Lecture 3

OLIGOPOLY (CONTINUED)

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Chapter 13
 Topics

Stackelberg Model.
Bertrand Model.
Cartels.
Comparison of Collusive/cartel, Cournot,
Stackelberg, and Competitive Equilibria.

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 Lecture 3

OLIGOPOLY (CONT.)

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 Stackelberg Model

In the Cournot model, both firms make

their output decisions at the same time.
Suppose, however, that one of the firms,
called the leader, can set its output before its
rival, the follower, sets its output.

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 Figure 13.5
Stackelberg
Equilibrium

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 Solved Problem 13.3

Use algebra to solve for the Stackelberg

equilibrium quantities and market price if
American Airlines were a Stackelberg
leader and United Airlines were a follower.
(Hint: As the graphical analysis shows,
American Airlines, the Stackelberg leader,
maximizes its profit as though it were a
monopoly facing a residual demand
function.)

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 Why Moving Sequentially Is Essential

When the firms move simultaneously,

United doesnt view Americans warning
that it will produce a large quantity as a
credible threat.
If United believed that threat, it would indeed
produce the Stackelberg follower output level.

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 Strategic Trade Policy

Suppose that two identical firms in two

different countries compete in a world
market.
Both firms act simultaneously, so neither firm
can make itself the Stackelberg leader.
A government may be tempted to intervene
to make its firm a Stackelberg leader.

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 Problems with Intervention

For government subsidies to work five

conditions must hold:
government must be able to set its subsidy
before the firms choose their output levels.
other government must not retaliate.
governments actions must be credible.
government must know enough about how
firms behave to intervene appropriately.
government must know which game the firms
are playing.
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 Table 13.3 Effects of a Subsidy
Given to United Airlines

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 Solved Problem 13.4

If governments subsidize identical

Cournot duopolies with a specific subsidy
of s per unit of output, what is the
qualitative effect (direction of change) on
the equilibrium quantities and price?
Assume that the before-subsidy best-
response functions are linear.

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 Solved Problem 13.4

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 Comparison of Collusive, Cournot,
Stackelberg, and Competitive Equilibria

How would American and United behave

if they colluded?
They would maximize joint profits by
producing the monopoly output, 96 units, at
the monopoly price, $243 per passenger.

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 Figure 13.6(a) Duopoly Equilibria

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 Figure 13.6(b) Duopoly Equilibria

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 Application: Deadweight Losses in the
Food and Tobacco Industries

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 Bertrand Model

Bertrand equilibrium (Nash-Bertrand

equilibrium) - a Nash equilibrium in
prices; a 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.
Bertrand equilibrium depends on whether
firms are producing identical or differentiated
products.

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 Best-Response Curves

Suppose that each of the two price-setting

oligopoly firms in a market produces an
identical product and faces a constant
marginal and average cost of $5 per unit.
What is Firm 1s best response if Firm 2 sets
a price of p2 = $10?

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 Figure 13.7 Bertrand Equilibrium
with Identical Products

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 Bertrand Versus Cournot

Cournot equilibrium price for firms with

constant marginal costs of $5 per unit by:

MC $5
p
1 1 /( n ) 1 1 /( n )

where n is the number of firms and is the market

demand elasticity.
If the market demand elasticity is = 1 and n = 2,
the Cournot equilibrium price is $5/(1 1 2) = $10
which is double the Bertrand equilibrium price.

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 Bertrand Equilibrium with Differentiated
Products

In markets with differentiated products

such markets, the Bertrand equilibrium is
plausible, and the two problems of the
homogeneous-goods model disappear:
Firms set prices above marginal cost, and
prices are sensitive to demand conditions.

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 Figure 13.8 Bertrand Equilibrium
with Differentiated Products

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 Why Cartels Form

A cartel forms if members of the cartel

believe that they can raise their profits by
coordinating their actions.
There is therefore collusion or cooperation
So cartels are basically cooperative
Oligopolies

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 Figure 13.1 Competition Versus Cartel
(a) Firm (b) Market

Price, p, $ per unit

Price, p, $ per unit

MC
S
em
pm pm
AC

pc pc ec

MCm
MCm
Market demand

MR

qm qc q* Qm Qc
Quantity, q, Units Quantity, Q, Units
per year per year

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 Laws Against Cartels

Cartels persist despite these laws for

three reasons:
international cartels and cartels within certain
countries operate legally.
some illegal cartels operate believing that
they can avoid detection or that the
punishment will be insignificant.
some firms are able to coordinate their
activity without explicitly colluding and
thereby running afoul of competition laws.
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 Laws Against Cartels (cont.)

In the late nineteenth century, cartels

were legal and common in the United
States.
Examples: oil, railroad, sugar, and tobacco.

Sherman Antitrust Act in 1890 and the

Federal Trade Commission Act of 1914,
Prohibit firms from explicitly agreeing to take
actions that reduce competition.

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 Laws Against Cartels (cont.)

The Organization of Petroleum Exporting

Countries (OPEC) - an international cartel
that was formed in 1960 by five major oil-
exporting countries:
Iran, Iraq, Kuwait, Saudi Arabia, and
Venezuela.
In 1971, OPEC members agreed to take an
active role in setting oil prices.

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 Why Cartels Fail

Cartels fail if noncartel members can

supply consumers with large quantities of
goods.

Each member of a cartel has an incentive

to cheat on the cartel agreement.

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 Maintaining Cartels

To keep firms from violating the cartel

agreement, the cartel must be able to
detect cheating and punish violators.
keep their illegal behavior hidden from
customers and government agencies.

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