MSM5200 Session14 Oligopoly

HRS 5201 - TERM 1- Credits 3 (Core)
S.Rajasulochana
Assistant Professor
TAPMI, Manipal
Session 14
9/5/2019 Market structure _Perfect Competition

Imperfect Competition
Oligopoly
Market Structures 2
Example: Consider a small town with140 residents
and its demand schedule for cell phone services
▪ Two firms: AT&T, Verizon
(duopoly: an oligopoly with two firms)
▪ Each firm’s costs: FC = $0, MC = $10
▪ Compute Revenue, Cost and Profit at different prices and
quantities.sold.
▪ If both firms compete with each other, what would be the
market outcomes?
▪ If both firms collude and act like a monopoly, what would be
the market outcome?
Market Structures 3
Cell Phone Duopoly in Smalltown
P Q Revenue Cost Profit Competitive
$0 140 $0 $1,400 –1,400 outcome:
P = MC = $10
5 130 650 1,300 –650
Q = 120
10 120 1,200 1,200 0
Profit = $0
15 110 1,650 1,100 550
20 100 2,000 1,000 1,000
25 90 2,250 900 1,350
Monopoly
30 80 2,400 800 1,600 outcome:
35 70 2,450 700 1,750 P = $40
40 60 2,400 600 1,800 Q = 60
45 50 2,250 500 1,750 Profit = $1,800
Interdependence
A key characteristic of oligopolies is that each firm can affect

the market, making each firm’s choices dependent on the
choices of the other firms. They are interdependent.
Interdependence leads to strategic behavior.

Strategic behavior is the behavior that occurs when what is
best for A depends upon what B does, and what is best for B
depends upon what A does.
Market Structures 5
EXAMPLE: Cell Phone Duopoly in Smalltown
• One possible duopoly outcome: collusion
• Collusion: an agreement among firms in a
market about quantities to produce or prices
to charge
• AT&T and Verizon could agree to each produce
half of the monopoly output:
• For each firm: Q = 30, P = $40, profits =
$900
• Cartel: a group of firms acting in unison,
e.g., AT&T and Verizon in the outcome with
collusion
Collusion vs. self-interest
P Q Duopoly outcome with collusion:
$0 140 Each firm agrees to produce Q = 30,
5 130 earns profit = $900.
10 120 If AT&T reneges on the agreement and
15 110 produces Q = 40, what happens to the
20 100 market price? AT&T’s profits?
25 90 Is it in AT&T’s interest to renege on the
30 80 agreement?
35 70
If both firms renege and produce Q = 40,
40 60 determine each firm’s profits.
45 50
Answers
P Q If both firms stick to agreement,
each firm’s profit = $900
$0 140
5 130 If AT&T reneges on agreement and
produces Q = 40:
10 120
Market quantity = 70, P = $35
15 110
AT&T’s profit = 40 x ($35 – 10) = $1000
20 100
25 90 AT&T’s profits are higher if it reneges.
30 80 Verizon will conclude the same, so
35 70 both firms renege, each produces Q = 40:
40 60 Market quantity = 80, P = $30
45 50 Each firm’s profit = 40 x ($30 – 10) = $800
Markets with Only a Few Sellers
• It is difficult to reach and enforce an agreement as the size of the
cartel increases.
• Each firm has to take into account:
The output effect
• Because P > MC, selling one more unit increases profit
The price effect
• Increasing production increases total amount sold, price falls and
lowers the profit
9
Equilibrium for an Oligopoly
• Nash equilibrium
• Economic actors interacting with one another
• Each choose their best strategy
• Given the strategies that all the other actors have
chosen
10
Markets with Only a Few Sellers
• The size of an oligopoly affects the market outcome

• As the number of sellers in an oligopoly grows larger
• Oligopolistic market looks more like a competitive
market
• Price approaches marginal cost
• Quantity produced approaches socially efficient level
11
The Economics of Cooperation
• The prisoners’ dilemma

• Particular “game” between two captured prisoners
• Illustrates why cooperation is difficult to maintain
even when it is mutually beneficial
• Dominant strategy
• Strategy that is best for a player in a game
• Regardless of the strategies chosen by the other
players
12
Figure 1
The Prisoners’ Dilemma
•In this game between two criminals suspected of committing a crime, the
sentence that each receives depends both on his or her decision whether to
confess or remain silent and on the decision made by the other.
13
The Economics of Cooperation
• Game oligopolists play

• In trying to reach the monopoly outcome
• Similar to the game that the two prisoners play in the prisoners’ dilemma
• Firms are self-interested
• And do not cooperate
• Even though cooperation (cartel) would increase profits
• Each firm has incentive to cheat
14
Figure 2
Jack and Jill’s Oligopoly Game
•In this game between Jack and Jill, the profit that each earns
from selling water depends on both the quantity he or she
chooses to sell and the quantity the other chooses to sell.
15

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HRS 5201 - TERM 1- Credits 3 (Core)

9/5/2019 Market structure _Perfect Competition

A key characteristic of oligopolies is that each firm can affect

Interdependence leads to strategic behavior.

• The size of an oligopoly affects the market outcome

• The prisoners’ dilemma

• Game oligopolists play

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