Oligopoly

1
Chapter 16

• Oligopoly

2
Some Old Monopoly Business
3
Some Old Monopoly Business
Find the Q where MRMC
Q
4
Some Old Monopoly Business
5
Some Old Monopoly Business
P
Find Price on the Demand Curve
Q
6
Some Old Monopoly Business
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Some Old Monopoly Business
P
Find Price on the Demand Curve
Q
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Some Old Monopoly Business
P
ATC
Find ATC at this Output
Q
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Some Old Monopoly Business
P
Profit
ATC
Calculate Profit or Loss
Q
10
Suppose a Town Has One Power Company which is a
Monopoly
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Suppose a Town Has One Power Company which is a
Monopoly
P
Q
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Suppose a Town Has One Power Company which is a
Monopoly
Consumer Surplus
Loss
P
Q
13
Finishing Ch 16
Great! Two new kids on the block!
Yeah. We introduce Game Theory. Youll learn
about Mark-Up Pricing,too!
Micro Sink or swim? Think Win!
14
Ch 16 Outline

• Notes on Market Structure
• Oligopoly Models
• Duopoly
• Game Theory
• Other Models

15
The Spectrum of Market Structure
16
The Spectrum of Market Structure
Pure Competition Chapter 14
17
The Spectrum of Market Structure
Pure Competition Chapter 14
Pure Monopoly Chapter 15
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The Spectrum of Market Structure
Pure Competition Chapter 14
Pure Monopoly Chapter 15
Imperfect Competition Chapters 16 17
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The Spectrum of Market Structure
Pure Competition Chapter 14
Pure Monopoly Chapter 15
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Imperfect Competition is...

• market structures between perfect competition
  and monopoly.
• Characteristic of
• firms have competitors but. . . Are not price
  takers (So P gt MC).

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Imperfect Competition

• Two types
• Monopolistic Competition
• Like Perfect competition,but products not
  identical
• Oligopoly
• Few large sellers
• interdependence

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Markets with Few Big Sellers Oligopoly

• Because few sellers, actions of any seller
  can have large impact on profits of all other
  sellers.
• INTERDEPENDENCE

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Markets with only a Few Sellers Oligopoly

• Characteristics of Oligopoly Market
• Few sellers
• Interdependence among firms
• Best off by cooperating and acting like a
  monopolist -- restrict Q to raise P
• .

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Measuring Market Structure 4 Firm Concentration
Ratio

• Sum the market share of the four largest firms in
  the industry
• Example Suppose the respective market shares of
  the four largest producers are 25, 15, 10, 10
• The 4 Firm Ratio is 60 (25151010)

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Classifying Market Structure in Terms of 4 Firm
Concentration Ratios

• MONOPOLY 90 Market
• DOMINANT FIRM OLIGOPOLY top firm 50 Market
• TIGHT OLIGOPOLY Top Four firms 60 Market
• LOOSE OLIGOPOLY Top Four firms less than 60

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Market Structures Judged as Non-Competitive

• Monopoly
• Dominant Firm Oligopoly
• Tight Oligopoly

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Market Structures Judged as Effectively
Competitive

• Loose Oligopoly
• Monopolistic Competition
• Perfect Competition

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Share of Output Produced in Effectively
Competitive Sector

• 1939 - 52
• 1958 - 56
• 1988 - 77
• Reasons for rise Antitrust activity,
  Deregulation, International Competition

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Not the most visibly colorful chapter, but it IS
interesting.
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Ch 16 Outline

• Oligopoly Models
• Duopoly
• Game Theory
• Other Models
• Antitrust Laws

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Duopoly Just Two Producers

• Shiva Omar own the only 2 wells in a Desert
• No Costs Involved in Operating the Well
• So profit TR - TC TR
• The Demand they face...

