Theory of the industry

Conjectural variation

Firm’s anticipated response from a rival firm if the firm changes output or price

What leaves to strategic uncertainty in oligopoly?

Interdependence of firms

Interdependence = individuals or things are dependent on one another

Reaction function

Reaction functions of the firms illustrate the profit maximising output level of firm A given any output produced by B, and vice versa.

Isoprofit line

A line that shows equal profits

Stackelberg equilibrium

Where an isoprofit line is tangential to reaction function

Cournot Model

Firms set output and move simultaneously

Stackelberg model

Firms set output and move sequentially

Bertrand model

Firms set price and move simultaneously

Firms undercut one another

homogenous products

Price leadership

Firms set their own price and move sequentially

Why do oligopolies have an incentive to collude?

Oligopolies jointly produce more than monopoly output

Contract curve

Shows the locus of tangencies between the isoprofit lines

Monopolist dilemma

MR equation

P+(dp/dq).q

Monopolist dilemma

In order to sell an extra unit the monopolist needs to cut the price. The cost of selling an extra unit reduces the price and loses revenue on all units which were marginal

This causes the MR equation to change: P-(dp/dq).q

Facts about monopolist dilemma

1. Monopolist will not produce where demand is inelastic = MR is negative, costs will increase and profits will fall
2. Monopolist dilemma becomes more acute the less elastic demand is (graph showing two different demand curves)
3. Competitive firm does not face this at MR=price
4. Price discrimination gives the monopolist a way out of dilemma = To sell an additional unit can price discriminate by charging a different price so do not lose revenue on inter-marginal units

Price discrimination

Involves varying the price to capture differences in WTP of consumers

First degree price discrimination

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Prices vary between units of output and across individuals.

(Accountants/cars salesman/airline tickets)

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Perfect price discrimination

Different price is charged for every single unit

Monopolist dilemma avoided as it produces where P=MC (perfect comp)

second degree price discrimination

Prices vary between units of output, but each consumer faces the same price schedule

Vary quality of good, so individuals with higher WTP self select and pay more per unit consumed (FIRST CLASS RAIL)

Third degree price discrimination

Prices vary between individuals but each unit sold sells at the same price

Firms identifies customer groups with different WTP and charges different prices based on characteristics of individuals

CONCESSIONARY PRICES