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Market Structure

Cartels (cooperative oligopoly models / collusion) Firms agree to restrict output & act like a monopoly illegal some cartels persist SA examples? incentives to (1) collude; (2) cheat on agreement. Firms gain by acting together like a monopoly (output & price). Only works if all act together The less elastic market DD, the higher p and benefits from forming the cartel.

Favourable conditions for emergence of cartels: small no. of large firms geographically close homogenous products difficult entry similar cost levels. Cartels will fail if: non-member firms can supply substitutes; member firms cheat. Noncooperative oligopoly: Cournot (firms act simultaneously) Stackelberg (one firm can act first) Cournot model non-cooperative simultaneous decisions imperfect info choose Q level Assume: 2 firms, & no others can enter Identical products One market period, & product cannot be stored for sale later. Each firms DD = total DD other firms output

Graph a: If American were a monopoly, American demand curve would be the market demand curve D. To maximise profit : American would set output so that MR intersects MC Which is 96 thousand passengers per quarter & the monopoly price is $243(the price is read above). Graph b: Duopoly: An oligopoly with two firms. American demand curve is not the entire market demand curve as it needs to consider Uniteds actions. American is only concerned about and transports residual demand. Residual demand calculation: Q qu (Total quantity-united quantity) If the price is $211, total quantity is 128; united flies 64....therefore American would fly 64. To maximise its profit American sets its output so that MR corresponds to MC & residual = MC.

American will sell a monopoly number of tickets 96 if united flies no passengers. The negative slope shows that American sells fewer tickets the more people American thinks that united will fly. Counot equilibrium (qa =qu =64).

Graphical approach: (market DD, residual DD, best-response curves) Algebraic approach to Cournot: Market DD: Q = 339 p MC = AC = $147 Americans residual DD: qA = Q qU = 339 p qU p = 339 qA qU MRr = 339 2qA qU Americans best-response: MRr = MC MRr = 339 2qA qU = MC = 147 339 2qA qU = 147 qA = (339 147) qU qA = 96 qU Uniteds best-response: qU = 96 qA Cournot eqm: solve the eqns simultaneously: qA = 96 (96 qA) qA = 64 qU = 64 Total output Q = qA + qU = 128 Substing into Q = 339 p, p = $211. Comparisons of outcomes In the Stackelburg model the leader produces twice as much as the follower. In the Stackelburg model output is generally higher and prices are generally lower therefore consumers prefer the Stackelburg equilibrium to the Counot equilibrium. Total Stackelburg model profit is lower because the follower usually earns less profit.

Stackelberg model One firm (the leader) is able to set its output before its rival/s (the follower/s). (Leader works out followers best-response curve.)

Residual DD & best-response curves when firms can choose any output level. E.g. American Airlines is able to act first. Dr = market DD qU (see Uniteds best-response curve) MRr = MC to find eqm P & qA; United will then produce qU determined by qA. Note: Firms ability to move first is essential (just announcing intended output not a credible threat) Important for strategic trade policy in real world. Problems with intervention: If the government wants to subsidise a domestic firm to produce the same output as it would if it were a Stackelburg leader 5 conditions must hold: The government must be able to set its subsidy before firms choose their output level. Other governments must not retaliate. Governments actions must be credible. The governments must know enough about how firms behave to intervene. The government must know all relevant facts about firms, including whether they are setting quantities.

Bertrand price-setting model: Monop comp or oligopoly Firms set p & let consumers decide on Q. Bertrand eqm: set of prices such that no firm can obtain a higher profit by choosing a different price if the other firms continue to charge these prices. Eqm different to Cournot and depends on whether firms sell identical or differentiated products.

With identical products: p = MC. e.g. 2 firms, constant MC & AC of $5/unit. Firm 2 charges p = $10. What p should Firm 1 set? (Its best response?) For any p > MC & AC Firm 2 charges, best response for Firm 1 is to undercut it slightly. (If Firm 2 charges p < $5, Firm 1 wont produce at all.) Best-response curves With identical products, p = MC; Bertrand eqm = perf compettv eqm. Cournot eqm: p = MC/ 1 + 1/(n) = $5 / 1 + 1 / (n). If = -1 and n = 2, p = $10. Bertrand unrealistic with identical products: Small no. firms 0 profit? Price unaffected by DD or no. of firms.

Bertrand eqm with differentiated products:

Each firm doesnt have to match rivals price cut exactly. Best-response curves for Coke & Pepsi. Firms can charge p > MC because of product differentiation.

N.B. Diffn depends on consumers perceptions. Effects of diffn on price: higher (less substitutable less elastic DD) Effects on welfare: although p > MC, welfare is not necessarily lower; consumers value variety & may gain utility (CS) from new brands. Monopolistic competition Free entry LR, only normal profits Each firm faces downsloping residual DD, so p > MC, because relatively few firms, or differentiated products. No. of firms: Each firms elasticity = n EoS and size of market DD determine how many firms the market can accommodate. Differentiated products: Firm charging slightly higher p will not lose all customers (market power).

Monop comp eqm: MR = MC; p = AC (but p > MC) Smallest Q at which AC curve reaches its minimum: full capacity or minimum efficient scale (here firm is reaping max poss EoS). A monop comp firm always operates at less than full capacity in the LR. Fixed costs & the no. of firms: Larger FC smaller no. of firms With airline example: MC = $147 / passenger; AC = 147 + F/q; F = $2.3m.