hello and welcome back to our discussion on oligopoly we had introduced the oligopoly
market structure we have talked about uh the about why the oligopoly market outcome is
a little more complicated than monopoly or perfect competition because in the latter
2 cases even in case of monopolistic competition also the firms have to make their own decisions
irrespective of what the other firms are doing in the industry or in the market
so there uh the output that they are going to produce the price that they are going to
charge and the profit that they are likely to make are solely dependent on their own
cost conditions and nothing else but in case of oligopoly we have seen that the firms since
there are only a few firms and entry and exit is uh difficult so there are only a few firms
in the market and lot of market power could be exercised but at the same time the firms
are going to uh look at the price and quantity of its rivals and act accordingly or accordingly
they are going to make their decisions of what price to charge and what output to uh
produce so we have looked at the kinked demand curve where we saw that there is a range uh
where there is the prices are sticky and the output is also sticky
so that kind of gives a stability to a oligopolistic market structure that uh for quite a range
uh of marginal cost quite a range between which if the cost fluctuates for any firm
it is not going to change its price or output so that kind of imparts a stability to the
oligopolistic market structures where the firms would not like to move away from the
price that they are already uh charging so now in this module we are going to take an
example we are really we are going to look at at demand
curve we are going to have some cost structure and we are going to see that if a oligopoly
firm has a demand curve like this and the cost structure and how is it likely to behave
what could be the price and what could be the output in such a situation where the firm
actually uh takes into account the decision of its rival so so let us look at the example
. now the example that we are considering there
are 2 firms uh they are vodafone and airtel they are service providers uh in a small town
so they are they are the only 2 firms who have network and they provide services in
that small town and we are assuming for simplicity a fixed cost equal to 0 and marginal cost
equals rupees 10 now the market demand schedule is given i
am going to write down the market demand schedule on the board and then once the market demand
schedule is given the firms have uh so here this is a special case of oligopoly where
there are instead of few firms there are actually 2 firms
so this situation is called duopoly where there are 2 firms so we are taking a very
simple example where there are 2 firms competing for the same market and they have very similar
costs and how are they going to share the market between themselves
so as i said in the previous modules that the firms have 2 choices the one the first
choice for the firm is to cooperate the first uh first choice is that one of the choices
is that the firms could decide that lets work in unison and decide what price to charge
and what output to produce so that will sort of give us some clarity and we need not worry
about the other firm so this is one option that they could try
the other option is not to cooperate and act independently and try to capture the as much
of the market or make as much profit as possible in that market so uh let’s see what happens
if they form a cartel cartel means that is the firms that is firms colluding to decide
on the price to charge and quantity to produce that is uh what we mean by cartel and here
we will see that in when they act as cartel they can decide to act as a monopoly so let
me first uh write down the demand schedule and then from there we can see .
