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Kuliah 10

Monopoly and
Oligopoly

Topik yg akan Dibicarakan

Monopoly

Monopoly Power

Sources of Monopoly Power

The Social Costs of Monopoly Power

Chapter 10

Slide 2

Topik yg akan Dibicarakan

Monopsony

Monopsony Power

Limiting Market Power: The Antitrust


Laws (UU Anti Monopoli)

Chapter 10

Slide 3

Ingat: Perfect Competition

Review of Perfect Competition

P = LMC = LRAC

Normal profits or zero economic profits in


the long run

Large number of buyers and sellers

Homogenous product

Perfect information

Firm is a price taker

Chapter 10

Slide 4

Ingat: Perfect Competition


Market

P
D

P
S

Individual Firm
LMC

P0

LRAC

P0
D = MR = P

Q0

q0

Ciri-Ciri Struktur Pasar Monopoli

Monopoly
1) One seller - many buyers
2) One product (no good substitutes)
3) Barriers to entry
4) Price maker (price control and
product)

Chapter 10

Slide 6

Monopoly

The monopolist is the supply-side of the


market and has complete control over
the amount offered for sale.

Profits will be maximized at the level of


output where marginal revenue equals
marginal cost.

Chapter 10

Slide 7

Monopoly

Finding Marginal Revenue

As the sole producer, the monopolist works


with the market demand to determine
output and price.

Assume a firm with demand:

Chapter 10

P = 6 Q or Qd= 6 - P

Slide 8

Total, Marginal, and Average Revenue


Price
P

Quantity
Q

$6
5
4
3
2
1

0
1
2
3
4
5

Chapter 10

Total
Revenue
(TR=P.Q)

$0
5
8
9
8
5

Marginal
Revenue
MR

--$5
3
1
-1
-3

Average
Revenue
AR

--$5
4
3
2
1

Slide 9

Average and Marginal Revenue


$ per
unit of
output

7
6
5
Average Revenue (Demand)

4
3
2

Chapter 10

Marginal
Revenue

7 Output
Slide 10

Monopoly

Observations
1) To increase sales the price must fall
2) MR < P
3) Compared to perfect competition

Chapter 10

No change in price to change sales

MR = P
Slide 11

Monopoly

Monopolists Output Decision


1) Profits maximized at the output level
where MR = MC
2) Cost functions are the same
(Q) R (Q) C (Q)
/ Q R / Q C / Q 0 MC MR
or MC MR

Chapter 10

Slide 12

Maximizing Profit When Marginal


Revenue Equals Marginal Cost
The
The Monopolists
Monopolists Output
Output Decision
Decision

At output levels below MR = MC the


decrease in revenue is greater than the
decrease in cost (MR > MC).

At output levels above MR = MC the


increase in cost is greater than the
decrease in revenue (MR < MC)

Chapter 10

Slide 13

Maximizing Profit When Marginal


Revenue Equals Marginal Cost
$ per
unit of
output

MC
P1
P*
AC
P2
Lost
profit

D = AR
MR
Q1
Chapter 10

Q*

Q2

Lost
profit

Quantity
Slide 14

Monopoly
The
The Monopolists
Monopolists Output
Output Decision
Decision

An Example

Cost C (Q ) 50 Q

C
MC
2Q
Q
Chapter 10

Slide 15

Monopoly
The
The Monopolists
Monopolists Output
Output Decision
Decision

An Example

Demand P (Q) 40 Q
R (Q) P(Q )Q 40Q Q
R
MR
40 2Q
Q
Chapter 10

Slide 16

Monopoly
The
The Monopolists
Monopolists Output
Output Decision
Decision

An Example

MR MC or 40 2Q 2Q
Q 10
When Q 10, P 30
Chapter 10

Slide 17

Monopoly
The
The Monopolists
Monopolists Output
Output Decision
Decision

An Example

By setting marginal revenue equal to


marginal cost, it can be verified that profit is
maximized at P = $30 and Q = 10.

