EconH200L13

EconH200L13 - Oligopoly Oligopoly is a market structure in...

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Oligopoly Oligopoly is a market structure in which the number of sellers is small. Oligopoly requires strategic thinking, unlike perfect competition, monopoly, and monopolistic competition. Under perfect competition, monopoly, and monopolistic competition, a seller faces a well defined demand curve for its output, and should choose the quantity where MR=MC. The seller does not worry about how other sellers will react, because either the seller is negligibly small, or already a monopoly. Under oligopoly, a seller is big enough to affect the market. You must respond to your rivals’ choices, but your rivals are responding to your choices.
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In oligopoly markets, there is a tension between cooperation and self-interest. If all the firms limit their output, the price is high, but then firms have an incentive to expand output. The techniques of game theory are used to solve for the equilibrium of an oligopoly market. “Duopoly” example: Jack and Jill choose how many gallons of water to pump and sell in town. To keep things simple, assume zero costs. The demand schedule gives us the price the buyers are willing to pay, as a function of the total combined output of Jack and Jill.
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If the market structure were perfectly competitive, the market supply curve would be based on marginal costs, so the price would be zero and the quantity would be 120. This is the socially efficient outcome. If the market structure were a monopoly, the price would be 60 and the quantity would be 60. This outcome maximizes industry profits, and there is a deadweight loss. If Jack and Jill could form a cartel , they would collude with each other to act in unison, like a monopoly. Each seller would produce 30 gallons and share the monopoly profits. Would they come to this arrangement if they had to choose their quantities separately?
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Suppose Jack expects Jill to produce 30 gallons. If he produces 30, both receive profits of $1800. But, if he produces 40, the total quantity supplied to the market is 70 gallons, so the market price is $50. Therefore, Jack’s profit would be $2000, and Jill’s profit would be $1500. By increasing output and expanding market share, total industry profits fall but Jack is better off. Since Jill is in the same situation, both sellers have an incentive to produce more than their share of the monopoly output. The cartel solution is not stable. Without the ability to commit to the cartel, self-interest pushes the price below the monopoly level.
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What is the duopoly solution? Suppose Jack and Jill each produce 40 gallons, so that the market price is $40 and each receives profits of $1600. Can either seller do better by choosing a different quantity? If Jack were to produce 30 gallons, the price would be $50 and his profits would only be $1500.
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EconH200L13 - Oligopoly Oligopoly is a market structure in...

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