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Convert the Multi-Plant Monopoly into an Oligopoly

Oligopoly Continued. Convert the Multi-Plant Monopoly into an Oligopoly. To maximize profits, two conditions must be satisfied when a firm has two plants:. Marginal costs of each plant must be equal : MC A = MC B. Marginal revenue must equal each plant’s marginal cost: MR = MC A = MC B.

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Convert the Multi-Plant Monopoly into an Oligopoly

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  1. Oligopoly Continued Convert the Multi-Plant Monopoly into an Oligopoly To maximize profits, two conditions must be satisfied when a firm has two plants: Marginal costs of each plant must be equal: MCA= MCB Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB MCA MCB MCB MCA 100 100 100 80 80 80 60 60 60 D 40 40 40 20 20 20 MR qA qB Q 50 100 50 100 150 200 50 100 150 200 200 qA = 50 MCA = $60 qB = 100 MCB = $60 qA + qB = = 150 MR = $60 P = $90 Owner retires and gives Plant A to his son Adam and Plant B to his daughter Beth Adam’s Firm Beth’s Firm Total Production qA= 50  MCA = $60 qB= 100  MCB = $60 Q = 150 MR = 60 P = $90

  2. Preview To cheat or not to cheat? If a firm believes that the other firm(s) will not retaliate, the firm has an incentive to cheat. retaliate aggressively, the firm does not have an incentive to cheat. As cheating and retaliation occurs: The joint profits of the firms fall. Consumer surplus rises. The gain in consumer surplus exceeds the loss in joint profits. Society as a whole becomes better off. Conflicting Interests of an Oligopolies and Cartels: Collective versus Individual It is in the collective interests of the firms in an industry to establish a cartel to maximize their joint profits by reducing production below the competitive level. But, if a cartel is established it may be in the individual interests of each firm to cheat on the cartel agreement by producing more to increase its individual profit.

  3. Scenario 1: No retaliation - Adam cheats and Beth does not retaliate? Quantity Slope of Demand Curve = .20 Adam Beth Joint Price To clear the market the quantity demanded must increase by 1 unit. Tomorrow 51 100 151 89.80 Today 50 100 150 90.00 The price must fall by .20, from $90.00 to $89.80. MCA = $60.00 Adam’s Adam’s Quantity Price Total Revenue = Price  Quantity Tomorrow: 51 89.80 89.8051 89.80(1 + 50) = 89.80 + 89.8050 Today: 50 90.00 90.0050 Adam’s Marginal Revenue = 89.80 + 89.8050  90.0050 Question: What does Adam’s marginal revenue (MRA) equal? = 89.80 + (89.80  90.00)50 = 89.80 + (.20)50  TR tends to rise by 89.80, the price, as a consequence of the additional unit sold.  TR tends to fall by 10.00, as a consequence of the lower price. Does Adam have an incentive to cheat if Beth does not retaliate?  Output Effect  Price Effect Yes   MRA = Adam’s Marginal Revenue = 89.80  10.00 = $79.80

  4. Adam produces one more unit of output and Beth does not retaliate: qA: 50  51 qB = 100 P: $90.00  $89.80 Adam’s Profit qA: 50  51 Increased by 1 MRA = $79.80 MCA = $60.00 MR = Change in total revenue resulting from a one unit change in production MC = Change in total cost resulting from a one unit change in production Adam’s Profit = TR  TC Produce 1 more unit Up by $19.80 Up by $79.80 Up by $60.00  Lab 18.1 Consumer surplus increases by 22

