Today

1
Today

• Oligopoly Theory
• Economic Experiment in Class

2
What happens when cartels wont work?

• Oligopoly

3
Theories of Oligopoly Behavior

• There are several theories of oligopoly behavior.
  
• Many seem to explain some industries.
• None seem to explain all industries.

4
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.

5
Bertrand Equilibrium

• Firms simultaneously choose prices
• ex pre-printed catalogs.
• Homogeneous product.
• Perfect Information.
• Ties split the market.
• Simplification
• constant marginal costs
• zero fixed costs.
• What does the equilibrium look like?

6
What would you charge?
P
What will the Bertrand equilibrium look like?
MC
Q
D
7
Bertrand Equilibrium
P
The equilibrium price is equal to marginal cost.
Profits are zero.
MC
D
Q
Q
8
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)

9
Cournot Equilibrium

• Firms choose quantities without knowing the other
  firms 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

10
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
Q
67
33
100
11
Cournot Equilibrium-Profit
P
Profits will be made.
53
MC
D
Q
67
33
100
12
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.

13
Oligopoly compared to Monopoly
Monopoly produces the least, prices the highest,
and earns the most profits.
P
Monopoly
70
2 firms, Cournot
Cournot is in-between.
53
Bertrand produces the most, has the lowest price,
and earns zero profits.
Bertrand
MC
20
D
Q
50
67
100
MR
14
Cournot v. Bertrand

• 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.

15
Cournot v. Bertrand, Contd

• 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.

16
Coming Up

• Externalities
• In Class Today
• A series of experiments about oligopoly behavior.