so so price and quantity 0 5 10 20 30 sorry 30
35 40 45 these are the prices that are possible and quantity is say 140 130 120 110 100 90
80 15 110 20 100 25 90 30 80 so this is the this is the price schedule and accordingly
these are the uh output schedule so you can imagine the output to be uh the number of
people they are they are serving number of customers you it can be imagined that way
uh so so this is the price and demand schedule
so lets write down the total revenue in each of these cases is 0 650 1200 1650 2000 2250
2400 2450 2400 2250 so these are the total revenue cost is since marginal cost is fixed
for every unit of output so this is 1400 this is 1300 then 1200 then 1100 1000 900 800
so these are the total cost and so profit as is equal to total revenue minus total cost
is equal to minus 1400 minus 650 0 550 1000 1350 1600 1750 1800 and 1750 so these are
the the this is the cost this is the revenue this is cost and this is uh profit so from
here first would you be able to tell from here what is the what is likely to be the
perfectly competitive output and what is likely to be the monopoly output
so from here one can clearly see so in case of perfect competition what happens in case
of competition in case of perfect competition price is equal to mc and profit is equal to
0 price is equal to mc and profit is equal to 0 so this basically gives us our competitive
output so this is our competitive output and this is our competitive profit
so the the pink line this is our perfectly competitive output so if the firms are to
behave as competitive firms if they are to behave as competitive firms and take the price
as given so in that uh in the market what they would do is they would uh produce the
output uh so that the profit is equal to 0 so that their total revenue is equal to total
cost or price is equal to their marginal cost and this is the competitive output
so what would happen now we said that the firms will decide to act like a monopoly what
if they collude now if the firms collude they are going to say that uh since monopoly gives
us the maximum profit lets get together we are the only 2 firms in this town Lets get
together act as a monopoly and we are going to charge the price in such a way that it
maximizes our joint profit so the total profit is going to be joint and
our costs are same so we are just going to split the profit into half between the 2 of
us and that is the price that we are going to charge and that is the output that we are
going to produce so what they do is they make mc is equal to
marginal revenue and accordingly from the demand curve they choose that level of uh
price which they they are going to uh decide the output on the basis of marginal cost equals
marginal revenue and accordingly and from there they are going to trace back the output
the price from the uh demand diagram from the demand curve and that is the price that
they are going to charge so that is going to give them the maximum
revenue so monopoly gives them the highest revenue so highest profit so where is the
highest profit in this schedule the highest profit lies here 1800 i hope you are able
to see it so this is the highest profit that is being earned here this is the highest profit
that is being earned here at a output level of 60 and a price level of 40 so this is the
monopoly output so had there been only one firm in this market
that firm would have produced 60 units of output and charged a price of 40 rupees and
gained a profit of 1800 rupees now since there are 2 firms in this market they are going
to split this amongst themselves so this is the cartel situation this is what they are
going to do so each of the firms is going to produce 30 units of output and they are
going to charge a charge a price of 40 rupees and accordingly they are each of the firms
is now going to get a so in case of cartel each firm earns profit is equal to 900 rupees
so each firm earns a profit equal to 900 rupees so the total profit in the market is 1800
rupees so that is that that is what they are going to do and this is what we see in the
uh slide also in the slide uh if they act like a monopoly in unison for each firm output
is equal to 30 and price is equal to 40 rupees so profit is equal to 900 rupees for each
of the firms now next thing to think about is each of the
firm wants to maximize its profit it has its own self interest in mind so what happens
so the next the firm the firm is he going to stop at producing 30 units is he going
to stop at producing 30 units . lets see what happens when one of the firms
say for example vodafone decides say vodafone now decides that let me break the agreement
let me break the agreement without informing the other firm without informing airtel let
me break the agreement and let me produce q equals 40 instead of 30 so it decides i
am going to produce 40 units instead of 30 units and in that case and the prevailing
price in the market is what so as soon as he produces 40 units airtel
airtel assuming that airtel so vodafone thinks that if it increases its output to 40 units
airtel will continue will continue to produce or let me uh just make it shorter airtel produces
q is equal to 30 so total output in the market is equal to 70 units now so total output in
the market is 70 units now and price immediately then falls to so price immediately falls to
35 rupees so price immediately falls to 35 rupees so
as soon as the price falls to 35 rupees what happens to vodafones profit so in this situation
if vodafone decides that i am going to increase the output then profit of vodafone profit
of vodafone is equal to 40 into 35 minus 10 cost price and output is equal to 1000 rupees
which is more than 900 rupees so when they decide when they collude vodafone
gets a profit of 900 rupees but if he breaks the agreement produces another another 10
more units in that case his profit is 1000 rupees as against 900 rupees so there is every
incentive for vodafone to break the agreement because all of them are profit maximizers
and he would like to maximize his profit so he is going to break the agreement or vodafone
is going to break the agreement and charge a higher price uh charge a or break the agreement
and produce a higher amount of output thus bringing down the price in the market and
hence getting a profit which is higher than the cartel situation
but now what happens and in this case what is if airtel continues to do the same the
profit of airtel is profit of airtel falls profit of airtel falls to 750 rupees so the
profit of airtel falls to 750 rupees so that is what happens so so when 35 70 profit is
1750 so when the one who is breaking the agreement he gets 1000 rupees out of this profit and
the other one who sticks to the agreement he gets a much lesser profit than 900 he gets
a lesser profit of 750 rupees so in that case so now the airtel also knows
if there is a collusion between the 2 firms and there is no way of uh legally enforcing
this agreement in that case each of the firm has enough incentive to break the agreement
so each of the firm knows this also so the airtel will know that it makes sense for vodafone
to break the agreement and produce a higher amount of output
so that is what airtel is also going to do or in in to think about it in a different
way is independently also the airtel also thinks in the same lines as vodafone and thinks
that if i break the agreement i am going to get a higher return i am going to get a higher
profit so let me break the agreement so as a result what happens is each of the firms
breaks the agreement and each of the firms ends up producing 40 units of output .
