Реферат: Under what conditions will the oligopolists agree to co-operate in their decisions
/>/>/>/>/>/>/>/>/><td/>/>/>/>/><td/>/>Oligopoly is a market structure under which only a fewsuppliers dominate the market and the entrance of new suppliers is eitherconstrained or impossible.[1]Usually, the oligopoly market is dominated by 2-10 firms, who have a jointshare of the market of 50% or more. Automobile, steel, air transport are commonexamples of oligopolies. Or, in a global sense, we could call oil producercountries oligopolies and OPEC – a cartel. At least some firms may influenceprice due to their important contribution to the total output. Every firm inthe situation of oligopoly knows that if it, or its competitors either changeprices or output, the revenues of all the participants on the market willchange. That means that firms are interdependent. For example, if GeneralMorors Corporation decides to raise prices on its cars, it should considerretaliative moves by Ford, Chrysler, and other competitors in order tocalculate the ultimate changes in sales.
It is generally assumed that every firm on the marketrealizes that its changes in prices or output will cause other firms toretaliate. The kind of retaliation any supplier expects from its competitors asa reaction to his changes in prices, output, or change of marketing strategy isthe main factor that influences its decisions[2].That expected reaction also influences the balance of oligopoly markets.
Oligopolies may interact in two main ways:
1) Price wars, when a firmtries to increase it sales by reducing prices, expecting that other firms willnot be able to respond by doing the same. This stops when no firm can low itsprices anymore, which occurs when P=AC and profit equals 0. Unfortunately forconsumers, price wars do not usually last long. Firms have temptations toco-operate with each other in order to set up higher prices and to sharemarkets in such a way, as to avoid new price wars and their bad impact onrevenues.
2) From the above factorresults co-operation. Its closest form is a cartel, when a union of oligopoliesacts as a monopoly. Cartels are illegal in many countries of the World.
Another reason for co-operation is to increase theentrance barriers to prevent other firms (especially the so-called hit andrun firms) to join the market and drop prices. In that situation firms tryto coordinate their activities.
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To answer this question, I first need to describe theway agreement between oligopolies form. Let us suppose that there are 15suppliers in the area A who want to co-operate with each other. These firms settheir prices equal to their average costs. Each of the firms is afraid to raiseprices for the reason its competitors might not follow that move and itsprofits will become negative. Let us suppose that the production is at thecompetitive level Qc (pic. A), that corresponds to the productionquantity under which the demand curve crosses MC, which is a horizontal sum ofthe marginal cost curves of each supplier. MC would coincide with the demandcurve if the market were perfectly competitive. Each firm produces 1/15 of thetotal output Qc.
Pic. А
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/>/> Pm
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MC D
MR
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Qm Qc Q`
The original balance exists at the point E.; thecompetitive price is Pc. At that price each of the producers gets normalrevenue. At the price Pm, resulting from the co-operation agreement, each firmcould maximize its profits by setting Pm=MC. If each of the firms does that,than there will be an over supply on the market, equal to QmQ units per month.The price would fall to Pc. In order to maintain cartel price, each of thefirms should produce no more than the quota qm.
When the firms decide to co-operate, they shouldimplement the following policies to be able to maximize their profits.
1) They should make surethat there exists an entrance barrier to the market in which they operate inorder to prevent other firms from selling a good at an old price after theyincrease prices for their output. If the barriers do not exist, then theincrease in prices would attract other producers. The supply would thenincrease and prices would fall below the monopoly level, co-operating firms aimto maintain.
2) They should decide onthe general pattern of production. This could be done by estimating marketdemand and by calculating marginal profit for all levels of production. Firmsneed to produce so that their MC=MR (we assume that all firms have similarproduction costs). The monopoly production level would maximize revenues ofeach of the firms (see Pic. A). The demand curve for the output is in theregion of D. The marginal revenue that corresponds to that curve is MR. Themonopoly production level equals to Qm, which corresponds to the point where MRcrosses MC. The monopoly price equals Pm. The current price equals Pc and thecurrent output – Qc. That means that the current balance is the same as itwould be under competition.
3) Each participant inco-operation agreement should have production quotas. The monopoly productionQm should be divided between all members of the treaty. For example, each firmcould produce a 1/15 share of Qm per month. If all the firms had identical costfunctions it would be equivalent to recommending them to balance theirproduction till their marginal costs become equal to the market marginalrevenue (MR’). Until the sum of the monthly outputs of all producers equals Qm,it is possible to maintain the monopoly price.
Firms under co-operation agreement usually encounterproblems when they try to make a decision about monopoly prices and the levelof output. These problems are especially serious if the firms cannot agree onthe estimate of the market demand, its price elasticity; or, if they havedifferent production costs.[3]Firms with higher production costs try to insist on higher prices.
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Every firm has incentives to increase its productionat cartel prices. At the same time, if everyone will increase production thenthe agreement will fail because prices will decrease to their initial level.Pic. B shows marginal and average costs of a typical producer. Before theconclusion of co-operation agreement the firm behaves as if the demand for itsoutput at the price Pc was perfectly elastic. It does not increase pricesbecause it fears to lose all its sales to its competitors. It produces thequantity qc. As all firms behave in the same way, the industrial output equalsQc, which is the value that would exist under perfect competition. Under thenewly established agreed prices the firm is allowed to produce qm units ofoutput, corresponding to the point at which MR equals MC of each of the firms.
Pic. В
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/>/>/> AC MC
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qm qc q`
Let us suppose that the owners of any one of the firmsthink that the market price will not fall if they start selling more than thatquantity. If they take Pm as price lying beyond their influence, then theirprofit maximizing output will be q’, under which Pm=MC. If the market pricedoes not decrease, the firm can increase its profits from PmABC to PmFGH byproducing above the quota.
Just one firm could be able to increase its outputwithout causing any significant decrease in market prices. Let us suppose,however, that all producers start producing above their quotas in order to maximizetheir profits under “cartel”[4]prices Pm. The industrial output would then increase to Q’, under which Pm=MC,which will result in excess supply as at that price the demand would be lowerthan the supply. Consequently, prices will fall until the market clears, i.e.till they become equal to Pc and the producers will come back where they haveinitially started.
Cartels usually try to penalize those who cheat withquotas. The main problem however occurs when the cartel price gets set up, somefirms, aiming to maximize their profits, could earn more by cheating. Ifeveryone is cheating the co-operation agreement breaks down as profits fall to0.
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1. Grebenschikov P.I.,Leusskiy A.I., Tarasevitch L.S, Microeconomics, St. Petersburg 1996., pp. 213- 216
2. Livshits A.Y. Introductionto the Market Economy, Moscow 1991, pp.158-161
3. McConnell C.P., et al.,Economics, Moscow 1993, pp. 125-7
4. Begg D., Fisher S.,Dornbusch R., Economics, 5th ed., McGraw-Hill1997, pp. 151-51, 176, 146, 148
5. Lancaster K., Introductionto Modern Microeconomics, 2nd ed., N-Y 1974, p. 200-1
6. Nicholson W., MicroeconomicTheory, 7th ed., The Dryden Press 1998, pp. 580-4