This can be seen graphically:

Chapter 10

Slide 18

Example of Profit Maximization


C = 50+Q2

t'

400

R = 40Q-Q2

300
c
200

t
Profits () =-2Q2+40Q-50

150
100
50
0
Chapter 10

c
5

10

15

20 Quantity
Slide 19

Example of Profit Maximization

Observations

Slope of rr = slope cc
and they are parallel at
10 units

400

Profits are maximized at


10 units

300

P = $30, Q = 10,
TR = P x Q = $300
AC = $15, Q = 10,
TC = AC x Q = 150
Profit = TR - TC
$150 = $300 - $150

t'

c
200

150

Profits

100
50

10

15

20
Quantity

Chapter 10

Slide 20

Example of Profit Maximization


$/Q

40

MC

30
AC

Profit

20
AR

15
10
MR
0
Chapter 10

10

15

20
Quantity

Slide 21

Example of Profit Maximization

Observations

$/Q

AC = $15, Q = 10,
TC = AC x Q = 150

40

Profit = TR = TC = $300
- $150 = $150 or

30

Profit = (P - AC) x Q =
($30 - $15)(10) = $150

MC

AC

Profit

20
AR

15
MR

10

10

15

20
Quantity

Chapter 10

Slide 22

Monopoly

A Rule of Thumb for Pricing

We want to translate the condition that


marginal revenue should equal marginal
cost into a rule of thumb that can be more
easily applied in practice.

This can be demonstrated using the


following steps:

Chapter 10

Slide 23

A Rule of Thumb for Pricing


R ( PQ)
1. MR

Q
Q
P
Q P

2. MR P Q
P P
Q
P Q

P
3. E d

P
Q
Chapter 10

Slide 24

A Rule of Thumb for Pricing


1
Q

P
4.

Q E
P
d
1

5 . MR P P
Ed

Chapter 10

Slide 25

A Rule of Thumb for Pricing


6 . is maximized @ MR MC
1
1
P P

ED
ED
MC
P
1 1 E D
Chapter 10

Slide 26

A Rule of Thumb for Pricing


1
= the markup over MC as a
7.
Ed
percentage of price (P-MC)/P

8. The markup should equal the


inverse of the elasticity of demand.

Chapter 10

Slide 27

A Rule of Thumb for Pricing


MC
9. P

1 1

E
d

Assume
Ed 4

MC 9

9
P
1 1

Chapter 10

$ 12
. 75
Slide 28

Monopoly

Monopoly pricing compared to perfect


competition pricing:

Monopoly
P > MC

Perfect Competition
P = MC

Chapter 10

Slide 29

Monopoly

Monopoly pricing compared to perfect


competition pricing:

The more elastic the demand the closer


price is to marginal cost.

If Ed is a large negative number, price is


close to marginal cost and vice versa.

Chapter 10

Slide 30

Monopoly

Shifts in Demand

In perfect competition, the market supply


curve is determined by marginal cost.

For a monopoly, output is determined by


marginal cost and the shape of the
demand curve.

Chapter 10

Slide 31

Shift in Demand Leads to


Change in Price but Same Output
$/Q

MC

P1
P2

D2
D1
MR2
MR1
Q1= Q2

Chapter 10

Quantity
Slide 32

Shift in Demand Leads to


Change in Output but Same Price
$/Q

MC

P1 = P2

D2
MR2
D1

MR1
Q1
Chapter 10

Q2

Quantity
Slide 33

Monopoly

Observations
Shifts

in demand usually cause a change


in both price and quantity.

monopolistic market has no supply


curve.

Chapter 10

Slide 34

Monopoly

Observations
Monopolist

may supply many different


quantities at the same price.

Monopolist

may supply the same quantity


at different prices.

Chapter 10

Slide 35

Monopoly

The Effect of a Tax

Under monopoly price can sometimes rise


by more than the amount of the tax.

To determine the impact of a tax:

t = specific tax

MC = MC + t

MR = MC + t : optimal production decision

Chapter 10

Slide 36

Effect of Excise Tax on Monopolist


$/Q

Increase in P: P0P1 > increase in tax

P1

P
P0

MC + tax
D = AR
MC
MR

Q1
Chapter 10

Q0

Quantity
Slide 37

Effect of Excise Tax on Monopolist

Question

Suppose: Ed = -2

How much would the price change?

