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Oligopoly
Denition
Oligopoly - an oligopoly is an industry consisting of a few rms. Duopoly is the simplest case of oligopoly. A duopoly is an
industry consisting of two rms. Study of the oligopoly:
Entry by new rms is impeded. Particularly, each rm's own price of output decisions aect its competitors' prots.
the interaction of a small number of rms. consider the duopolistic case of two rms supplying the same product.
When a market is in equilibrium, rms are doing the best they can and have no reason to change their price or output. Nash equilibrium: each rm is doing the best it can given
what its competitors are doing.
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Oligopoly
Classication of theories ( to analyze the interaction) Non-collusive
Simultaneous moves
quantity setting - Cournot price setting - Bertrand
Collusive
Cartels
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= 0 = y1 = y1 (y2 )
, reaction curve : relationship between a rm's prot maximizing output and the amount it thinks its competitor will produce.
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= 0 = y2 = y2 (y1 )
Firm 1:
2. c2 (y2 ) = 15y2 + y2
F .O .C .
1 = 60 2y1 y2 2y1 = 0 y1
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1 y1 R1 ( y2 ) 15 y2 . 4
15
y1
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Oligopoly: simultaneous moves & quantity competition Quantity Q y Competition; p ; An Example p In equilibrium, y = R (y ) = 15 y , and y = R (y ) =
1
1 4 2
45y1 4
y2 60
1 y1 R1 ( y2 ) 15 y2 . 4
1 y1 R1 ( y2 ) 15 y2 . 4
Cournot-Nash equilibrium
8 13 48 y1
* y* , y 1 2 13,8 .
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Note: the leader can make a prot at least as large as the Cournot-Nash equilibrium prot, but it doesn't need to
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The C-N output levels are (y1 , y2 ) = (13, 8) so the leader produces more than its C-N output. This is true generally.
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with one rm decides its price ahead of the others. Think of one large rm (the leader) and one small rm (the follower). The price leader sets its price ahead of the other rm. The small rms are price-taker and so its supply reaction to a market price p is S (p ) = y2 (p )
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Oligopoly: Collusion
Cartels: an industry where rms get together and attempt to set
prices and outputs so as to maximize total industry prots. Ex. OPEC Let's consider two rms. The prot-maximization problem facing the two rms is to choose their outputs y1 and y2 so as to maximize total industry prots
max y1 ,y2 p (y1 + y2 )[y1 + y2 ] c1 (y1 ) c2 (y2 )
F .O .C .
p ( y1 + y2 )+ p ( y1 + y2 )+ p Y p Y (y1 + y2 ) = MC1 (y1 ) (y1 + y2 ) = MC2 (y2 )
Familiar?
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Oligopoly: Collusion
Cartels: an industry where rms get together and attempt to set
prices and outputs so as to maximize total industry prots. Ex. OPEC Let's consider two rms. The prot-maximization problem facing the two rms is to choose their outputs y1 and y2 so as to maximize total industry prots
max y1 ,y2 p (y1 + y2 )[y1 + y2 ] c1 (y1 ) c2 (y2 )
F .O .C .
p ( y1 + y2 )+ p ( y1 + y2 )+ p Y p Y (y1 + y2 ) = MC1 (y1 ) (y1 + y2 ) = MC2 (y2 )
Familiar? Multi-plant rms. Please calculate the equilibrium y1 , y2 , p , Revenue1 , Revenue2 , prot1 , prot2 using the example setting.
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Oligopoly: Collusion
The rms cannot do worse by colluding since they can cooperatively choose their Cournot-Nash equilibrium output levels and so earn their Cournot-Nash equilibrium prots. So collusion must provide prots at least as large as their Cournot-Nash equilibrium prots. Such a cartel is not stable. Why? Firm i can benet from increasing its output to the level higher than the one decided by Cartel. How? For rm 1, it can instead make the decision according to
max 1 = p (y1 + y2 )y1 c1 (y1 ) y1
Oligopoly: Collusion
The optimality condition for the cartel solution is
p (y1 + y2 )+
p ( y1 + y2 ) = MC1 (y1 ) Y
Thus, if rm 1 believes that rm 2 will keep its output xed, then it will believe that it can increase prots by increasing the own production.