so each of the firms now so each of the firms now break the agreement
and airtel also produces now airtel also produces q is equal to 40 so total output in the market
now becomes 80 even higher price now falls to 30 and now now the profit falls to so each
of the firms now this calculating in similar way so profit of vodafone now reduces to 800
rupees and for airtel also profit reduces to 800 rupees
so uh so they each of them is going to break the agreement and each of them is now going
to produce uh higher amount of output because they dont trust each other each of them is
going to produce a higher amount of output so firstly there is distrust amongst the firms
that the other is going to probably break the agreement second is they are acting in
self interest and they are going to do whatever is going to make them best uh make them the
best of in this situation so this is what they are going to do and they
will end up each getting a profit of 800 rupees which is now less than the cartel uh outcome
of 900 rupees so what we see is even if the firms decide to collude and they agree to
produce a certain amount of output which makes their profit highest in the joint profit highest
because of their self interest getting priority they end up producing a output level which
is actually much more than the monopolistic level of output and the result is that each
of them ends up getting a profit which is less than the monopoly profit which is less
than the uh cartel outcome of profit so this is what happens and next another interesting
thing to see would be uh are they going to keep on increasing the output so so 40 is
something we uh tried now vodafone is it going to increase the output to 50 is he is he going
to increase it to 50 so what happens if vodafone increases the output to 50 .
so going by the same argument if the vodafone increases its price to uh or output to 50
then uh this is 50 and total output then becomes 90 so price will be 25 price will be 25 and
vodafone profit will reduce to 50 into 25 minus 10 equals 750 so in that case vodafone
if vodafone uh decides to increase its output even further to 50 units in that case its
profit is going to fall from 40 units so in that case it is not going to increasing
his output and it just going to continue to produce 40 units so both the both the so this
is this the vodafone is not going to choose so neither of the firms is going to increase
the output even further beyond 40 units and they will settle at producing 40 units and
together they are going to produce 80 units in the market
. so uh to summarize there is conflict between
collusion and self interest so although collusion leads to a higher profit for individual firms
acting on self interest leads the firms to such a situation where they end up getting
a profit which is less than uh collusion outcome so both firms earning higher profits if they
stick to the cartel agreement but individually they have incentive to break the agreement
and together they end up producing more than monopoly output at a lesser price and lesser
profit self interest and lack of trust on rivals
may make it difficult for cartels to sustain especially since there is no legal binding
possible on the cartel members so as you may already know that cartel is uh cartel formation
is not legal for the benefit of the consumers because if the firms get together and if there
is legally if it is cartel is enforceable then they will end up producing monopoly output
at monopoly price which is uh not at all a desirable situation for the customers so for
the consumers so this is something which is not uh legally uh approved
so so because since it is not legally enforceable there is every incentive for the firms to
default on the agreement and they work on their they basically act on their own self
interest and they end up producing a output level which is higher than the monopoly output
level which is which in a sense actually is beneficial for the consumers
so uh this was an example that uh illustrated how a cartel formation or how collusion is
not so easy in case of oligopoly uh in the following modules we are going to talk more
about these thank you