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Lecture 11 oligopoly
1. Lecture 11 HE 101 Monopolistic Competition and Oligopoly Source: Pyndyck, Rubinfeld and Koh (2006) complemented with own materials
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4. A Monopolistically Competitive Firm in the Short and Long Run Quantity $/Q Quantity $/Q Short Run Long Run (c) Y.E. Riyanto MC AC MC AC D SR MR SR D LR MR LR Q SR P SR Q LR P LR
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7. Monopolistically and Perfectly Competitive Equilibrium (LR) $/Q Quantity $/Q Quantity Perfect Competition Monopolistic Competition (c) Y.E. Riyanto Deadweight loss MC AC D = MR Q C P C MC AC D LR MR LR Q MC P
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18. Firm 1’s Output Decision Q 1 P 1 (c) Y.E. Riyanto MC 1 50 MR 1 (75) D 1 (75) 12.5 If Firm 1 thinks Firm 2 will produce 75 units, its demand curve is shifted to the left by this amount. D 1 (0) MR 1 (0) Firm 1’s demand curve, D 1 (0), if it thinks that Firm 2 produces nothing. D 1 (50) MR 1 (50) 25 If Firm 1 thinks Firm 2 will produce 50 units, its demand curve is shifted to the left by this amount.
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20. Reaction Curves and Cournot Equilibrium Firm 2’s reaction curve shows how much it will produce as a function of how much it thinks Firm 1 will produce. Q 2 Q 1 25 50 75 100 25 50 75 100 x x x x Firm 1’s reaction curve shows how much it will produce as a function of how much it thinks Firm 2 will produce. The x’s correspond to the previous model. (c) Y.E. Riyanto Firm 2’s Reaction Curve Q*2(Q 2 ) Firm 1’s Reaction Curve Q* 1 (Q 2 )
21. Reaction Curves and Cournot Equilibrium Q 2 Q 1 25 50 75 100 25 50 75 100 x x x x In Cournot equilibrium, each firm correctly assumes how much its competitors will produce and thereby maximize its own profits. (c) Y.E. Riyanto Firm 2’s Reaction Curve Q*2(Q 2 ) Firm 1’s Reaction Curve Q* 1 (Q 2 ) Cournot Equilibrium
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28. Duopoly Example Q 1 Q 2 The demand curve is P = 30 - Q and both firms have 0 marginal cost. (c) Y.E. Riyanto Firm 2’s Reaction Curve 30 15 Firm 1’s Reaction Curve 15 30 10 10 Cournot Equilibrium
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31. Duopoly Example Q 1 Q 2 30 30 For the firm, collusion is the best outcome followed by the Cournot Equilibrium and then the competitive equilibrium (c) Y.E. Riyanto Firm 1’s Reaction Curve Firm 2’s Reaction Curve 10 10 Cournot Equilibrium Collusion Curve 7.5 7.5 Collusive Equilibrium 15 15 Competitive Equilibrium (P = MC; Profit = 0)
59. Payoff Matrix for Prisoners’ Dilemma Prisoner A Don’t confess Don’t confess Prisoner B Would you choose to confess? Confess Confess (c) Y.E. Riyanto -5, -5 -1, -10 -2, -2 -10, -1 Dominant Strategy Nash Eq. (confess;confess) better outcomes
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63. Collusion (Price Fixing) BA and Virgin: Flying in formation Aug 2nd 2007 From The Economist print edition It takes two to fix prices FOR years British Airways (BA) described itself as “the world's favorite airline”. It no longer looks so popular in London and Washington. On August 1st the firm was hit with a transatlantic double whammy after it was found guilty of colluding with a rival, Virgin Atlantic, to fix prices on long-haul passenger routes . Britain's Office of Fair Trading (OFT) handed down a record fine of £121.5m ($246m). A few hours later, America's Department of Justice (DoJ) imposed a $300m penalty of its own. The severity of the American fine also reflected BA's role in a different international conspiracy involving Korean Air and Lufthansa. A clearer example of illegal price-fixing than that between BA and Virgin would be hard to imagine. The two firms discussed “fuel surcharges” at least six times between August 2004 and January 2006, during which time they rose from £5 to £60 on a return ticket. A transatlantic bust was particularly fitting for the OFT. During Labour's period in office, it has introduced American-style, cartel-busting sanctions on companies that prefer cozy deals with rivals to the bracing winds of competition. But despite many protracted investigations into sectors such as banking and supermarkets that attract consumers' ire, the OFT has struggled to find the kind of smoking-gun evidence of collusion it needed to look as terrifying as it and the government wished. That is partly the nature of the beast. Collusion is difficult to prove : as Mr Collins observes, the tricky thing about colluders is that they do their business in secret. Indeed, the airlines' price-fixing came to light only after Virgin's legal department alerted the authorities . This was no selfless dedication to consumers' welfare. Virgin hoped to benefit from the “ leniency policy ”, which was introduced in the 1998 Competition Act and copied from similar laws in America, granting immunity to firms that blow the whistle . Virgin was just as complicit as BA in the price-fixing and has, presumably, benefited from it financially. Not only was the airline saving itself from the risk of prosecution, but it was also grassing up a rival with whom it has had a bruising relationship in the past. It grates to see one firm get away with something while another is punished, but leniency policies are, probably, a good thing. The ability to claim immunity gives a powerful incentive for businesses to police their own industries, which ought to improve things for consumers. After all, half a victory is better than none. (c) Y.E. Riyanto
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