1Chapter 13Oligopoly and Monopolistic CompetitionKey issues1. market structure2.game theory3.cooperative oligopoly models (cartels)4.Cournot model of noncooperative oligopoly5. Stackelberg model of noncooperative oligopoly6.monopolistic competition7.Bertrand model of noncooperative oligopolyMarket structuresmarkets differ according to • number of firms in market• ease of entry and exit• ability of firms to differentiate their products Oligopoly• 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 productsMonopolistic competition• small or moderate number of firms• free entry• Q = 0• p = AC• usually products differentiatedTable 13.1 Properties of Monopoly, Oligopoly, Monopolistic Competition, and Competition2Strategies 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 firms Nash 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' strategiesAirlines• consider single-period, duopoly, quantity-setting game• duopoly: an oligopoly with two ("duo") firms• American Airlines and United Airlines compete for customers on flights between Chicago and Los AngelesNotation• Q = total number of passengers flown by both firms; sum of:• qA= passengers on American Airlines• qU= passengers on United Airlines3Firms 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• in this Table 13.2 game, each firm has a dominant strategy• 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 (qA= qU= 64), each firm earns $4.1 million (< $4.6 million it would make if firms restricted their outputs to qA= qU= 48)• 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 agreement Prisoners' 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 strategies4Collusion 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 game Supergame• if a single-period game is played repeatedly, firms engage in a• supergame: • players’ strategies in this period may depend on rivals' actions in previous periods• in a repeated game, firm can influence its rival's behavior by• signaling• threatening to punishThreat• suppose American announces to United that it will use the following two-part strategy:• American produces smaller quantity each period as long as United does the same• if United produces larger quantity in period t, then American will produce larger quantity in period t + 1and all subsequent periods• thus, if firms play same game indefinitely, they should find it easier to colludeKnow number of periods• suppose firms know that they are going to play game for T periods •period T is like a single-period game, and all firms cheat •hence T-1 period is last interesting period • by same reasoning, they cheat in that period, etc.• cheating is less likely to occur if end period is unknown or there is no endCooperative oligopoly modelsAdam Smith: "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or some contrivance to raise prices"Cartels failluckily for consumers, cartels often fail because • each firm in a cartel has an incentive to cheat on the cartel agreement by producing extra output• governments forbid them5Historic cartelsin late nineteenth century, cartels (trusts) were legal and common in the United States• oil• railroads• sugar• tobacco trusts Laws against cartels• in response to trusts' high prices, Congress passed • Sherman Antitrust Act in 1890• Federal Trade Commission Act of 1914• these laws prohibit firms from explicitly agreeing to take actions that reduce competition, such as jointly setting price • these anti-cartel laws are called • antitrust laws in U.S.• competition policies in most other countriesWhy some cartels persist1. tacit collusion2. international cartels (OPEC) and cartels within certain countries operate legally3. illegal cartel believes it can avoid detection or
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