Transcript lec20 - People.vcu.edu

Today
Oligopoly Theory
 Economic Experiment in Class

What happens when cartels won’t
work?
Oligopoly
Theories of Oligopoly Behavior
There are several theories of oligopoly
behavior.
 Many seem to explain some industries.
 None seem to explain all industries.

2 Among Many Possibilities

Bertrand Equilibrium
–

Assumes firms primarily choose price, then sell
quantity demanded
Cournot Equilibrium
–
Assumes firms primarily choose the quantity to
produce, then let the market demand determine
price.
Bertrand Equilibrium

Firms simultaneously choose prices
–
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
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Homogeneous product.
Perfect Information.
“Ties” split the market.
Simplification:
–
–

ex: pre-printed catalogs.
constant marginal costs
zero fixed costs.
What does the equilibrium look like?
What would you charge?
P
What will the Bertrand
equilibrium look like?
MC
D
Q
Bertrand Equilibrium
P
The equilibrium price is equal
to marginal cost.
Profits are zero.
D MC
Q*
Q
Bertrand Equilibrium Explained

Unless there are zero profits, the firms will
undercut each other to get more sales.

The result is like perfect competition, but
here we have only a few firms.
–
Zero profits
–
P = MC (allocatively efficient)
Cournot Equilibrium

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Firms choose quantities without knowing the other
firm’s quantity choice.
Each firm sells its output for the highest price
possible, given total market output.
Homogeneous product
Perfect Information
Same constant MC as above, zero fixed costs
Same market demand as above
Cournot Equilibrium
P
In this example each firm
would produce 33 1/3 units.
(We will not study how this
equilibrium is found.)
Do these firms make profits
in equilibrium?
$53
MC
D
33
67
100
Q
Cournot Equilibrium-Profit
P
Profits will be made.
$53
MC
D
33
67
100
Q
Overview of Cournot
Equilibrium
Firms make positive profits.
 There must be barriers to entry in order for
these to last in the long run.
 P > MC, so deadweight loss compared to
the efficient quantity.

Oligopoly compared to
Monopoly
Monopoly produces the
least, prices the highest,
and earns the most
profits.
P
$70
Cournot is in-between.
$53
$20
50
67
MR
100
Bertrand produces the
MC most, has the lowest
price, and earns zero
D
Q profits.
Cournot v. Bertrand
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Bertrand indicates that without cooperation, the
equilibrium is the same as in perfect competition.
The Bertrand equilibrium provides the efficient
quantity of the good.
Cournot indicates that without cooperation,
oligopolists can make profits as a monopolist
does.
The Cournot equilibrium will result in too little
being produced, compared to the efficient
quantity.
Cournot v. Bertrand, Cont’d
Which is correct as a model of firm
behavior? Probably neither.
 Firms tend to say they act as price
competitors, but market outcomes typically
reflect a Cournot solution.

Coming Up
Externalities
 In Class Today:

–
A series of experiments about oligopoly
behavior.