3250:200 Lecture Notes - Lecture 17: Root Mean Square, Oligopoly, Strategic Dominance

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16 Nov 2017

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This chapter focuses on oligopoly, a market structure with high concentration ratios concentration ratio- the percentage of the market"s total output supplied by its four largest rms. The higher the concentration ratio, the less competition oligopoly- a market structure in which only a few sellers offer similar or identical products. Oligopoly strategic behavior in oligopoly : game theory- the study of how people behave in strategic situations. A rm"s decision about p or q can affect other rms and cause them to react, the rm will consider these reactions when making decisions. One possible outcome : collusion collusion- an agreement among rms in a market about quantities to produce or prices to charge cartel- a group of rms acting in unison. Both rms would be better off it both stick to the cartel agreement. But each rm has incentive to renege on the agreement lesson : it is dif cult for oligopoly rms to form cartels and honor their agreements.

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2. Deviating from the collusive outcome

Mays and McCovey are beer-brewing companies that operate in a duopoly (two-firm oligopoly). The daily marginal cost (MC) of producing a can of beer is constant and equals $0.80 per can. Assume that neither firm had any startup costs, so marginal cost equals average total cost (ATC) for each firm.

Suppose that Mays and McCovey form a cartel, and the firms divide the output evenly. (Note: This is only for convenience; nothing in this model requires that the two companies must equally share the output.)

Place the black point (plus symbol) on the following graph to indicate the profit-maximizing price and combined quantity of output if Mays and McCovey choose to work together.

Monopoly Outcome PRICE (Dollars per can)QUANTITY (Thousands of cans of beer)DemandMRMC = ATC

When they act as a profit-maximizing cartel, each company will producecans and chargeper can. Given this information, each firm earns a daily profit of, so the daily total industry profit in the beer market is.

Oligopolists often behave noncooperatively and act in their own self-interest even though this decreases total profit in the market. Again, assume the two companies form a cartel and decide to work together. Both firms initially agree to produce half the quantity that maximizes total industry profit. Now, suppose that Mays decides to break the collusion and increase its output by 50%, while McCovey continues to produce the amount set under the collusive agreement.

Maysâs deviation from the collusive agreement causes the price of a can of beer to toper can. Mays's profit is now, while McCoveyâs profit is now. Therefore, you can conclude that total industry profit when Mays increases its output beyond the collusive quantity.

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3250:200 Lecture Notes - Lecture 17: Root Mean Square, Oligopoly, Strategic Dominance

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