ECO101H1 Lecture Notes - Lecture 18: Strategic Dominance, Nash Equilibrium, Normal-Form Game

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1 Aug 2010
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Thursday, November 19th, 2009.
Oligopoly and Monopolistic Competition
Market Structure
Perfect Monopolistic Oligopoly Monopoly
Competition Competition
No. of firms Many Many Few One
in industry
Product Identical Differentiated Identical or No close
Differentiated substitutes
Example Wheat Family Auto TTC
Farmer Restaurants Manufacturers
______________________________________________________________________________
Oligopoly: Key Features
x No Single Theory
x Economic profits can range from nil (same as in perfect competition) to monopoly level
x Mutual interdependence among firms is central to analysis
Two Sellers: Will They Earn Monopoly Profits?
Assume (for simplicity): MC = 0 = ATC (Example: town wells)
Market Demand Curve Total Revenue (= Profit)
P Q
80 20 1600
70 25 1750
60 30 1800
50 35 1750
40 40 1600
30 45 1350
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Monopolist Maximizes Profits
Observations
1) To maximize profit, produces output where MR = MC
2) Since MC = 0, MR = 0 at profit-maximizing output Ù monopolist maximizes total
revenue
(numerical example)
1. How do oligopolists collude
2. By fixing prices
(at monopoly level, if joint profits are maximized)
3. Price fixing is illegal
(so agreements cannot be enforced by the courts)
4. Result: agreements (cartels) may break down
Duopolist: Possible Outcomes
1. Collude (Form Cartel)
(1) Replicate monopoly output
Q = 30
P = 60
P
DD
30
MR
60
MC = 0
Q
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Document Summary

N economic profits can range from nil (same as in perfect competition) to monopoly level. N mutual interdependence among firms is central to analysis. Assume (for simplicity): mc = 0 = atc (example: town wells) Duopolist: possible outcomes: collude (form cartel) (1) replicate monopoly output. Profit = 1800 (2) must allocate market share. 50 : 50 (for example) => q = 15 (each firm) Market output increases from 30 to 25 (q = 35) Market price declines form 60 to 50 (since q = 35) Result: firms cheat and cartel breaks down: equilibrium (a) each firm: q = 20 => q = 40 (20 + 20) Note: lower profit than if did not cheat cartel (b) no incentive for either firm to increase output further. If firm raises q to 25, then q = 45 (20 + 25)  profit = 750 (20 * 30 = 750) Each firm is optimizing, given the strategy of the other firm.

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