Today

1
Today

• Oligopoly Theory
• Economic Experiment in Class

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What happens when cartels wont work?

• Oligopoly

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Theories of Oligopoly Behavior

• There are several theories of oligopoly behavior.
  
• Many seem to explain some industries.
• None seem to explain all industries.
• Many share the notion of a Nash equilibrium.

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Nash Equilibrium

• When no firm wants to unilaterally change what it
  is doing.
• Assumes that firms do not cooperate with each
  other.

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Bertrand Equilibrium

• Firms simultaneously choose prices.
• Homogeneous product.
• Perfect Information.
• Ties split the market.
• Simplification Zero costs.
• What does the equilibrium look like?

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What would you charge?
P
What will the Nash-Bertrand equilibrium look
like? (No firm wants to unilaterally change its
price.)
Q
D
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Bertrand Equilibrium
P
With the assumption of zero costs, the
equilibrium price is zero. Profits are zero.
D
Q
Q
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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)

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Cournot Equilibrium

• Firms choose quantities without knowing the other
  firms quantity choice.
• Equilibrium is when one firm would not have
  changed its quantity if it had known the other
  firms choice. This must hold for both firms.

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Cournot Equilibrium, Contd.

• Each firm sells its output for the highest price
  possible, given total market output.
• Note there is one market price.

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Cournot on graph
Suppose a duopoly. Firm 2 guesses various
quantities for firm 1. Pick any q1 (say, 20).
What is the optimal q2?
P
D
Q
20
100
MR
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Cournot on graph
P
It is always optimal to split the difference
between q1 and 100. Is this an equilibrium?
(Hint Does firm 1 regret its choice of 20 units?)
40
D
Q
20
100
60
MR
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Cournot on graph
P
Given firm 2 produces 40 units, firm 1 now wishes
it had chosen 30 units (for a mkt total of
70). Firm 1 20 Firm 2 40 units is not a
Cournot equilibrium.
40
30
D
Q
70
20
100
60
40
MR
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Nash-Cournot Equilibrium

• For two firms with identical costs, they will
  choose identical output levels in equilibrium.
• In our example, each firm produces 33 1/3 units.

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Nash-Cournot Equilibrium
P
Each firm produces 33 1/3 units. Neither wishes
to change, given the others output. Do these
firms make profits in equilibrium?
33
D
Q
MR
33
100
67
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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 gt MC, so deadweight loss compared to the
  efficient quantity.

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Cournot compared to Monopoly
P
Industry output is greater. Price is
lower. Profits are lower. (How do we
know?) Deadweight loss (compared to efficient
level of output) is lower.
Monopoly
2 firms, Cournot
50
33
D
Bertrand
Q
33
100
67
50
MR
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Cournot v. Bertrand

• Bertrand indicates that without cooperation, the
  equilibrium is the same as in perfect
  competition.
• Cournot indicates that without cooperation,
  oligopolists can make profits, similar to
  monopolist.

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Cournot v. Bertrand, Contd

• Which is correct? Probably neither.
• Firms tend to say they act as price competitors,
  but market outcomes typically reflect a Cournot
  solution.

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Coming Up

• Monday Externalities
• Wednesday
• no class because of Thanksgiving holiday
• Monday 11/27
• Prepare for 3rd exam covering chapters 22, 23,
  and 30.
• Wednesday 11/29
• Exam 3

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Group Work

• A series of experiments about oligopoly behavior.