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Chapter 10

Chapter 10 EC260.docx

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Karen Huff

EC260 Chapter 10 - Oligopoly Week 9 -Oligopoly – a market with a small number of firms -They realize relatively high profits -There is a high entry barrier that managers erect using their cooperative market power Cooperative Behaviour -Conditions in oligopolistic industries tend to encourage cooperation among rival managers -This can increase profit, decrease uncertainty, and raise barriers to discourage others from entering the market -Cartel – when a collusive arrangement is made openly and formally -Price maximizes the profit earned by the cartel, but it says nothing about how this profit is divided among cartel managers -Cartel managers determine the distribution of sales across members; this is the process that makes cartels unstable -Cartel managers can increase corporate profit by reallocating output among members to reduce the cost of producing the cartel’s total output The Breakdown of Collusive Agreements -Managers who break away from a cartel – or secretly cheat – can increase profit as long as rival managers do not do the same thing and the cartel does not punish this behaviour -There is a constant threat to the existence of a cartel. Its members have an incentive to cheat and once a few do so, others may follow Price Leadership -Price leadership – in oligopolistic industries, managers at one firm have significant market power and can set their price -We assume the market is composed of a large dominant firm and a number of small firms. Managers at the dominant firm set the price for the market but let the small firms sell all they want at that price. Whatever amount the small firms do not supply at that price is provided by the dominant firm -Managers at small firms are price takers Possible Behaviour in Markets with Few Rivals -Two firms are duopolies -The two firms produce an identical product, and mangers make their output decisions simultaneously. When rival managers make decisions without knowing the decisions of others, we say decision making is simultaneous -Managers often make simultaneous decisions When Rivals are Few: Price Competition -Often price competition results in a downward spiral of price cuts, stopped only by the constraint of marginal cost -Managers should try to avoid this behaviour -If managers at both firms want to compete on price, the competition will drive price down to the level of their marginal cost -The price equal to marginal cost will be the ultimate resolution of a pricing contest EC260 Chapter 10 - Oligopoly Week 9 When Rivals are Few: Collusion -The market demand curve is the cartel’s demand curve and the cartel’s marginal cost curve is the horizontal summation of each firm’s marginal cost curve -The carte behaves as a monopolist and sets its marginal revenue equal to its marginal cost When Rivals are Few: Quantity (Capacity) Competition -Forming a cartel is often illegal. But, strictly competing on price is a lose-lose strategy -Manag
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