Oligopoly and Monopolistic CompetitionKey issuesMarket structuresSlide 4OligopolyStrategies and gamesGame theoryFirm's objectiveNash equilibriumDuopolyFirms act simultaneouslyDominant strategyNoncooperative gameWhy don't firms cooperate?Prisoners' dilemma gameCollusion in repeated gamesNoncooperative oligopolyBasic Cournot modelCournot equilibriumAmerican Airlines’ Profit-Maximizing Output: MonopolyAmerican Airlines’ Profit-Maximizing Output: DuopolyAmerican and United’s Best-Response CurvesDuopoly Equilibria: QuantitiesDuopoly Equilibria: ProfitsCournot equilibrium varies with number of firmsStackelberg modelStackelberg Game TreeStackelberg EquilibriumCredibility and CommitmentSupergameSupergame OutcomesCartelsSlide 34Structure of Industry: Incentives for Collective ActionWhy can cartels raise profits?Why some cartels persistDiamond CartelCartels failWhy cartels failCompetition versus CartelSolved problemSlide 43Maintaining cartelsDetection and enforcementEntry and cartel successLysine cartelLysine buyersMergersSome mergers raise efficiencyMonopolistic competitionMonopolistically Competitive EquilibriumMonopolistic Competition Among Airlines: Two firmsMonopolistic Competition Among Airlines: Three firmsFixed cost and number of firmsNumber of firmsBertrandBertrand Equilibrium with Identical ProductsBertrand Equilibrium with Differentiated Products1. Market structure2. Game theory3. Cournot model of noncooperative oligopoly4. Stackelberg model of noncooperative oligopoly5. Cooperative oligopoly models6. Monopolistic competitionOligopoly and Monopolistic CompetitionKey issues1. market structure2. game theory3. Cournot model of oligopoly4. Stackelberg model of oligopoly 5. cartels6. monopolistic competition7. Bertrand model of oligopolyMarket structures markets differ according to •number of firms in market•ease of entry and exit•ability of firms to differentiate their productsOligopoly•small group of firms in a market with substantial barriers to entry •because relatively few firms compete in such a market, •each firm faces a downward-sloping demand curve•each firm can set its price: p > MC•market failure: inefficient (too little) consumption•each affects rival firms•typical oligopolists differentiate their productsStrategies and games•oligopolistic or monopolistically competitive firm use a •strategy:•battle plan of actions (such as setting a price or quantity) it will take to compete with other firms •oligopolies engage in a •game:•any competition between players (such as firms) in which strategic behavior plays a major roleGame theory•set of tools used by economists, political scientists, military analysts, and others to analyze decision making by players (such as firms) who use strategies •these analytic tools can be used to analyze •oligopolistic games•poker•coin-matching games•tic-tac-toe•elections•nuclear warFirm's objective•obtain largest possible profit (or payoff) at game’s end •typically, one firm's gain comes at expense of other firms •each firm's profit depends on actions taken by all firmsNash equilibrium•set of strategies is a Nash equilibrium if, •holding strategies of all other players (firms) constant, •no player (firm) can obtain a higher payoff (profit) by choosing a different strategy•in a Nash equilibrium, no firm wants to change its strategy because each firm is using its •best response:•strategy that maximizes its profit given its beliefs about its rivals' strategiesDuopoly•consider single-period, duopoly, quantity-setting game•duopoly: an oligopoly with two ("duo") firmsFirms act simultaneously•each firm selects a strategy that•maximizes its profit •given what it believes other firm will do•firms are playing •a noncooperative game of imperfect information:•each firm must choose an action before observing rivals’ simultaneous actionsDominant strategy•a strategy that strictly dominates all other strategies regardless of which actions rivals’ chose•firm chooses its dominant strategy•where a firm has a dominant strategy, its belief about its rival's behavior is irrelevantNoncooperative game•firms do not cooperate in a single-period game•In Nash equilibrium, each firm earns less than it would make if firms restricted their outputs•sum of firms' profits is not maximized in this simultaneous choice, one-period gameWhy don't firms cooperate?•don't cooperate due to a lack of trust:•each firm can profitably use low-output strategy only if it trusts other firm!•each firm has a substantial profit incentive to cheat on a collusive agreementPrisoners' dilemma game all players have dominant strategies that lead to a profit (or other payoff) that is inferior to what they could achieve if they cooperated and played alternative strategiesCollusion in repeated games•in a single-period prisoners' dilemma game, firms produce more than they would if they colluded •why, then, are cartels frequently observed?•collusion is more likely in a multiperiod game: single-period game played repeatedly•punishment: not possible in a single-period game but possible in a multiperiod gameNoncooperative oligopoly•many models of noncooperative oligopoly behavior •firms choose quantities•Cournot model•Stackelberg model•firms set prices: Bertrand modelBasic Cournot model•duopoly: 2 firms (no other firms can enter)•firms sell identical products•market that lasts only 1 period (product or service cannot be stored and sold later)•as in prisoners' dilemma game, firms are playing noncooperative game of imperfect information•each firm chooses its output level before knowing what other firm will choose•firms may choose any output level they wantCournot equilibrium•Nash equilibrium where firms choose quantities•set of quantities sold by firms such that, holding quantities of all other firms constant, no firm can obtain a higher profit by choosing a different quantityAmerican Airlines’ Profit-Maximizing Output: MonopolyAmerican Airlines’ Profit-Maximizing Output: DuopolyAmerican and United’s Best-Response CurvesDuopoly Equilibria: QuantitiesDuopoly Equilibria: ProfitsCournot equilibrium varies with number of firmsStackelberg model•Cournot model: both firms make their output decisions simultaneously•Heinrich von Stackelberg's model: firms act sequentially•leader firm sets its output first•then its rival (follower) sets its outputStackelberg
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