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d 1 dy1
>0
strategic decisions that take into account each other's actions and responses Payo: Value associated with a possible outcome Strategy: Rule or plan of action for playing a game Optimal strategy: strategy that maximizes a player's expected payo
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L
Player A
R
This is the games g payoff matrix.
U D
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PAYOFF MATRIX FOR ADVERTISING GAME Firm B Advertise 10, 5 6, 8 Dont advertise 15, 0 10, 2
Equilibrium? Advertising is a dominant strategy for Firm A. The same is true for
Firm B: No matter what firm A does, Firm B does best by advertising. The outcome for this game is that both firms will advertise. equilibrium q in dominant strategies g Outcome of a g game in which each firm is doing the best it can regardless of what its competitors are doing.
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PAYOFF MATRIX FOR ADVERTISING GAME Firm B Advertise 10, 5 6, 8 Dont advertise 15, 0 10, 2
Equilibrium? Advertising is a dominant strategy for Firm A. The same is true for Firm B : No matter what firm A does, Firmthat B does best by advertising. Dominant strategy: strategy is optimal no matterThe what outcome for this game is that both firms will advertise. an opponent does equilibrium q Equilibrium in dominant strategies g Outcome of a g game which in dominant strategies: outcome of a in game ineach firm is doing the best can regardless of what its are doing. which eachit rm is doing the best itcompetitors can regardless of what is competitors are doing. Advertising is a dominant strategy for Firm A. The same is true for rm B. No matter what rm A does, rm B does best by advertising. The outcome for this game is that both rms Copyright 2013 Pearson Education, Inc. Microeconomics Pindyck/Rubinfeld, 8e. 5 of 47 will advertise.
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L
Player A
U D
plays areeach we likely to see this reply game? A play of theWhat game where strategy is for a best to the other is a Nash equilibrium. The example has two Nash-equilibria; (U , L) and (D , R ). A Nash equilibrium can be interpreted as a pair of expectations about each person's choice such that, when the other person's choice is revealed, neither individual wants to change his behavior.
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L U
Player A
R (0,4) (3,2)
(1,2) (0,5)
mixed
So the game has no Nash equilibria in pure strategies. Even so, , the game g does have a Nash equilibrium, q , but strategies in mixed strategies.
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the ideal outcome is one in which neither prisoner confesses so that both get two years in prison. confesses, prison Confessing, Confessing however, however is a dominant strategy for each prisonerit yields a higher payoff regardless of the strategy of the other prisoner. Dominant strategies are also maximin strategies. The outcome in which both prisoners confess is both a Nash equilibrium and a maximin solution. Thus, in a very strong sense, it is rational for each prisoner to confess.
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the ideal outcome is one in which neither prisoner The strategy (Don't confess, Don't confess) is a Pareto confesses so that both get two years in prison. confesses, prison Confessing, Confessing however, however is a dominant strategy forno eachother prisonerit yields a higher payoff regardless of the both ecient there is strategy choice that makes strategy of the other prisoner. players better o - while the strategy (confess, confess) is Dominant strategies are also maximin strategies. The outcome in which both Pareto inecient. prisoners confess is both a Nash equilibrium and a maximin solution. Thus, in a very strong sense, it is rational for each prisoner to confess. The unique Nash equilibrium for this game is for both players to confess. In fact, both players confessing is not only a Nash equilibrium, it is a dominant strategy equilibrium, since each player has the same optimal choice independent of the other player.
Copyright 2013 Pearson Education, Inc. Microeconomics Pindyck/Rubinfeld, 8e. 10 of 47
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