Oligopoly is a market structure - 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 cu...

Реферат - Oligopoly is a market structure

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. 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. Livshits A.Y. Introduction to the Market Economy, Moscow 1991, p. 161 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” 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. 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.

Grebenschikov P.I., Leusskiy A.I., Tarasevitch L.S, Microeconomics, St. Petersburg 1996., pp. 213- 216 Livshits A.Y. Introduction to the Market Economy, Moscow 1991, pp.158-161 McConnell C.P., et al., Economics, Moscow 1993, pp. 125-7 Begg D., Fisher S., Dornbusch R., Economics, 5th ed., McGraw-Hill 1997, pp. 151-51, 176, 146, 148 Lancaster K., Introduction to Modern Microeconomics, 2nd ed., N-Y 1974, p. 200-1 Nicholson W., Microeconomic Theory, 7th ed., The Dryden Press 1998, pp. 580-4

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