Chapter 10

Slide 38

Effect of Excise Tax on Monopolist

Answer
MC
P
1 1
Ed
If Ed 2 P 2 MC
If MC increases to MC t
P 2( MC t ) 2 MC 2t
Price increases by twice the tax.

What would happen to profits?

Chapter 10

Slide 39

Monopoly Power

Scenario:

Chapter 10

Four firms with equal share (5,000) of a


market for 20,000 toothbrushes at a price
of $1.50.

Slide 40

The Demand for Toothbrushes


$/Q

$/Q
At a market price
of $1.50, elasticity of
demand is -1.5.

2.00

2.00

The demand curve for Firm A


depends on how much
their product differs, and
how the firms compete.

1.60
1.50

1.50
1.40
Market
Demand

1.00

1.00
10,000

20,000

30,000

Quantity

3,000

5,000

7,000

QA

The Demand for Toothbrushes


$/Q

$/Q
At a market price
of $1.50, elasticity of
demand is -1.5.

2.00

2.00

Firm A sees a much more


elastic demand curve due to
competition--Ed = -.6. Still
Firm A has some monopoly
power and charges a price
which exceeds MC.

1.60
1.50

MCA

1.50
1.40

DA

Market
Demand
1.00

MRA

1.00
10,000

20,000

30,000

Quantity

3,000

5,000

7,000

QA

Monopoly Power

Measuring Monopoly Power

In perfect competition: P = MR = MC

Monopoly power: P > MC

Chapter 10

Slide 43

Monopoly Power

Lerners Index of Monopoly Power

L = (P - MC)/P

Chapter 10

The larger the value of L (between 0 and


1) the greater the monopoly power.

L is expressed in terms of Ed

L = (P - MC)/P = -1/Ed

Ed is elasticity of demand for a firm, not


the market
Slide 44

Monopoly Power

Monopoly power does not guarantee


profits.

Profit depends on average cost relative


to price.

Question:

Chapter 10

Can you identify any difficulties in using the


Lerner Index (L) for public policy?
Slide 45

Monopoly Power

The Rule of Thumb for Pricing

MC
P
1 1 Ed

Chapter 10

Pricing for any firm with monopoly power

If Ed is large, markup is small

If Ed is small, markup is large

Slide 46

Elasticity of Demand and Price Markup


$/Q

$/Q

The more elastic is


demand, the less the
markup.

P*

MC

MC

P*
AR

P*-MC

MR
AR
MR

Q*

Quantity

Q*

Quantity

Markup Pricing:
Supermarkets to Designer Jeans

Supermarkets
1. Several firms
2. Similar product
3. E d 10 for individual stores
MC
MC
4 .P

1.11( MC )
1 1 .1 0.9
5. Prices set about 10 - 11% above MC.

Chapter 10

Slide 48

Markup Pricing:
Supermarkets to Designer Jeans

Convenience Stores
1. Higher prices than supermarkets
2. Convenience differentiates them
3. Ed 5
MC
MC
4.P

1.25( MC )
1 1 5 0.8
5. Prices set about 25% above MC.

Chapter 10

Slide 49

Markup Pricing:
Supermarkets to Designer Jeans
Convenience
Convenience Stores
Stores

Convenience stores have more


monopoly power.

Question:

Chapter 10

Do convenience stores have higher profits


than supermarkets?

Slide 50

Markup Pricing:
Supermarkets to Designer Jeans
Designer
Designer Jeans
Jeans

Designer jeans
Ed = -3 to -4

Chapter 10

Price 33 - 50% > MC

MC = $12 - $18/pair

Wholesale price = $18 - $27

Slide 51

The Pricing of
Prerecorded Videocassettes
1985
Title

1999
Retail Price($)

Purple Rain
Raiders of the Lost Ark
Jane Fonda Workout

Title

Retail Price($)

$29.98 Austin Powers


24.95 A Bugs Life
59.95 Theres Something
about Mary
The Empire Strikes Back
79.98 Tae-Bo Workout
An Officer and a Gentleman 24.95 Lethal Weapon 4
Star Trek: The Motion Picture 24.95 Men in Black
Star Wars
39.98 Armageddon

$10.49
17.99
13.99
24.47
16.99
12.99
15.86

The Pricing of
Prerecorded Videocassettes

What Do You Think?


