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Lecture 9

ECO101H1 Lecture Notes - Lecture 9: Monopolistic Competition, Demand Curve, Price Fixing


Department
Economics
Course Code
ECO101H1
Professor
Jack Carr
Lecture
9

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Oligopoly
Few firms
Face downward-sloping demand curves
Aware of mutual interdependence
Auto Manufacturers (North America)
1. Few firms (GM, Chrysler, Ford)
2. Face downward-sloping demand curves
Should GM raise price of its compact cars?
3. Mutual interdependence
If GM raises price, what will competitors do?
Oligopolists (few sellers, aware of interdependence)
1. If compete with one another, industry profits may fall to competitive level (zero economic
profits)
2. If form a SUCCESSFUL cartel, industry profits may equal monopoly profits
Insights:
1. Most oligopolists compete with one another
2. Cartels are illegal
3. Cartels, if formed, may break down for incentive reasons (Text: the conflict between
cooperation and self-interest)
Oligopolists may try to collude (form a cartel) rather than to compete with one another
1. Forming a cartel (“price-fixing”) is illegal
2. Economic analysis draws attention to incentives (which may cause a cartel to break
down)
Numerical Example: Purpose
1. What output would a profit-maximizing monopolist produce in special case where MC =
0 = ATC?
2. Why might oligopolists, if agree to form an illegal cartel, NOT succeed in earning
monopoly profits?
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:
MR = MC = 0 => P = 60 Q = 30 Profit = 1800
Monopolist Maximizes Profit (ignore MC and ATC curves – in this example they are
equal to zero)
Observations
1. To maximize profit, produces output where MR = MC
2. Since MC = 0, MR = 0 at profit-maximizing output ó monopolist maximizes total
revenue
Duopolist: Possible Outcomes
1. Collude (Form Cartel)
Replicate monopoly outcome
Q = 30
P = 60
Profit = 1800
Must allocate market share
50:50 (for example => q = 15 (each firm)
=> profit = 900 (each firm)
2. Incentive to Cheat: Cartel May Break Down
1. How do oligopolists collude?
By fixing prices (at monopoly level, if joint profits are maximized)
Price fixing is illegal (so agreements cannot be enforced by the courts)
Result: agreements (cartels) may break down
The Incentive to Cheat the Cartel: Detail
1. Firm: To cheat or not to cheat
If does not cheat, q = 15 and profit = 900
If cheats and increases q to 20 (say) and the other firm stays the same
o Market output increases from 30 to 35 (Q = 35)
o Market price declines from 60 to 50 (since Q = 35)
o Profit increases to 1,000 (20 * 50 = 1,000)
Result: Firms cheat and cartel breaks down
Observation
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