  5. Scenario 2: 1-For-1 Retaliation – Adam Cheats and Beth Retaliates Quantity Slope of Demand Curve = .20 Adam Beth Joint Price To clear the market the quantity demanded must increase by 2 units. Tomorrow 51 101 152 89.60 Today 50 100 150 90.00 The price must fall by .40, from $90.00 to $89.60. MCA = $60.00 Adam’s Adam’s Quantity Price Total Revenue = Price  Quantity Tomorrow: 51 89.60 89.6051 89.60(1 + 50) = 89.60 + 89.6050 50 90.00 90.0050 Today: Adam’s Marginal Revenue = 89.60 + 89.6050  90.0050 Question: What does Adam’s marginal revenue (MRA) equal? = 89.60 + (89.60  90.00)50 = 89.60 + (.40)50  TR tends to rise by 89.60, the price, as a consequence of the additional unit sold.  TR tends to fall by 20.00, as a consequence of the lower price. Does Adam still have an incentive to cheat?  Output Effect  Price Effect Yes   MRA = Adam’s Marginal Revenue = 89.60  20.00 = $69.60

  6. Adam produces one more unit of output and Beth does retaliate: qA: 50  51 qB = 101 P: $90.00  $89.60 Adam’s Profit qA: 50  51 Increased by 1 MRA = $79.80 MCA = $60.00 MR = Change in total revenue resulting from a one unit change in production MC = Change in total cost resulting from a one unit change in production Adam’s Profit = TR  TC Produce 1 more unit Up by $9.60 Up by $69.60 Up by $60.00  Lab 18.1 Consumer surplus increases by 60

  7. Scenario 3: 3-For-1 Retaliation – Adam Cheats and Beth Retaliates Aggressively Quantity Slope of Demand Curve = .20 Adam Beth Joint Price To clear the market the quantity demanded must increase by 4 units. Tomorrow 51 103 154 89.20 Today 50 100 150 90.00 The price must fall by .80, from $90.00 to $89.20. MCA = $60.00 Adam’s Adam’s Quantity Price Total Revenue = Price  Quantity Tomorrow: 51 89.20 89.2051 89.20(1 + 50) = 89.20 + 89.2050 Today: 50 90.00 90.0050 Adam’s Marginal Revenue = 89.20 + 89.2050  90.0050 Question: What does Adam’s marginal revenue (MRA) equal? = 89.20 + (89.20  90.00)50 = 89.20 + (.80)50  TR tends to rise by 89.20, the price, as a consequence of the additional unit sold.  TR tends to fall by 40.00, as a consequence of the lower price. Does Adam have an incentive to cheat?  Output Effect  Price Effect No   MRA = Adam’s Marginal Revenue = 89.20  40.00 = $49.20

  8. Adam produces one more unit of output and Beth does retaliate: qA: 50  51 qB = 101 P: $90.00  $89.60  Lab 18.2 Consumer surplus increases by 122 Firms: Joint profit falls. Adam’s profit falls; Adam has no incentive to cheat. Consumers: Consumer Surplus rises. The increase in consumer surplus is greater than the fall in joint profits. Society as a whole (firms and consumers together) is better off.

  9. Summary To cheat or not to cheat? If a firm believes that the other firm(s) will not retaliate, the firm has an incentive to cheat. retaliate aggressively, the firm does not have an incentive to cheat. As cheating and retaliation occurs: The joint profits of the firms fall. Consumer surplus rises. The gain in consumer surplus exceeds the loss in joint profits. Society as a whole becomes better off. Conflicting Interests of an Oligopolies and Cartels: Collective versus Individual It is in the collective interests of the firms in an industry to establish a cartel to maximize their joint profits by reducing production below the competitive level. But, if a cartel is established it may be in the individual interests of each firm to cheat on the cartel agreement by producing more to increase its individual profit. Question: What might affect a firm’s temptation to cheat? Government regulation. Personal ties. Threat of retaliation.

  10. Role of the Government Antitrust legislation: Broadly speaking antitrust legislation is designed to prevent • a firm from becoming a monopoly • or • an oligopoly from colluding and acting as a cartel. Regulation Airline Deregulation Act: In 1978, Congress passed and President Carter signed the Airline Deregulation Act. This act phased in the deregulation of the industry: 1981 - CAB lost authority over domestic routes 1983 - CAB lost authority over airline prices 1984 - CAB was disbanded

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