Understanding Oligopoly and Cartels

Nov 4, 2024

Lecture on Oligopoly and Cartels

Introduction to Oligopoly

  • Continuation of the discussion on oligopolies, focusing on cartels.
  • Previous discussion on non-cooperative equilibria in oligopolies.

Cartels and Cooperative Equilibria

  • Cartels: Groups of firms cooperating to achieve monopoly-like outcomes.
  • Example: American and United airlines cooperating as a cartel.
    • Demand: 339 - q, Price: 339 - q, Marginal Cost: 147.
    • As a monopoly: Optimal quantity = 96 flights, Price = $243, Profits = $4608 per firm.
    • Non-cooperative equilibrium: 64 flights, Price = $211, Profits = $4096 per firm.
    • Cooperation increases profits by 12.5%.

Instability of Cartels

  • Cartels are fundamentally unstable due to self-interest and incentive to cheat.
  • Example of Cheating: If American increases flights from 48 to 50, price falls to $241.
    • American profits increase to $4700.
    • United profits decrease to $4512.
  • Cheating Incentive: Firms benefit from cheating by sharing the negative effects with others.

Legal and Historical Context

  • Cartels are illegal due to antitrust laws.
  • History: 1800s saw attempts at cartelization in railroads and oil.
    • Formation of trusts to enforce cooperation.
    • Antitrust laws were enacted to prevent these practices.

Examples of Cartelization

  • Movie Industry: Production companies bought theaters, exclusive film rights led to antitrust action.
  • Airlines: British Airlines and Virgin Atlantic's hidden price coordination.
  • Sports: NFL's exemption from antitrust laws, forming a legal cartel.
  • International Cartels: OPEC’s partial success in oil production.
  • Government-Endorsed Cartels: Voluntary export restraints with Japan in the 1980s.

Economic Welfare and Market Structures

  • Comparison of perfect competition, monopoly, and oligopoly.
  • Monopoly: Higher profits, fewer flights (lower market output).
  • Perfect Competition: Maximizes welfare with highest quantity sold.
  • Oligopoly Outcome: In between monopoly and competition outcomes.
    • More firms reduce markup and approach competitive equilibrium.

Mergers and Economies of Scale

  • Mergers evaluated by federal government based on economies of scale vs. market power.
    • Example: Hospital mergers in the 2000s led to higher prices without efficiency gains.

Price Competition (Bertrand Model)

  • Firms compete on price, not quantity.
  • Can achieve competitive equilibrium with just two firms.
  • Situations Favoring Price Competition: Markets with small production lags.

Product Differentiation

  • Firms use differentiation to escape Bertrand competition and increase market power.
  • Example: Cereal brands introducing diverse products to differentiate.

Conclusion

  • Competitive markets enhance social welfare but reduce firm profits.
  • Understanding oligopolistic behavior, cartels, and market structures is crucial for economic policy and welfare.

Note: This lecture covers complex topics in game theory, industrial organization, and economic policy, highlighting real-world applications and implications.

Full transcript