ECON 323-Test 3 (ch.13)

Laws Against Cartels

-In the nineteenth century, cartels were legal and common in the United States. examples: oil, railroad, sugar, and tobacco -Sherman Antitrust Act in 1890 and the Federal Trade Commission Act of 1914, prohibit firms from explicitly agreeing to take actions that reduce competition.

Cartels

-Oligopolistic firms have an incentive to form cartels in which they collude in setting prices or quantities so as to increase their profits. -The Organization of Petroleum Exporting Countries (OPEC) is a well-known example of an international cartel. -A cartel forms if members of the cartel believe that they can raise their profits by coordinating their actions.

Oligopoly

-Oligopoly -Cartel -Monopolistic

Fixed Costs and the Number of Firms

-The number of firms in a monopolistically competitive equilibrium depends on firms' costs. -The larger each firms' fixed cost, the smaller the number of monopolistically competitive firms in the market equilibrium.

Equilibrium, Elasticity, and the Number of Firms

-We can write a typical Cournot firm's profit-maximizing condition as: MR=P(1+1/nE)=MC

Bertrand Versus Cournot

-When firms produce identical products and have a constant marginal cost, firms receive positive profits and the price is above marginal cost in the Nash-Cournot equilibrium. -However, in the Nash-Bertrand equilibrium, firms earn zero profits and price equal marginal cost.

Why Cartels Fail

-Cartels fail if noncartel members can supply consumers with large quantities of goods. -Each member of a cartel has an incentive to cheat on the cartel agreement.

Mergers

-If antitrust or competition laws prevent firms from colluding, firms could try to achieve the same end by merging to form a monopoly. -U.S. laws restrict the ability of firms to merge if the net effect is to harm society.

Nonidentical Firms

-If the firms' marginal costs vary, then the firms' best-response functions will as well. -In the resulting Nash-Cournot equilibrium, the relatively low-cost firm produces more. -As long as the products are undifferentiated, they both charge the same price.

Stackelberg Oligopoly

-In the Cournot model, both firms make their output decisions at the same time. -Suppose, however, that one of the firms, called the leader, can set its output before its rival, the follower, sets its output.

Differentiated Products

In differentiated products markets, the Bertrand equilibrium is plausible, and the two "problems" of the homogeneous-goods model disappear: -Firms set prices above marginal cost, and -prices are sensitive to demand conditions and the number of firms.

Market Structures

Market differ according to: -the number of firms in the market, -the ease with which firms may enter and leave the market, and -the ablility of firms in a market to differentiate their products from those of their rivals.

Cartels persist despite these laws for three reasons:

1. International cartels and cartels within certain countries operate legally. 2. Some illegal cartels operate believing that they can avoid detection or that the punishment will be insignificant. 3. Some firms are able to coordinate their activity without explicitly colluding and thereby running afoul of competition laws.

Bertrand equilibrium (Nash-Bertrand equilibrium)-

A Nash equilibrium in prices; a set of prices such that no firm can obtain a higher profit by choosing a different price if the other firms continue to charge these prices. -Bertrand equilibrium depends on whether firms are producing identical or differentiated products.

Monopolistic Competition

Monopolistically competitive markets do not have barriers to entry, -so firms enter market until no new firm can enter profitably. -monopolistically competitive firms face downward-sloping residual demand curves, so they charge prices above marginal cost.

Cournot Oligopoly

There restrictive assumptions: 1. All firms are identical in the sense that they have the same cost functions and produce identical, undifferentiated products. 2. We initially illustrate each of these oligopoly models for a duopoly. 3. The market lasts for only one period. Each firm chooses its quantity or price only once.

Maintaining Cartels

To keep from violating the cartel agreement, the cartel must be able to: -Detect cheating and punish violators. -Keep their illegal behavior hidden from customers and government agencies.

Equilibrium

Two conditions hold in a long-run monopolistically competitive equilibrium: 1. Marginal revenue equals marginal cost, b/c firms set output to maximize profit, and 2. Price equals average cost, b/c firms enter until no further profitable entry is possible.

Cartel-

a group of firms that explicitly agree to coordinate their activities.

Monopolistic Competition-

a market structure in which firms have market power but no additional firm can enter and earn positive profits.

Cournot equilibrium (Nash-Cournot equilibrium)-

a set of quantities sold by firms such that, holding the quantities of all other firms constant, no firm can obtain a higher profit by choosing a different quantity. -Example: American Airlines and United Airlines compete for customers on flights between Chicago and Los Angeles.

Oligopoly-

a small group of firms in a market with substantial barriers to entry.

Duopoly-

an oligopoly with two firms. -Three models: Cournot model, Stackelberg model, Bertrand model.