a firm move first Contrast Stackelberg in price Extensive form games Simultaneous move games in extensive form CP Figure 6 9 Would it matter for the PD Differentiated products Examples most goods Differentiation makes a firm s residual demand curve less elastic Hard to lose all your sales even if your price is high Hard to attract all rival s customers even if your price is great Softens competition 6 Various Oligopoly Models Static one period price setting game Differentiated products Various approaches to differentiation Space metaphor Roughly CP chapter 7 Measures of differentiation How much consumers care about which product versus about price Inverse measure cross elasticity of demand Given rival s price this contributes to your residual demand elasticity 7 Differentiated product demand Demand quantity for good 1 decreases in price 1 increases in prices 2 n Inverse demand price for good 1 decreases in all goods quantities but by more in good 1 s Difference in coefficients reflects differentiation CP equations 7 4 7 8 For next time Read CP chapter 7 to page 220 representative consumer model 8 Hotelling Model Model of location given price p c Special case no differentiation Remember model of TV programming choice Changes if prices also variable Not so clear what happens then What if three firms rather than two Hotelling Model Prices given locations Locations at ends of line segment Could be away from ends see problem set Each consumer wants just one unit Could have own demand curve instead Firms set prices Nash equilibrium in prices Ignoring price dynamics as discussed 9 Solving Hotelling Model Can calculate each firm s best response function e g p 0 p 1 Solve the simultaneous linear equations What are we doing by doing that Result p c t Makes sense qualitatively Solving with Residual Demand Another way of solving the Hotelling price model Uses familiar concept of residual demand Calculated slope of residual demand It is 1 2t In symmetric equilibrium each firm s quantity Hence Lerner equation implies answer 10 Group central purchasing Already discussed idea examples Let s see how it works in otherwise Hotelling model of differentiation pricing If everyone else joined would you Price if you join Price if you don t Transportation cost if you do if don t Monopolistic Competition Free entry but soft competition Monopolistic competition Too many brands of toothpaste How does residual demand elasticity vary with entry Entry increases competition most models Entry just shares demand this model Examples 11 Bresnahan Reiss CP page 78 Entry against a monopoly or duopoly lowers price very noticeably Entry into oligopoly with 3 firms doesn t do nearly so much Workable competition with 3 firms Is subsequent entry wasteful What makes competition monopolistic Something about behavior Just don t rock the boat keep price where it was Or something about product differentiation Then entry may not be wasteful even if it doesn t affect price 12 Some announcements Problem set 2 Due Correction Fair warning My office hours today next Tuesday Midterm next Thursday Reading CP chapter 8 to page 267 SCP studies CP describe many difficulties in profit regressions What econometrics says about this Publication biases 13