Should

producers lower the price of


videocassettes to increase sales and
revenue?

Sources of Monopoly Power

Why do some firms have considerable


monopoly power, and others have little
or none?

A firms monopoly power is determined


by the firms elasticity of demand.

Chapter 10

Slide 54

Sources of Monopoly Power

The firms elasticity of demand is


determined by:
1) Elasticity of market demand
2) Number of firms
3) The interaction among firms

Chapter 10

Slide 55

The Social Costs of Monopoly Power

Monopoly power results in higher prices


and lower quantities.

However, does monopoly power make


consumers and producers in the
aggregate better or worse off?

Chapter 10

Slide 56

Deadweight Loss from Monopoly Power


$/Q
Lost Consumer Surplus

Because of the higher


price, consumers lose
A+B and producer
gains A-C.

MC
Deadweight
Loss

A
PC

Pm

B
C
AR

MR
Qm
Chapter 10

QC

Quantity
Slide 57

The Social Costs of Monopoly Power

Rent Seeking

Chapter 10

Firms may spend to gain monopoly power

Lobbying

Advertising

Building excess capacity

Slide 58

The Social Costs of Monopoly Power

The incentive to engage in monopoly


practices is determined by the profit to
be gained.

The larger the transfer from consumers


to the firm, the larger the social cost of
monopoly.

Chapter 10

Slide 59

The Social Costs of Monopoly Power

Example

1996 Archer Daniels Midland (ADM)


successfully lobbied for regulations
requiring ethanol be produced from corn

Question

Chapter 10

Why only corn?

Slide 60

The Social Costs of Monopoly Power

Price Regulation

Recall that in competitive markets, price


regulation created a deadweight loss.

Question:

Chapter 10

What about a monopoly?

Slide 61

Price Regulation
$/Q

Marginal revenue curve


when price is regulated
to be no higher that P1.

MR

MC

Pm
P1
P2 = PC

AC
P3
P4

AR

Forprice
output
levels
above Q1 ,
below
P
results
If Any
price
is
lowered
to
PC output
4
Ifthe
leftoriginal
alone, a
monopolist
average
and
inIfthe
firm
incurring
a to
loss.
price
is
lowered
P
increases
to
its
maximum
3Qoutput
produces
Q
and
charges
Pm.
C and
m
marginal
revenue
curves
apply.
decreases
a shortage
exists.
there is noand
deadweight
loss.
Qm Q1
Chapter 10

Q3

Qc

Q3

Quantity
Slide 62

The Social Costs of Monopoly Power

Natural Monopoly
A

firm that can produce the entire output of


an industry at a cost lower than what it
would be if there were several firms.

Chapter 10

Slide 63

Regulating the Price


of a Natural Monopoly
$/Q

Natural monopolies occur


because of extensive
economies of scale

Quantity
Chapter 10

Slide 64

Regulating the Price


of a Natural Monopoly
$/Q

Unregulated, the monopolist


would produce Qm and
charge Pm.
If the price were regulate to be PC,
the firm would lose money
and go out of business.

Pm

Setting the price at Pr


yields the largest possible
output;excess profit is zero.

AC

Pr

MC

PC

AR
MR
Qm
Chapter 10

Qr

QC

Quantity
Slide 65

The Social Costs of Monopoly Power

Regulation in Practice

Chapter 10

It is very difficult to estimate the firm's cost


and demand functions because they
change with evolving market conditions

Slide 66

The Social Costs of Monopoly Power

Regulation in Practice

An alternative pricing technique---rate-ofreturn regulation allows the firms to set a


maximum price based on the expected rate
or return that the firm will earn.

P = AVC + (D + T + sK)/Q, where


P

= price, AVC = average variable cost


D = depreciation, T = taxes
s = allowed rate of return, K = firms capital
stock
Chapter 10

Slide 67

The Social Costs of Monopoly Power

Regulation in Practice

Using this technique requires hearings to


arrive at the respective figures.

