How THE SIZE OF AN OUGOPOLY AFFECTS THE MARKET OUTCOME
We can use the insights from this analysis of duopoly to discuss how the size of an oligopoly is likely to affect the outcome in a market. Suppose, for instance, that John and Joan suddenly discover water sources on their property and join Jack and Jill in the water oligopoly, The schedule in Table 1 remains the same, but now more producers are available to satisfy this demand.I v would an increase in the number of sellers from two to four affect the price and quantity of water in the wn?
If the sellers of water could form a cartel, they would once age.1 try to maximize total profit by producing the monopoly quantity and charging the monopoly price. Just as when there were only two sellers, the members of the cartel would need to agree on production levels for each member and find some way to enforce the agreement. As the cartel grows larger, however,’ this outcome is less likely. Reaching and enforcing an agreement become more difficult as the size of the group increases.
• The output effect: Because price is above marginal cost, selling 1 more gallon of water at the going price will raise profit.
• The price effect: Raising production will increase the total amount sold, which will lower the price of water and lower the profit on all the other gallons sold.
If the output effect is larger than the price effect, the well owner will increase production. If the price effect is larger than the output effect, the owner will not raise production. (In fact, in this case, it is profitable to reduce production.) Each oligopolist continues to increase production until these two marginal effects exactly balance, taking the other firms’ production as given.
Now consider how the number of firms in the industry affects the marginal analysis of each oligopolist.The larger the number vi sellers, the less concerned about its own impact on the market price. That is, as the oligopoly grows in size, the magnitude of the price effect falls. When the oligopoly grows very large, the price effect disappears altogether, leaving only the output effect. In this extreme case, each firm in the oligopoly increases production as long as price is above marginal cost.
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