1. Economics 101: Principles of Economics 1.Questions? 2.Please hand in Data Assignment #1

2. The Prisoner’s Dilemma Two firms enter a cartel agreement to restrict output and produce Q monopoly Payoffs are firms’ profits Equilibrium? Self-interested behavior leads to less than optimal outcomes for all In US, cartels are illegal, so firms must enforce agreement themselves. More firms  cheating more likely –Cheater gets higher  because smaller  P –Harder to detect cheater since smaller   Yellow Firm Cheat 10 5 25 5 20 Blue Firm Comply CheatComply Repeated game (forever) –Payoffs are firms’ profits each week –Can punish partner for cheating –“Tit-for-tat” strategy by Yellow is one possibility. What does Blue do? –Conclusion: collusion is more likely

3. Models of Oligopoly Augie Cournot model Joe Bertrand model Hank Stackelberg model Dominant Firm model –Here the leader assumes its rivals behave as competitors in choosing q i Output Price ($/unit) D mkt How much can dominant firm sell? S fringe P1P1 P2P2 Now dominant firm sets MR = MC MR domin MC domin Q dom P dom At P dom, competitive rivals produce Q fringe Q fringe Q dom + comp < Q comp + comp Q d+c Q c+c P dom > MC dom & P dom = MC fringe MC dom

4. Models of Oligopoly Application: pharmaceutical industry –Patent on drug X expires  copycats –P brand-name drug ? Output Price ($/unit) D mkt S fringe MR domin MC domin Q dom P dom Q fringe Q d+c S’ fringe Q’ dom P’ dom P brand-name drug falls Brand-name manufacturers often then engage in 3rd-degree price discrimination P HMO/Hosp < P local pharmacy Why? But there are drawbacks to this market segmentation strategy –Pharmacies have sued brand- name manufacturers to give them same low price

5. Models of Oligopoly Augie Cournot Joe Bertrand Hank Stackelberg Dominant Firm model Cooperative (cartel) model

6. Cooperative Model of Oligopoly Cartel model of oligopoly –Firms attempt to coordinate price and output decisions to earn monopoly  –Banned by antitrust laws in the US, but not in many other countries Output Price D mkt S P1P1 Q Price Output MarketFirm d AC MC d cartel mr cartel q * cartel P2P2 MR mkt Nq * cartel P2P2 Why do cartels fail? (1) incentive to cheat (2) heterogeneous cost structures/size/output (3)  econ >0  entry caviar cartel storycaviar cartel story d’ q * cheater

7. OPEC and CIPEC OPEC is the Organization of Petroleum Exporting CountriesOrganization of Petroleum Exporting Countries CIPEC is the French acronym for Int’l Council of Copper Exporting CountriesInt’l Council of Copper Exporting Countries Why has OPEC been successful in raising its price, but CIPEC has not? OPEC as a dominant firm Output Price D mkt How much can dominant firm sell? S non-opec P1P1 P2P2 Now dominant firm sets MR = MC MR opec MC opec Q opec P opec At P opec, rivals produce Q fringe Q fringe Q opec + comp < Q comp + comp Q total Q c+c P opec >> P comp P comp Inelastic S non-opec & inelastic D mkt  inelastic D opec  P opec >> P comp Price controls on gas in 1970s actually reinforced OPEC’s strategy!! –Encouraged domestic consumption –Discouraged domestic production Oil Market

8. OPEC and CIPEC CIPEC (Chile, Peru, Zambia, Zaire) MC CIPEC is not much less than MC non-cipec Why has OPEC been successful in raising its price, but CIPEC has not? CIPEC as a dominant firm Output Price D mkt How much can dominant firm sell? S non-cipec P1P1 P2P2 Now dominant firm sets MR = MC MR opec MC cipec Q cipec P cipec At P cipec, rivals produce Q fringe Q fringe Q total Q c+c P cipec not much above P comp P comp Why can’t CIPEC increase copper prices much? –D for copper is more elastic (aluminum is a good substitute) –Comp’ve supply more elastic than for oil (if P rises, simply go to scrap heap) Successful cartel needs relatively inelastic D & inelastic S non-cartel. Not easy Copper Market