The hearing process creates a regulatory


lag that may benefit producers (1950s &
60s) or consumers (1970s & 80s).

Question

Chapter 10

Who is benefiting in the 1990s?


Slide 68

Struktur Pasar Oligopoli

OLIGOPOLY ?

Chapter 10

Slide 69

Ciri-Ciri Pasar Oligopoli

Characteristics

Small number of firms

Product differentiation may or may not exist

Barriers to entry

Price Setter/Price Leadership

Chapter 10

Slide 70

Contoh Oligopoly

Contoh di AS

Automobiles
Steel
Aluminum

Petrochemicals

Electrical equipment

Computers

Chapter 10

Contoh di
Indonesia

Industri Semen

Industri Otomotif

Industri Kaca
lembaran

Industri Rokok

Industri CPO
Slide 71

Oligopoly

The barriers to entry are:

Chapter 10

Natural

Scale economies

Patents

Technology

Name recognition

Slide 72

Oligopoly

The barriers to entry are:

Chapter 10

Strategic action

Flooding the market

Controlling an essential input

Slide 73

Oligopoly

Management Challenges

Strategic actions

Rival behavior

Question

Chapter 10

What are the possible rival responses to a


10% price cut by Ford?

Slide 74

Oligopoly

Equilibrium in an Oligopolistic Market

In perfect competition, monopoly, and


monopolistic competition the producers did
not have to consider a rivals response
when choosing output and price.

In oligopoly the producers must consider


the response of competitors when
choosing output and price.

Chapter 10

Slide 75

Oligopoly

Equilibrium in an Oligopolistic Market

Chapter 10

Defining Equilibrium

Firms doing the best they can and have


no incentive to change their output or
price

All firms assume competitors are taking


rival decisions into account.

Slide 76

Oligopoly

Nash Equilibrium

Chapter 10

Each firm is doing the best it can given


what its competitors are doing.

Slide 77

Oligopoly

The Cournot Model

Chapter 10

Duopoly

Two firms competing with each other

Homogenous good

The output of the other firm is assumed


to be fixed

Slide 78

Firm 1s Output Decision


If Firm 1 thinks Firm 2 will
produce nothing, its demand
curve, D1(0), is the market
demand curve.

P1
D1(0)

If Firm 1 thinks Firm 2 will produce


50 units, its demand curve is
shifted to the left by this amount.

MR1(0)

D1(75)

If Firm 1 thinks Firm 2 will produce


75 units, its demand curve is
shifted to the left by this amount.

MR1(75)

MC1
MR1(50)
12.5 25

Chapter 10

D1(50)
50

What is the output of Firm 1


if Firm 2 produces 100 units?

Q1
Slide 79

Oligopoly

The Reaction Curve

Chapter 10

A firms profit-maximizing output is a


decreasing schedule of the expected
output of Firm 2.

Slide 80

Reaction Curves
and Cournot Equilibrium
Q1
100

Firm 1s reaction curve shows how much it


will produce as a function of how much
it thinks Firm 2 will produce. The xs
correspond to the previous model.
Firm 2s reaction curve shows how much it
will produce as a function of how much
it thinks Firm 1 will produce.

75

Firm 2s Reaction
Curve Q*2(Q2)

50 x

25

Cournot
Equilibrium

x
Firm 1s Reaction
Curve Q*1(Q2)

25
Chapter 10

In Cournot equilibrium, each


firm correctly assumes how
much its competitors will
produce and thereby
maximize its own profits.

50

x
75

100

Q2
Slide 81

Oligopoly

Questions
1) If the firms are not producing at the
Cournot equilibrium, will they adjust
until the Cournot equilibrium is
reached?
2) When is it rational to assume that its
competitors output is fixed?

