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,Lecture12,MonopolisticCompetitionandOligopoly,Lecture12,Slide2,TopicstobeDiscussed,MonopolisticCompetitionOligopolyPriceCompetitionCompetitionVersusCollusion:ThePrisonersDilemma,Lecture12,Slide3,TopicstobeDiscussed,ImplicationsofthePrisonersDilemmaforOligopolisticPricingCartels,Lecture12,Slide4,MonopolisticCompetition,Characteristics1)Manyfirms2)Freeentryandexit3)Differentiatedproduct,Lecture12,Slide5,MonopolisticCompetition,Theamountofmonopolypowerdependsonthedegreeofdifferentiation.Examplesofthisverycommonmarketstructureinclude:ToothpasteSoapColdremedies,Lecture12,Slide6,MonopolisticCompetition,ToothpasteCrestandmonopolypowerProctermarginalcostforfirm1isMC1=100,whilemarginalcostforfirm2isMC2=190.CalculatetheCournotequilibriumquantities.,Lecture12,Slide43,FirstMoverAdvantage-TheStackelbergModel,AssumptionsOnefirmcansetoutputfirstMC=0MarketdemandisP=30-QwhereQ=totaloutputFirm1setsoutputfirstandFirm2thenmakesanoutputdecision,Lecture12,Slide44,Firm1MustconsiderthereactionofFirm2Firm2TakesFirm1soutputasfixedandthereforedeterminesoutputwiththeCournotreactioncurve:Q2=15-1/2Q1,FirstMoverAdvantage-TheStackelbergModel,Lecture12,Slide45,Firm1ChooseQ1sothat:,FirstMoverAdvantage-TheStackelbergModel,Lecture12,Slide46,SubstitutingFirm2sReactionCurveforQ2:,FirstMoverAdvantage-TheStackelbergModel,Lecture12,Slide47,ConclusionFirm1soutputistwiceaslargeasfirm2sFirm1sprofitistwiceaslargeasfirm2sQuestionsWhyisitmoreprofitabletobethefirstmover?Whichmodel(CournotorShackelberg)ismoreappropriate?,FirstMoverAdvantage-TheStackelbergModel,Lecture12,Slide48,Example,Twofirmshavethesameconstantaverageandmarginalcost,AC=MC=20,andfacethemarketdemandcurveP=500-Q=500-(Q1+Q2).SupposeFirm1istheStackelbergleader.A)FindFirm2sCournotreactioncurve.B)WriteouttheexpressionforFirm1stotalrevenueandsubstituteinFirm2sreactioncurve.C)DeriveMR1fromyouranswertopartB)andsetitequaltoMCtofindtheprofitmaximizingoutputforFirm1.FindtheprofitmaximizingoutputlevelforFirm2(thefollower)formitsreactioncurve.D)Whatareprofitsforeachfirm?,Lecture12,Slide49,PriceCompetition,Competitioninanoligopolisticindustrymayoccurwithpriceinsteadofoutput.TheBertrandModelisusedtoillustratepricecompetitioninanoligopolisticindustrywithhomogenousgoods.,Lecture12,Slide50,PriceCompetition,AssumptionsHomogenousgoodMarketdemandisP=30-QwhereQ=Q1+Q2MC=$3forbothfirmsandMC1=MC2=$3,BertrandModel,Lecture12,Slide51,PriceCompetition,AssumptionsTheCournotequilibrium:Assumethefirmscompetewithprice,notquantity.,BertrandModel,Lecture12,Slide52,PriceCompetition,Howwillconsumersrespondtoapricedifferential?(Hint:Considerhomogeneity)TheNashequilibrium:P=MC;P1=P2=$3Q=27;Q1&Q2=13.5,BertrandModel,Lecture12,Slide53,PriceCompetition,Whynotchargeahigherpricetoraiseprofits?HowdoestheBertrandoutcomecomparetotheCournotoutcome?TheBertrandmodeldemonstratestheimportanceofthestrategicvariable(priceversusoutput).,BertrandModel,Lecture12,Slide54,PriceCompetition,CriticismsWhenfirmsproduceahomogenousgood,itismorenaturaltocompetebysettingquantitiesratherthanprices.Evenifthefirmsdosetpricesandchoosethesameprice,whatshareoftotalsaleswillgotoeachone?Itmaynotbeequallydivided.,BertrandModel,Lecture12,Slide55,PriceCompetition,PriceCompetitionwithDifferentiatedProductsMarketsharesarenowdeterminednotjustbyprices,butbydifferencesinthedesign,performance,anddurabilityofeachfirmsproduct.,Lecture12,Slide56,PriceCompetition,AssumptionsDuopolyFC=$20VC=0,DifferentiatedProducts,Lecture12,Slide57,PriceCompetition,AssumptionsFirm1sdemandisQ1=12-2P1+P2Firm2sdemandisQ2=12-2P1+P1P1andP2arepricesfirms1and2chargerespectivelyQ1andQ2aretheresultingquantitiestheysell,DifferentiatedProducts,Lecture12,Slide58,PriceCompetition,DeterminingPricesandOutputSetpricesatthesametime,DifferentiatedProducts,Lecture12,Slide59,PriceCompetition,DeterminingPricesandOutputFirm1:IfP2isfixed:,DifferentiatedProducts,Lecture12,Slide60,NashEquilibriuminPrices,P1,P2,Lecture12,Slide61,NashEquilibriuminPrices,DoestheStackelbergmodelpredictionforfirstmoverholdwhenpriceisthevariableinsteadofquantity?Hint:Wouldyouwanttosetpricefirst?,Lecture12,Slide62,Example,IfC(Q1)=10Q1andC(Q2)=5Q2,findthedifferentiated-productsBertrandequilibrium,giventhefollowingdemandcurves:Q1(P1,P2)=1,000-20P1+15P2andQ2(P1,P2)=800+5P1-15P2,Lecture12,Slide63,APricingProblemforProcter&Gamble,Scenario1)Procter&Gamble,KaoSoap,Ltd.,andUnilever,LtdwereenteringthemarketforGypsyMothTape.2)Allthreewouldbechoosingtheirpricesatthesametime.,DifferentiatedProducts,Lecture12,Slide64,Scenario3)Procter&Gamblehadtoconsidercompetitorspriceswhensettingtheirprice.4)FC=$480,000/monthandVC=$1/unitforallfirms,DifferentiatedProducts,APricingProblemforProcter&Gamble,Lecture12,Slide65,Scenario5)P&Gsdemandcurvewas:Q=3,375P-3.5(PU).25(PK).25WhereP,PU,PKareP&Gs,Unilevers,andKaospricesrespectively,DifferentiatedProducts,APricingProblemforProcter&Gamble,Lecture12,Slide66,ProblemWhatpriceshouldP&Gchooseandwhatistheexpectedprofit?,DifferentiatedProducts,APricingProblemforProcter&Gamble,P&GsProfit(inthousandsof$permonth),1.10-226-215-204-194-183-174-165-1551.20-106-89-73-58-43-28-15-21.30-56-37-192153147621.40-44-25-612294662781.50-52-32-153203652681.60-70-51-34-18-11430441.70-93-76-59-44-28-131151.80-118-102-87-72-57-44-30-17,Competitors(Equal)Prices($),P&GsPrice($)01.401.501.601.701.80,Lecture12,Slide68,WhatDoYouThink?1)Whywouldeachfirmchooseapriceof$1.40?Hint:ThinkNashEquilibrium2)Whatistheprofitmaximizingpricewithcollusion?,APricingProblemforProcter&Gamble,Lecture12,Slide69,CompetitionVersusCollusion:ThePrisonersDilemma,Whywouldnteachfirmsetthecollusionpriceindependentlyandearnthehigherprofitsthatoccurwithexplicitcollusion?,Lecture12,Slide70,Assume:,CompetitionVersusCollusion:ThePrisonersDilemma,Lecture12,Slide71,PossiblePricingOutcomes:,CompetitionVersusCollusion:ThePrisonersDilemma,Lecture12,Slide72,PayoffMatrixforPricingGame,Firm2,Firm1,Charge$4,Charge$6,Charge$4,Charge$6,Lecture12,Slide73,Thesetwofirmsareplayinganoncooperativegame.Eachfirmindependentlydoesthebestitcantakingitscompetitorintoaccount.QuestionWhywillbothfirmsbothchoose$4when$6willyieldhigherprofits?,CompetitionVersusCollusion:ThePrisonersDilemma,Lecture12,Slide74,Anexampleingametheory,calledthePrisonersDilemma,illustratestheproblemoligopolisticfirmsface.,CompetitionVersusCollusion:ThePrisonersDilemma,Lecture12,Slide75,ScenarioTwoprisonershavebeenaccusedofcollaboratinginacrime.Theyareinseparatejailcellsandcannotcommunicate.Eachhasbeenaskedtoconfesstothecrime.,CompetitionVersusCollusion:ThePrisonersDilemma,Lecture12,Slide76,PayoffMatrixforPrisonersDilemma,PrisonerA,Confess,Dontconfess,Confess,Dontconfess,PrisonerB,Wouldyouchoosetoconfess?,Lecture12,Slide77,PayoffMatrixfortheP&GPrisonersDilemma,Conclusions:OligipolisticMarkets1)Collusionwillleadtogreaterprofits2)Explicitandimplicitcollusionispossible3)Oncecollusionexists,theprofitmotivetobreakandlowerpriceissignificant,Lecture12,Slide78,Charge$1.40,Charge$1.50,Charge$1.40,UnileverandKao,Charge$1.50,P&G,PayoffMatrixfortheP&GPricingProblem,WhatpriceshouldP&Gchoose?,Lecture12,Slide79,ImplicationsofthePrisonersDilemmaforOligipolisticPricing,ObservationsofOligopolyBehavior1)Insomeoligopolymarkets,pricingbehaviorintimecancreateapredictablepricingenvironmentandimpliedcollusionmayoccur.,Lecture12,Slide80,ObservationsofOligopolyBehavior2)Inotheroligopolymarkets,thefirmsareveryaggressiveandcollusionisnotpossible.Firmsarereluctanttochangepricebecauseofthelikelyresponseoftheircompetitors.Inthiscasepricestendtoberelativelyrigid.,ImplicationsofthePrisonersDilemmaforOligipolisticPricing,Lecture12,Slide81,TheKinkedDemandCurve,$/Q,Quantity,Lecture12,Slide82,TheKinkedDemandCurve,$/Q,MR,Quantity,Lecture12,Slide83,ImplicationsofthePrisonersDilemmaforOligopolisticPricing,PriceSignalingImplicitcollusioninwhichafirmannouncesapriceincreaseinthehopethatotherfirmswillfollowsuit,PriceSignaling&PriceLeadership,Lecture12,Slide84,ImplicationsofthePrisonersDilemmaforOligopolisticPricing,PriceLeadershipPatternofpricinginwhichonefirmregularlyannouncespricechangesthatotherfirmsthenmatch,PriceSignaling&PriceLeadership,Lecture12,Slide85,ImplicationsofthePrisonersDilemmaforOligopolisticPricing,TheDominantFirmModelInsomeoligopolisticmarkets,onelargefirmhasamajorshareoftotalsales,andagroupofsmallerfirmssuppliestheremainderofthemarket.Thelargefirmmightthenactasthedominantfirm,settingapricethatmaximizeditsownprofits.,Lecture12,Slide86,PriceSettingbyaDominantFirm,Price,Quantity,Lecture12,Slide87,Cartels,Characteristics1)Explicitagreementstosetoutputandprice2)Maynotincludeallfirms,Lecture12,Slide88,Cartels,ExamplesofsuccessfulcartelsOPECInternationalBauxiteAssociationMercurioEuropeo,ExamplesofunsuccessfulcartelsCopperTinCoffeeTeaCocoa,Characteristics3)Mostofteninternational,Lecture12,Slide89,Cartels,Characteristics4)ConditionsforsuccessCompetitivealternativesufficientlydeterscheatingPotentialofmonopolypower-inelasticdemand,Lecture12,Slide90,Cartels,ComparingOPECtoCIPECMostcartelsinvolveaportionofthemarketwhichthenbehavesasthedominantfirm,Lecture12,Slide91,TheOPECOilCartel,Price,Quantity,Lecture12,Slide92,Cartels,AboutOPECVerylowMCTDisinelasticNon-OPECsupplyisinelasticDOPECisrelativelyinelastic,Lecture12,Slide93,TheOPECOilCartel,Price,Quantity,QOPEC,P*,Lecture12,Slide94,TheCIPECCopperCartel,Price,Quantity,Lecture12,Slide95,Example,Supposetherearetenidenticaltextileproducers.Eachfirmproducesataconstantmarginalcostof$2.ThemarketdemandcurveisgivenbyP=12-0.1Q,wherepriceismeasuredindollarsandquantityinpounds.Thetenfirmsarecurrentlybehavingascompetitive(price-taking)firms.Theyarethinkingofformingacartelwiththepurposeofrestrictingquantityandraisingthepricetothemonopolylevel.A)Whatisthecurrentmarketprice,marketoutput,andoutputperfirm?B)Whatwouldbethecartelprice,carteloutput,andoutput(individualquota)perfirm?C)Ifprofitsfromthecartelweredividedequally,whatwouldbeeachfirmsshareofthecartelprofits?D)Supposeonefirmdecidesto“cheat”bychargingaprice25centsbelowthecartelprice.Thisfirmwillsellalloftheiroutput(theircartelquotafrompartB)plustheadditionaloutputdemanded)atthisdiscountedprice.Willcheatingbeprofitable,comparedtoyouranswerfrompartC)?(Assumethattheotherninefirmsstayloyaltothecartel.),Lecture12,Slide96,Cartels,ObservationsTobesuccessful:TotaldemandmustnotbeverypriceelasticEitherthecartelmustcontrolnearlyalloftheworldssupplyorthesupplyofnoncartelproducersmustnotbepriceelastic,Lecture12,Slide97,TheCartelizationofIntercollegiateAthletics,Observations1)Largenumberoffirms(colleges)2)Largenumberofconsumers(fans)3)Veryhighprofits,Lecture12,Slide98,QuestionHowcanweexplainhighprofitsinacompetitivemarket?(Hint:ThinkcartelandtheNCAA),TheCartelizationofIntercollegiateAthletics,Lecture12,Slide99,TheMilkCartel,1990swithlessgovernmentsupport,thepriceofmilkfluctuatedmorewidelyInresponse,thegover
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