OligopolyMicroeconomics

TPS

Write down the name of an industry which has just a few huge companies. Think of two firms which use ads to ‘steal’ consumers from each other. Coke and Pepsi Apple and Microsoft United Airlines and Delta

Defining Oligopoly

Oligopolists are … A few firms which are the only producers of a good.

These firms set the P of their products

They have a degree of Market Power.

A monopoly is … An industry controlled by oligopolists.

Defining Oligopoly

Key characteristics are … A few large firms

Produce almost all the total output in the industry

Strong barriers to entry

Product could be … Identical (oil)

Differentiated (cars)

Strategic behavior and mutual interdependence advertising

Defining Oligopoly

Key characteristics are … Strategic behavior and mutual interdependence

The actions of one firm have an impact on another large firm

Honda v. Toyota

Advertising

Super Bowl ads

Is It an Oligopoly or Not? Level of Concentration in the Market

Concentrated OJ Very dense

100% of market share

Monopoly

Is It an Oligopoly or Not? Level of Concentration in the Market

Concentrated OJ in swimming pool Very diluted – taste little OJ

Small % of market share

Perfect Competition

Is It an Oligopoly or Not? Level of Concentration in the Market

Concentrated OJ in a pitcher with little water Thick and syrupy

Very concentrated Auto industry

Oligopoly

Large portions of market share

Ologopoly

Is It an Oligopoly or Not?

Statistical Measure Four-firm Concentration Ratio (CR4)

Sum of the market share of the 4 largest firms in the industry

Industry A is closer to being

an oligopolyA B

30% 12%

20% 10%

10% 8%

5% 4%

CR4 = 65% CR4 = 34%

Oligopoly QuestionWhich of the following is true for an oligopoly?

I. There are a few firms, each with a large market share.

II. The firms in the industry are interdependent.

III. The industry experiences diseconomies of scale.

a. I only

b. II only

c. III only

d. I and II only

e. I, II, and III

Defining Oligopoly

A Duopoly is … Two firms which have most of the market share.

Colluding is … to act together through a secret understanding,

especially with evil or harmful intent.

to conspire in a fraud.

A Duopoly Example

There are only two gas stations in the small rural town of Boonetuckey. These gas stations, Alyssa’s Quickee Stop and Oscar’s Pump Station, are duopolists in the gasoline market. They each sell 50% of all the gas in town.

Boonetuckey Gasoline Demand Schedule

MC = $1/gallon of gas

PC Market – P = MC = $1What is the TR these firms would

split?$1400

How much TR would each firm receive?

1400/2 = $700

P/Gallon Qd TR

$8.00 0 $ ---

7.50 100 750

7.00 200 1400

6.50 300 1950

6.00 400 2400

5.50 500 2750

5.00 600 3000

4.50 700 3150

4.00 800 3200

3.50 900 3150

3.00 1000 3000

2.50 1100 2750

2.00 1200 2400

1.50 1300 1950

1.00 1400 1400

0.50 1500 750

Boonetuckey Gasoline Demand Schedule

MC = $1/gallon of gas

Oligopoly MarketAlyssa and Oscar decide to

collude.They decide to charge $4/gallon.They decide to sell 800 gallons

total.How many gallons does each one

sell?800/2 = 400 gallons

What is the total TR?$3200.

How much TR does each receive?3200/2 = $1600

P/Gallon Qd TR

$8.00 0 $ ---

7.50 100 750

7.00 200 1400

6.50 300 1950

6.00 400 2400

5.50 500 2750

5.00 600 3000

4.50 700 3150

4.00 800 3200

3.50 900 3150

3.00 1000 3000

2.50 1100 2750

2.00 1200 2400

1.50 1300 1950

1.00 1400 1400

0.50 1500 750

Boonetuckey Gasoline Demand Schedule

What is one of them cheats?!!!

Alyssa decides she can secretly sell an additional 100 gallons of gas!

Consequences?????How many gallons now being sold?

900 = 400 + 100 + 400Price is now equal to ?????

$3.50/gallon

What is Alyssa’s new TR? Is it more or less?

$3.50 * 500 = $1750What is Oscar’s new TR? Is it more or less?

$3.50 * 400 = $1400

P/Gallon Qd TR

$8.00 0 $ ---

7.50 100 750

7.00 200 1400

6.50 300 1950

6.00 400 2400

5.50 500 2750

5.00 600 3000

4.50 700 3150

4.00 800 3200

3.50 900 3150

3.00 1000 3000

2.50 1100 2750

2.00 1200 2400

1.50 1300 1950

1.00 1400 1400

0.50 1500 750

Collusion Agreements

ILLEGAL

Games Oligopolists Play Close Rivals compete with each other.

Choices made by each player affect the outcomes for both.

They are mutually interdependent. Game Theory is …

The study of how interdependent decision makers make choices.

Payoff Matrix shows … How the payoff to each player depends on the actions

of both.

Games Oligopolists Play Dominant Strategy is one that …

Outperforms any other strategy NO MATTER WHAT strategy your opponent selects. It is possible to NOT HAVE a dominant strategy!!

What is Player 1’s dominant strategy? defect

What is Player 2’s dominant strategy? No dominant strategy

Games Oligopolists Play A Nash Equilibrium is when …

The game ends with both players happy with the outcome, given the choice made by their rival. What is GM’s dominant strategy?

confess

What is FORD’s dominant strategy? Confess

GM

Advertise Don’t Advertise

FORD Advertise Ford: $100GM: $100

Ford: $150GM: $50

Don’t Advertise

Ford: $50GM: $150

Ford: $50GM: $50

Games Oligopolists Play A Prisoners’ Dilemma is when …

Players pursue their dominant strategy

The game comes to a Nash Equilibrium.

The outcome is undesirable.

Could have been avoided with a cooperative agreement (collusion).

Rivals have an opportunity to cooperate (collusion) but someone chooses to cheat on the agreement.

Games Oligopolists Play Two crooks have been caught by the police on suspicion of a major crime.

However, the cops cannot prove they are the robbers without a confession. What is Crook 1’s dominant strategy?

confess

What is Crook 2’s dominant strategy? Confess

Crook 2

Confess Silent

Crook 1 Confess #1: 5 years#2: 5 years

#1: 1#2: 20

Silent #1: 20#2: 1

#1: 2#2: 2

PUBLIC POLICY TOWARD OLIGOPOLIESRestraint of Trade and the Antitrust Laws

Antitrust laws make it illegal to restrain trade or attempt to monopolize a market. Sherman Antitrust Act of 1890 Clayton Act of 1914

Tacit Collusion and Price Wars Tacit Collusion is …

Firms agree to keep the price above competitive levels

Tacit Collusion does not usually work because … Large number of firms =

easier to ‘cheat’ Easier for other firms to enter the industry

Complex Products and Pricing Schemes Too many options

Think Verizon and AT&T phones and service plans

Tacit Collusion and Price Wars Tacit Collusion does not usually work because …

Firms have quite diverse characteristics and interests Varied countries, states, labor union agreements, suppliers

Bargaining power of buyers Breakfast cereal companies sell to large grocery chains