Chapter 10

Slide 82

Oligopoly
The
The Linear
Linear Demand
Demand Curve
Curve

An Example of the Cournot Equilibrium

Chapter 10

Duopoly

Market demand is P = 30 - Q where Q =


Q1 + Q2

MC1 = MC2 = 0

Slide 83

Oligopoly
The
The Linear
Linear Demand
Demand Curve
Curve

An Example of the Cournot Equilibrium

Firm 1s Reaction Curve

Total Revenue, R1 PQ1 (30 Q )Q1


30Q1 (Q1 Q2 )Q1

30Q1 Q12 Q2Q1

Chapter 10

Slide 84

Oligopoly
The
The Linear
Linear Demand
Demand Curve
Curve

An Example of the Cournot Equilibrium


MR1 R1 Q1 30 2Q1 Q2
MR1 0 MC1
Firm 1' s Reaction Curve
Q1 15 1 2 Q2
Firm 2' s Reaction Curve
Q2 15 1 2 Q1

Chapter 10

Slide 85

Oligopoly
The
The Linear
Linear Demand
Demand Curve
Curve

An Example of the Cournot Equilibrium

Cournot Equilibrium : Q1 Q2
15 1 2(15 1 2Q1 ) 10
Q Q1 Q2 20
P 30 Q 10
Chapter 10

Slide 86

Duopoly Example
Q1
30
Firm 2s
Reaction Curve

The demand curve is P = 30 - Q and


both firms have 0 marginal cost.

Cournot Equilibrium

15
10

Firm 1s
Reaction Curve
10
Chapter 10

15

30

Q2
Slide 87

Oligopoly
Profit
Profit Maximization
Maximization with
with Collusion
Collusion

R PQ (30 Q)Q 30Q Q


MR R Q 30 2Q

MR 0 when Q 15 and MR MC

Chapter 10

Slide 88

Oligopoly
Profit
Profit Maximization
Maximization with
with Collusion
Collusion

Contract Curve

Q1 + Q2 = 15

Q1 = Q2 = 7.5

Chapter 10

Shows all pairs of output Q1 and Q2 that


maximizes total profits
Less output and higher profits than the
Cournot equilibrium
Slide 89

Duopoly Example
Q1
30
Firm 2s
Reaction Curve

For the firm, collusion is the best


outcome followed by the Cournot
Equilibrium and then the
competitive equilibrium

Competitive Equilibrium (P = MC; Profit = 0)

15

Cournot Equilibrium
Collusive Equilibrium

10
7.5

Firm 1s
Reaction Curve

Collusion
Curve

7.5 10
Chapter 10

15

30

Q2
Slide 90

First Mover Advantage-The Stackelberg Model

Assumptions

One firm can set output first

MC = 0

Market demand is P = 30 - Q where Q =


total output

Firm 1 sets output first and Firm 2 then


makes an output decision

Chapter 10

Slide 91

First Mover Advantage-The Stackelberg Model

Firm 1

Must consider the reaction of Firm 2

Firm 2

Chapter 10

Takes Firm 1s output as fixed and


therefore determines output with the
Cournot reaction curve: Q2 = 15 - 1/2Q1

Slide 92

First Mover Advantage-The Stackelberg Model

Firm 1
Choose

Q1 so that:

MR MC, MC 0 therefore MR 0
R1 PQ1 30Q1 - Q - Q2Q1
2
1

Chapter 10

Slide 93

First Mover Advantage-The Stackelberg Model

Substituting Firm 2s Reaction Curve


for Q2:
R1 30Q1 Q12 Q1 (15 1 2Q1 )
15Q1 1 2 Q

2
1

MR1 R1 Q1 15 Q1
MR 0 : Q1 15 and Q2 7.5

Chapter 10

Slide 94

First Mover Advantage-The Stackelberg Model

Conclusion

Firm 1s output is twice as large as firm 2s

Firm 1s profit is twice as large as firm 2s

Questions

Why is it more profitable to be the first


mover?

Which model (Cournot or Shackelberg) is


more appropriate?

Chapter 10

Slide 95

Price Competition

Competition in an oligopolistic industry


may occur with price instead of output.

The Bertrand Model is used to illustrate


price competition in an oligopolistic
industry with homogenous goods.

Chapter 10

Slide 96

Price Competition
Bertrand
Bertrand Model
Model

Assumptions

Homogenous good

Market demand is P = 30 - Q where


Q = Q1 + Q2

MC = $3 for both firms and MC1 = MC2 =


$3

Chapter 10

Slide 97

Price Competition
Bertrand
Bertrand Model
Model

Assumptions

The Cournot equilibrium:

P $12

for both firms $81

Chapter 10

Assume the firms compete with price, not


quantity.

