Oligopoly

1. Oligopoly Cartel

2. Cartel Oligopoly is conducive to collusion If a few firms face identical or highly similar demand and costs... They will seek joint profit maximization...

3. Incentives for Collusion • Decrease competition, achieve monopoly-like behavior • Decrease uncertainty • Decrease ease of entry

4. Perfect Cartel

5. Perfect Cartel • If the Cartel Maintains the Monopoly Price, in a perfect cartel the profits made by individual firms will not be retained by them, profit MCa MCb ACb ACa P D MR Qa Qb

6. Perfect Cartel • instead they will be brought under a common pool. These profits will be divided by the member firms according to the terms of agreement reached between them at the time of forming the cartel. • The allocation of output quota to each of them is made on the grounds of minimizing cost and not as a base for determining profit distribution.

7. Market Sharing Cartel

8. Market Sharing Cartel • In a loose type of cartel the market-sharing by the firms occurs. • There are two methods of market sharing. • Market sharing by non-price competition.Only a uniform price is set and member firms are free to produce and sell the amount of outputs which will maximize the individual profits. If the different member firms have identical costs, the agreed uniform price will be the monopoly price.

9. Market Sharing Cartel • But when there are cost differences the price will be fixed by bargaining. The price will be such as ensure some profits to high-cost firms. • But with cost differences such loose cartels are quite unstable. Because the low cost firms will have an incentive to cut price to increase their profits.

10. Market Sharing Cartel • Market sharing by quota. Member firms agree on quota of output to be sold. In case of homogeneous output and identical cost, the monopoly solution will emerge with the market being equally shared by them. • Two Criteria are usually adopted to fix the quotas of firms, past level of sales and productive capacity • The second common base for the quota system is the geographical division (region wise) of market.

11. Incentive to Cheat • Firms would be better off cooperating and jointly maximizing their profits However, each firm has an incentive to cheat by lowering price because the demand curve facing each firm is more elastic than the market demand curve. • This conflict makes collusive agreements difficult to maintain.

12. Gaining from Cheating • Using industry demandDi and marginal revenueMRi, oligopolists maximize their joint profit where MRi=MC– at output Qi and price Pi . • Demand facing each firm df(where no other firms cheat) would be much more elastic than industry demandDi . • The firm maximizes its profit where MRf=MC by expanding output to qf and lowering its price to Pf from Pi Firm Industry Pi Pi Pf MC MC df MRi Di MRf qf Qi

13. Individual firms have an intensive to cheat by cutting price to expand out put Gaining from Cheating • Using industry demandDi and marginal revenueMRi, oligopolists maximize their joint profit where MRi=MC– at output Qi and price Pi . • Demand facing each firm df(where no other firms cheat) would be much more elastic than industry demandDi . • The firm maximizes its profit where MRf=MC by expanding output to qf and lowering its price to Pf from Pi Firm Industry Pi Pi Pf MC MC df MRi Di MRf qf Qi

14. Duopoly Model • determine the profit maximizing output for the industry. • assign a production quota to each firm.

15. Duopoly Model • One firm cheats on the agreement and increases production to 3,000 units a week. • With 5,000 units supplied, the price falls to $7,500 a unit.

16. Duopoly Model • Despite the fall in price, the cheat makes a bigger profit, because its average total cost falls. • The cheat’s profit becomes $4.5 million a week.

17. Duopoly Model • Here, both firms cheat and increase production to 3,000 units a week. • With 6,000 units on offer for sale, the price falls to $6,000 a unit (zero economic profit).

18. Instability of Cartel • since each firm has incentive to “cheat”, cartels often fall apart • cheating problem is exacerbated by the fact that competition can occur on many margins • competition from new firms • if cartel firms are making economic profits, incentive for new firms to enter the market • if let new firms into cartel, profit for each member diminishes • if exclude new entrants, they will cut price and take business away from cartel

19. Instability of Cartel • to be successful, a cartel must • get agreement on production levels • prevent cheating by cartel members • restrict entry of new competitors

20. Instability of Cartel • factors increasing probability of successful collusion • few sellers • easier to reach agreement • easier to monitor production and prevent cheating • stable demand • easier to determine if cheating is occurring by looking at changes in own sales • similar costs • if have different costs, more difficult to reach agreement on price and output • for a given P and Q, if have different costs get different levels of profit

21. Instability of Cartel • factors increasing probability of successful collusion • homogeneous product • fewer variables to agree on • limits margins on which to compete • sealed-bid auctions • bidding to specifications makes product homogeneous • easy to detect cheaters since all bids are revealed • no antitrust enforcement

22. Instability of Cartel • factors increasing probability of successful collusion • government regulations help enforce cartel • government established cartels • example: government permitted six New England states to form a milk cartel (Northeast Interstate Dairy Compact -- NIDC). In 1999 legislation allowed dairy farmers in Northeastern states surrounding NIDC to join NIDC, 7 in 16 Southern states to form a new regional cartel. Soy milk became more popular. • entry restrictions • licensing • enforce minimum prices • price regulation

23. American Antitrust Law The Sherman Act, 1890 Section 1: Every contract, combination in the form of a trust or otherwise, or conspiracy, in restraint of trade or commerce among the several states, or with foreign nations, is hereby declared to be illegal.

24. American Antitrust Law The Sherman Act, 1890 Section 2: Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several states, or with foreign nations, shall be deemed guilty of a felony.

25. American Antitrust Law The Sherman Act, 1890 Section 7: Any person “injured in his business or property” by anything forbidden in the act, may sue to recover threefold the damages sustained, including the costs of the suit.

26. American Antitrust Law The Clayton Act and its Amendments Clayton Act 1914 Robinson-Patman Act 1936 Cellar-Kefauver Act 1950 These Acts prohibit the following practices only if they substantially lessen competition or create monopoly.

27. American Antitrust Law The Clayton Act and its Amendments 1. Price discrimination: predatory pricing; unjustified volume discounts. 2. Contracts that require other goods to be bought from the same firm (called tying arrangements).

28. American Antitrust Law The Clayton Act and its Amendments 3. Contracts that require a firm to buy all its requirements of a particular item from a single firm (called requirements contracts.) 4. Contracts that prevent a firm from selling competing items (called exclusive dealing).

29. American Antitrust Law The Clayton Act and its Amendments 5. Contracts that prevent a buyer from reselling a product outside a specified area (called territorial confinement). 6. Acquiring competitor’s shares or assets. 7. Interlocking directorships among competing firms.