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Реферат: Under what conditions will the oligopolists agree to co-operate in their decisions
Реферат: Under what conditions will the oligopolists agree to co-operate in their decisions
Oligopoly is a market structure under which only a few suppliers dominate the
market and the entrance of new suppliers is either constrained or impossible.
[1] Usually, the oligopoly market is dominated by 2-10 firms, who have a
joint share of the market of 50% or more. Automobile, steel, air transport are
common examples of oligopolies. Or, in a global sense, we could call oil
producer countries oligopolies and OPEC – a cartel. At least some firms may
influence price due to their important contribution to the total output. Every
firm in the situation of oligopoly knows that if it, or its competitors either
change prices or output, the revenues of all the participants on the market
will change. That means that firms are interdependent. For example, if General
Morors Corporation decides to raise prices on its cars, it should consider
retaliative moves by Ford, Chrysler, and other competitors in order to
calculate the ultimate changes in sales.
It is generally assumed that every firm on the market realizes that its changes
in prices or output will cause other firms to retaliate. The kind of
retaliation any supplier expects from its competitors as a reaction to his
changes in prices, output, or change of marketing strategy is the 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 firm tries to increase it sales by reducing prices,
expecting that other firms will not be able to respond by doing the same.
This stops when no firm can low its prices anymore, which occurs when P=AC
and profit equals 0. Unfortunately for consumers, price wars do not usually
last long. Firms have temptations to co-operate with each other in order to
set up higher prices and to share markets in such a way, as to avoid new
price wars and their bad impact on revenues.
2) From the above factor results co-operation. Its closest form is a
cartel, when a union of oligopolies acts as a monopoly. Cartels are illegal
in many countries of the World.
Another reason for co-operation is to increase the entrance barriers to prevent
other firms (especially the so-called hit and run firms) to join the
market and drop prices. In that situation firms try to coordinate their
activities.
To answer this question, I first need to describe the way agreement between
oligopolies form. Let us suppose that there are 15 suppliers in the area A who
want to co-operate with each other. These firms set their prices equal to their
average costs. Each of the firms is afraid to raise prices for the reason its
competitors might not follow that move and its profits will become negative.
Let us suppose that the production is at the competitive level Qc
(pic. A), that corresponds to the production quantity under which the demand
curve crosses MC, which is a horizontal sum of the marginal cost curves of each
supplier. MC would coincide with the demand curve if the market were perfectly
competitive. Each firm produces 1/15 of the total output Qc.
Pic. А
Pm
Pc E
MR`
MC D
MR
Qm Qc Q`
The original balance exists at the point E.; the competitive price is Pc. At
that price each of the producers gets normal revenue. At the price Pm,
resulting from the co-operation agreement, each firm could 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 the firms should
produce no more than the quota qm.
When the firms decide to co-operate, they should implement the following
policies to be able to maximize their profits.
1) They should make sure that there exists an entrance barrier to the
market in which they operate in order to prevent other firms from selling a
good at an old price after they increase prices for their output. If the
barriers do not exist, then the increase in prices would attract other
producers. The supply would then increase and prices would fall below the
monopoly level, co-operating firms aim to maintain.
2) They should decide on the general pattern of production. This could be
done by estimating market demand and by calculating marginal profit for all
levels of production. Firms need to produce so that their MC=MR (we assume
that all firms have similar production costs). The monopoly production level
would maximize revenues of each of the firms (see Pic. A). The demand curve
for the output is in the region of D. The marginal revenue that corresponds
to that curve is MR. The monopoly production level equals to Qm, which
corresponds to the point where MR crosses MC. The monopoly price equals Pm.
The current price equals Pc and the current output – Qc. That means that the
current balance is the same as it would be under competition.
3) Each participant in co-operation agreement should have production
quotas. The monopoly production Qm should be divided between all members of
the treaty. For example, each firm could produce a 1/15 share of Qm per
month. If all the firms had identical cost functions it would be equivalent
to recommending them to balance their production till their marginal costs
become equal to the market marginal revenue (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 encounter problems when they try to
make a decision about monopoly prices and the level of output. These problems
are especially serious if the firms cannot agree on the estimate of the market
demand, its price elasticity; or, if they have different production costs.
[3] Firms with higher production costs try to insist on higher prices.
Every firm has incentives to increase its production at cartel prices. At the
same time, if everyone will increase production then the agreement will fail
because prices will decrease to their initial level. Pic. B shows marginal
and average costs of a typical producer. Before the conclusion of co-
operation agreement the firm behaves as if the demand for its output at the
price Pc was perfectly elastic. It does not increase prices because it fears
to lose all its sales to its competitors. It produces the quantity qc. As all
firms behave in the same way, the industrial output equals Qc, which is the
value that would exist under perfect competition. Under the newly established
agreed prices the firm is allowed to produce qm units of output,
corresponding to the point at which MR equals MC of each of the firms.
Pic. В
   AC MC
Pm A F
C B
H G
MR`
qm qc q`
Let us suppose that the owners of any one of the firms think that the market
price will not fall if they start selling more than that quantity. If they
take Pm as price lying beyond their influence, then their profit maximizing
output will be q’, under which Pm=MC. If the market price does not decrease,
the firm can increase its profits from PmABC to PmFGH by producing above the
quota.
Just one firm could be able to increase its output without causing any
significant decrease in market prices. Let us suppose, however, that all
producers start producing above their quotas in order to maximize their 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 lower than 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 have initially
started.
Cartels usually try to penalize those who cheat with quotas. The main problem
however occurs when the cartel price gets set up, some firms, aiming to
maximize their profits, could earn more by cheating. If everyone is cheating
the co-operation agreement breaks down as profits fall to 0.
1. Grebenschikov P.I., Leusskiy A.I., Tarasevitch L.S,
Microeconomics, St. Petersburg 1996., pp. 213- 216
2. Livshits A.Y. Introduction to 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, 5
th ed., McGraw-Hill 1997, pp. 151-51, 176, 146, 148
5. Lancaster K., Introduction to Modern Microeconomics
, 2nd ed., N-Y 1974, p. 200-1
6. Nicholson W., Microeconomic Theory, 7th
ed., The Dryden Press 1998, pp. 580-4
[1] Grebenschikov P.I., Leusskiy A.I.,
Tarasevitch L.S, Microeconomics, St. Petersburg 1996., p. 213
[2] Livshits A.Y. Introduction to the Market Economy, Moscow 1991, p.159
[3] Livshits A.Y. Introduction to the Market Economy, Moscow 1991, p. 161
[4] I am using the expression “cartel
price” for the purpose of simplification. What I mean by it is the high price
that resulted from the co-operation agreement between oligopolies.
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