Slide 98

Price Competition
Bertrand
Bertrand Model
Model

How will consumers respond to a


price differential? (Hint: Consider
homogeneity)
The

Nash equilibrium:
P = MC; P1 = P2 = $3
Q = 27; Q1 & Q2 = 13.5

Chapter 10

Slide 99

Price Competition
Bertrand
Bertrand Model
Model

Why not charge a higher price to raise


profits?

How does the Bertrand outcome compare to


the Cournot outcome?

The Bertrand model demonstrates the


importance of the strategic variable (price
versus output).

Chapter 10

Slide 100

Price Competition
Bertrand
Bertrand Model
Model

Criticisms

When firms produce a homogenous good,


it is more natural to compete by setting
quantities rather than prices.

Even if the firms do set prices and choose


the same price, what share of total sales
will go to each one?

Chapter 10

It may not be equally divided.


Slide 101

Price Competition

Price Competition with Differentiated


Products

Chapter 10

Market shares are now determined not just


by prices, but by differences in the design,
performance, and durability of each firms
product.

Slide 102

Price Competition
Differentiated
Differentiated Products
Products

Assumptions

Duopoly

FC = $20

VC = 0

Chapter 10

Slide 103

Price Competition
Differentiated
Differentiated Products
Products

Assumptions

Firm 1s demand is Q1 = 12 - 2P1 + P2

Firm 2s demand is Q2 = 12 - 2P1 + P1

Chapter 10

P1 and P2 are prices firms 1 and 2


charge respectively

Q1 and Q2 are the resulting quantities


they sell
Slide 104

Price Competition
Differentiated
Differentiated Products
Products

Determining Prices and Output

Set prices at the same time

Firm 1 : 1 P1Q1 $20


P1 (12 2 P1 P2 ) 20
12 P1 - 2 P P1 P2 20
2
1

Chapter 10

Slide 105

Price Competition
Differentiated
Differentiated Products
Products

Determining Prices and Output

Firm 1: If P2 is fixed:
Firm 1' s profit maximizing price
1 P1 12 4 P1 P2 0
Firm 1' s reaction curve
P1 3 1 4 P2
Firm 2' s reaction curve
P2 3 1 4 P1

Chapter 10

Slide 106

Nash Equilibrium in Prices


P1

Firm 2s Reaction Curve


Collusive Equilibrium

$6

$4
Firm 1s Reaction Curve

Nash Equilibrium

$4
Chapter 10

$6

P2
Slide 107

The Kinked Demand Curve


$/Q

If the producer raises price the


competitors will not and the
demand will be elastic.
If the producer lowers price the
competitors will follow and the
demand will be inelastic.

Quantity
Chapter 10

MR

Slide 108

The Kinked Demand Curve


$/Q

So long as marginal cost is in the


vertical region of the marginal
revenue curve, price and output
will remain constant.

MC
P*

MC

Quantity

Q*
Chapter 10

MR

Slide 109

Implications of the Prisoners


Dilemma for Oligopolistic Pricing
Price
Price Signaling
Signaling &
& Price
Price Leadership
Leadership

Price Signaling
Implicit

collusion in which a firm announces


a price increase in the hope that other
firms will follow suit

Chapter 10

Slide 110

Implications of the Prisoners


Dilemma for Oligopolistic Pricing
Price
Price Signaling
Signaling &
& Price
Price Leadership
Leadership

Price Leadership
Pattern

of pricing in which one firm


regularly announces price changes that
other firms then match

Chapter 10

Slide 111

Implications of the Prisoners


Dilemma for Oligopolistic Pricing

The Dominant Firm Model

In some oligopolistic markets, one large


firm has a major share of total sales, and a
group of smaller firms supplies the
remainder of the market.

The large firm might then act as the


dominant firm, setting a price that
maximized its own profits.

Chapter 10

Slide 112

Price Setting by a Dominant Firm


Price

SF

The dominant firms demand


curve is the difference between
market demand (D) and the supply
of the fringe firms (SF).

