Today

1. Today • Oligopoly Theory • Economic Experiment in Class

2. What happens when cartels won’t 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 firm’s 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 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? P $53 MC D Q 67 33 100

11. Cournot Equilibrium-Profit Profits will be made. P $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 > 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, Cont’d • 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.