Chapter 7.2
Oligopoly & Cartels
OLIGOPOLY
• Last day, saw non-co-operative ologopolies
and noted incentive to collude. Here we
want to look at varies possible collusion
scenarios:
• Tacit collusion
– price leadership: dominant firm
Dominant firm price leadership
£
Leader assumes
everyone else will act
like a perfectly
competitive firm once it
sets price, by setting
their P=MC
Dmarket
O
Q
Division of the market between leader and followers
Dominant firm price leadership
£
So Supply curve for
everybody else is just
their MC curve
So leader takes their
MC/supply curve as
given
Dmarket
O
Q
Division of the market between leader and followers
Dominant firm price leadership
£
Sall other firms
So what is left
over for the
market leader
at each price
Dmarket
O
Notice reverse
strategic
thinking
Q
Division of the market between leader and followers
Dominant firm price leadership
£
P1
P2
O
Sall other firms
Above P1 it gets
nothing, below
P2 no
Dmarket competitors
b
Q
Division of the market between leader and followers
Dominant firm price leadership
£
P1
Sall other firms
a
POF
Dleader
P2
O
Above P1 it gets
nothing, below
P2 no
Dmarket competitors
b
Q
Division of the market between leader and followers
Dominant firm price leadership
£
P1
Sall other firms
What about at
prices between
P1 and P2?
a
POF
Dleader
P2
O
QOF
Dmarket
What if price
were POF, what
would other
b firms supply?
Q
Division of the market between leader and followers
Dominant firm price leadership
£
P1
Sall other firms
a
POF
Dleader
P2
O
Dmarket
But leftovers
represent
demand curve
for lead firm
b
Q
Division of the market between leader and followers
Dominant firm price leadership
£
P1
Sall other firms
a
Dleader
P2
O
So now leader
obviously
maximises its
profit subject to
its demand curve
Dmarket
b
Q
Division of the market between leader and followers
Dominant firm price leadership
£
P1
Sall other firms
So need to draw
in MR, MC and
AC curves
a
Dmarket
P2
O
b
Q
Division of the market between leader and followers
Dominant firm price leadership
£
MCleader
PL
Sall other firms
l
Dmarket
Dleader
MRleader
O
QL
Determination of price and output
Q
Dominant firm price leadership
£
MCleader
PL
l
Sall other firms
t
Dmarket
Dleader
MRleader
O
QL
QT
Determination of price and output
Q
Dominant firm price leadership
£
MCleader
PL
l
f
Sall other firms
Remember
followers are a
large group of
smaller firms
t
Dmarket
And QT=QL+QF
Dleader
MRleader
O
QL
QF
QT
Determination of price and output
Q
Alternative Leadership: Price leader aiming to
£ maximise profits for a given market share
AR = D market
O
Q
Price leader aiming to maximise profits
for a given market share
£
Assume constant
market share
for leader
AR = D market
AR = D leader
=40% of Market
O
Q
Price leader aiming to maximise profits
for a given market share
£
AR = D market
AR = D leader
MR leader
O
Q
Price leader aiming to maximise profits
for a given market share
£
MC
AR = D market
AR = D leader
MR leader
O
Q
Price leader aiming to maximise profits
for a given market share
£
MC
PL
l
AR = D market
AR = D leader
MR leader
O
QL
Q
Price leader aiming to maximise profits
for a given market share
£
MC
PL
l
t
Remainder QT-QL
divided up
amongst other
producers
AR = D market
AR = D leader
MR leader
O
QL
QT
Q
OLIGOPOLY
• Tacit collusion
– price leadership: dominant firm
– price leadership: barometric
Like
case where firm has constant market
share. One firm chooses price given D, MR &
MC, others follow
OLIGOPOLY
• Tacit collusion
– price leadership: dominant firm
– price leadership: barometric
– rules of thumb
AC
pricing
P=(1+.10)AC
Benchmark
Pricing £9.99, £14,99, £19.99
Benchmark
on Advertising and/or design
Recent
implicit criticism by Virgin of BA by
OLIGOPOLY
• Tacit collusion
– price leadership: dominant firm
– price leadership: barometric
– Rules of thumb
• Collusion and the law
– Can be difficult to prove
– What is the difference between all agreeing a
price and one-price competitively set?
OLIGOPOLY
• Non-collusive oligopoly: the kinked demand
curve theory
– assumptions of the model
 If
you drop price everyone will follow
 If you raise price you are on your own
Suppose initially we have traditional diagram for firm
£
But once equilibrium is established, if
you raise price nobody follows you,
and if you lower it everybody does
MC
P1
D
MR
O
Q1
Q
Kinked demand for a firm under oligopoly
£
So above Q1 Demand curve is now
flatter
and below Q1 it is steeper
MC
P1
D
O
Q1
Q
Kinked demand for a firm under oligopoly
£
P1
D
O
Q1
Q
Kinked demand for a firm under oligopoly
£
So now firm faces the following
demand curve
P1
D
O
Q1
Q
£
MR for the top
part of the curve
P1
MR
a
O
Q1
D = AR
Q
£
MR for the lower part of
the curve?