P1

MCD

P*
DD
P2

QF QD
Chapter 10

QT

MRD

At this price, fringe firms


sell QF, so that total
sales are QT.

Quantity
Slide 113

Cartels

Characteristics
1) Explicit agreements to set output and
price
2) May not include all firms

Chapter 10

Slide 114

Cartels

Characteristics
3) Most often international

Chapter 10

Examples of
successful cartels
OPEC
International
Bauxite
Association
Mercurio Europeo

Examples of
unsuccessful cartels
Copper
Tin
Coffee
Tea
Cocoa
Slide 115

Cartels

Characteristics
4) Conditions for success

Chapter 10

Competitive alternative sufficiently


deters cheating

Potential of monopoly power--inelastic


demand

Slide 116

Cartels

Comparing OPEC to CIPEC

Chapter 10

Most cartels involve a portion of the market


which then behaves as the dominant firm

Slide 117

The OPEC Oil Cartel


Price

TD

SC
TD is the total world demand
curve for oil, and SC is the
competitive supply. OPECs
demand is the difference
between the two.

OPECs profits maximizing


quantity is found at the
intersection of its MR and
MC curves. At this quantity
OPEC charges price P*.

P*

DOPEC
MCOPEC
MROPEC

QOPEC
Chapter 10

Quantity
Slide 118

Cartels

About OPEC

Very low MC

TD is inelastic

Non-OPEC supply is inelastic

DOPEC is relatively inelastic

Chapter 10

Slide 119

The OPEC Oil Cartel


TD

Price

SC
The price without the cartel:
Competitive price (PC) where
DOPEC = MCOPEC

P*

DOPEC
MCOPEC

Pc
MROPEC

QC
Chapter 10

QOPEC

QT

Quantity
Slide 120

The CIPEC Copper Cartel


Price

TD and SC are relatively elastic


DCIPEC is elastic
CIPEC has little monopoly power
P* is closer to PC

TD

SC
MCCIPEC
DCIPEC

P*
PC

MRCIPEC

QCIPEC
Chapter 10

QC

QT

Quantity
Slide 121

Cartels

Observations

Chapter 10

To be successful:

Total demand must not be very price


elastic

Either the cartel must control nearly all


of the worlds supply or the supply of
noncartel producers must not be price
elastic
Slide 122

The Cartelization
of Intercollegiate Athletics

Observations
1) Large number of firms (colleges)
2) Large number of consumers (fans)
3) Very high profits

Chapter 10

Slide 123

The Cartelization
of Intercollegiate Athletics

Question

Chapter 10

How can we explain high profits in a


competitive market? (Hint: Think cartel and
the NCAA)

Slide 124

The Milk Cartel

1990s with less government support,


the price of milk fluctuated more widely

In response, the government permitted


six New England states to form a milk
cartel (Northeast Interstate Dairy
Compact -- NIDC)

Chapter 10

Slide 125

The Milk Cartel

1999 legislation allowed dairy farmers in


Northeastern states surrounding NIDC
to join NIDC, 7 in 16 Southern states to
form a new regional cartel.

Soy milk may become more popular.

Chapter 10

Slide 126

Summary

In a monopolistically competitive
market, firms compete by selling
differentiated products, which are highly
substitutable.

In an oligopolistic market, only a few


firms account for most or all of
production.

Chapter 10

Slide 127

Summary

In the Cournot model of oligopoly, firms


make their output decisions at the same
time, each taking the others output as
fixed.

In the Stackelberg model, one firm sets


its output first.

Chapter 10

Slide 128

Summary

The Nash equilibrium concept can also


be applied to markets in which firms
produce substitute goods and compete
by setting price.

Firms would earn higher profits by


collusively agreeing to raise prices, but
the antitrust laws usually prohibit this.

Chapter 10

Slide 129

Summary

The Prisoners Dilemma creates price


rigidity in oligopolistic markets.

Price leadership is a form of implicit


collusion that sometimes gets around
the Prisoners Dilemma.

In a cartel, producers explicitly collude


in setting prices and output levels.

Chapter 10

Slide 130