P1
a
D = AR
b
O
Q
Q1
MR
£
P1
a
D = AR
b
O
Q
Q1
MR
Kinked Demand Curve Theory
• Why is this model important ?
• Because it helps to explain why we tend to
observe relatively stable prices in
oligopolistic industries
Stable price under conditions of a kinked demand curve
£
To see this lets
draw in the original
D, MR and MC
curve here.
P1
a
D = AR
b
O
Q
Q1
MR
Stable price under conditions of a kinked demand curve
£
To see this lets
draw in the original
D, MR and MC
curve here.
P1
a
D = AR
b
O
Q
Q1
MR
Stable price under conditions of a kinked demand curve
£
To see this lets
draw in the original
D, MR and MC
curve here.
Notice the
original MC
lies between
points a and b
P1
a
D = AR
b
O
Q
Q1
MR
Stable price under conditions of a kinked demand curve
£
But what if MC changes?
MC2
P1
MC1
a
D = AR
b
O
Q
Q1
MR
Stable price under conditions of a kinked demand curve
£
So MC can vary a lot and
price won’t change
MC2
P1
MC1
a
D = AR
b
O
Q
Q1
MR
OLIGOPOLY
• Non-collusive oligopoly: the kinked demand
curve theory
• Offers a reason for stable prices besides
collusion
• But other reasons why prices may be stable
• Prices may be costly to change
• Menu costs
– – don’t believe personally
The remaining material in this
presentation was not used in lectures
though it is relevant for the classwork
for weeks 9 &10 Please see section 7.3
of Sloman for more information
OLIGOPOLY
• Oligopoly and the public interest
– advantages
– disadvantages
– difficulties in drawing general conclusions
• Advertising and the public interest
• Oligopoly and contestable markets
PRICE DISCRIMINATION
• Meaning of price discrimination
• Types of price discrimination
– first degree
First-degree price discrimination
P
P1
D
O
200
Q
First-degree price discrimination
P
P1
D
O
200
Q
PRICE DISCRIMINATION
• Meaning of price discrimination
• Types of price discrimination
– first degree
– second degree
PRICE DISCRIMINATION
• Meaning of price discrimination
• Types of price discrimination
– first degree
– second degree
– third degree
Third-degree price discrimination
P
P1
D
O
200
Q
Third-degree price discrimination
P
P2
P1
D
O
150
200
Q
PRICE DISCRIMINATION
• Meaning of price discrimination
• Types of price discrimination
– first degree
– second degree
– third degree
• Conditions necessary for price
discrimination to operate
PRICE DISCRIMINATION
• Profit-maximising prices and output under
price discrimination
– first degree
– third degree
Profit-maximising output under
third-degree price discrimination
DX
O
O
MRX
(a) Market X
O
Profit-maximising output under
third-degree price discrimination
DY
DX
O
MRY
O
O
MRX
(a) Market X
(b) Market Y
Profit-maximising output under
third-degree price discrimination
DY
DX
O
MRY
O
MRT
O
MRX
(a) Market X
(b) Market Y
(c) Total
(markets X + Y)
Profit-maximising output under
third-degree price discrimination
MC
DY
DX
O
MRY
O
MRT
O
MRX
(a) Market X
(b) Market Y
(c) Total
(markets X + Y)
Profit-maximising output under
third-degree price discrimination
MC
DY
DX
O
MRY
O
O
MRX
(a) Market X
MRT
(b) Market Y
3000
(c) Total
(markets X + Y)
Profit-maximising output under
third-degree price discrimination
MC
5
DY
DX
O
MRY
O
O
MRX
(a) Market X
MRT
(b) Market Y
3000
(c) Total
(markets X + Y)
Profit-maximising output under
third-degree price discrimination
MC
5
DY
DX
O 1000
MRY
O
O
MRX
(a) Market X
MRT
(b) Market Y
3000
(c) Total
(markets X + Y)
Profit-maximising output under
third-degree price discrimination
MC
5
DY
DX
O 1000
MRY
O
MRX
(a) Market X
2000
(b) Market Y
MRT
O
3000
(c) Total
(markets X + Y)
Profit-maximising output under
third-degree price discrimination
MC
9
5
DY
DX
O 1000
MRY
O
MRX
(a) Market X
2000
(b) Market Y
MRT
O
3000
(c) Total
(markets X + Y)
Profit-maximising output under
third-degree price discrimination
MC
9
7
5
DY
DX
O 1000
MRY
O
MRX
(a) Market X
2000
(b) Market Y
MRT
O
3000
(c) Total
(markets X + Y)
PRICE DISCRIMINATION
• Profit-maximising prices and output under
price discrimination
– first degree
– third degree
• Advantages to the firm
PRICE DISCRIMINATION
• Profit-maximising prices and output under
price discrimination
– first degree
– third degree
• Advantages to the firm
• Price discrimination and the public interest
PRICE DISCRIMINATION
• Profit-maximising prices and output under
price discrimination
– first degree
– third degree
• Advantages to the firm
• Price discrimination and the public interest
– advantages
PRICE DISCRIMINATION
• Profit-maximising prices and output under
price discrimination
– first degree
– third degree
• Advantages to the firm
• Price discrimination and the public interest
– advantages
– disadvantages