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Market Demand Curve
Price
P60
D
0
Q 60
Quantity
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Quantity Price Total Revenue

• 20 100 2,000
• 30 90 2,700
• 40 80 3,200
• 50 70 3,500
• 60 60 3,600
• 70 50 3,500
• 80 40 3,200
• 90 30 2,700

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Duopoly Pricing Output One Case

• Step 1 Shiva and Omar each produce 30 gallons
• Price is 60.
• Total Profit 3,600
• thats 1,800 for each

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Quantity Price Total Revenue

• 20 100 2,000
• 30 90 2,700
• 40 80 3,200
• 50 70 3,500
• 60 60 3,600
• 70 50 3,500
• 80 40 3,200
• 90 30 2,700

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Duopoly Price Output

• Step 2, Omar produces 40 gallons, Shiva produces
  30.
• Market price falls to 50
• Total Profit falls to 3,500
• Omar gets 2000 (50x40)
• Shiva gets only 1500

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Quantity Price Total Revenue

• 20 100 2,000
• 30 90 2,700
• 40 80 3,200
• 50 70 3,500
• 60 60 3,600
• 70 50 3,500
• 80 40 3,200
• 90 30 2,700

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Duopoly Pricing Output

• Step 3 Shiva decides to produce 40 gallons
• Total output rises to 80
• Price falls to 40
• Total profit falls to 3,200
• Each earns 1,600

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Quantity Price Total Revenue

• 20 100 2,000
• 30 90 2,700
• 40 80 3,200
• 50 70 3,500
• 60 60 3,600
• 70 50 3,500
• 80 40 3,200
• 90 30 2,700

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Duopoly Price Output

• Step 4
• Note that if Omar increased output to 50.
• Total output rises to 90
• Price Falls to 30
• Total Profit falls to 2700
• Omar would only earn 1500 (50X30)

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If Duopolists Acted Like Monopolist
Price
P60
D
MR
MC
0
Q 60
Quantity
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If Acted Like Perfect Competitors
Price
D
P0
Supply
Q 120
Quantity
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If Duopolists Act Like Shiva Omar
Price
40
MR
D
MC
0
80
Quantity
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Lessons From Duopoly Example

• A duopoly (and oligopoly) market may result
  in
• 1 Collusion
• 2 Cartels
• 3 Interdependence
• 4 Price, Output Profits between Perf. Comp.
  Monopoly

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• Pursuit of self-interest .
• Production greater than monopoly but less than
  competitive level.
• prices lower than monopoly but greater than
  competitive.
• Profits less than monopoly

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Oligopoly Size and Market Outcome

• As number of sellers grows larger, market is more
  like a competitive market.

47
Finishing Ch 16
Great! Two new kids on the block!
Yeah. We introduce Game Theory. Youll learn
about Mark-Up Pricing,too!
Micro.. Sink or Swim? Think Win!
48
Game Theory Cooperation

• Game Theory studies how people behave in
  strategic situations.
• Strategic each firm considers how others
  might respond to its decisions

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Game Theory Cooperation

• Elements of Game Theory
• Players
• Strategies
• Payoff - Matrix (shows outcomes)

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The Prisoners Dilemma

• Dominant Strategy The best strategy for a player
  to follow regardless of the strategies pursued by
  other players.

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Advertising Game Theory Approach
Coca Cola
Ads
No Ads
C 0 P0
C -5 P 10
Ads
C 10 P -5
C 8 P 8
No Ads
Pepsi
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Advertising Game Theory Approach
Coca Cola
Ads
No Ads
C -10 P-10
C -5 P 5
Ads
C 5 P -5
C 12 P 12
No Ads
Pepsi
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How much to produce, feel troubled
lostEquate MR with Marginal Cost.

• Get real!!!
• Mark-up Pricing

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Mark-Up PricingGrungy Tooth Paste
G
Does Your Mouth Celebrate Christmas Colors every
day of of the yeargreen teeth .red gums?.
18
MC
10
100
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Mark-Up PricingGeneric Tarter Control Tooth Paste
OkaySo your tarter problem isnt as bad as
your dogs but your teeth are decaying faster
than the half-life of uranium...
T
12
MC
10
100
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Mark-Up Pricing
G
18
T
12
MC
10
100
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Mark-Up Pricing
G
D inelastic
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D elastic
T
12
MC
10
100
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Other Oligopoly Models

• The Kinked Demand Curve Model
• Dominant Firm Model
• Plateau Demand Model

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Kinked Demand Curve Model
Demand
MC
P
MR
Q
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Public Policy Toward Oligopolies

• Oligopolists have incentive to collude to
• Reduce production
• Raise prices
• Increase profits
• People in the same trade seldom meet together...
  but the conversation ends in a conspiracy against
  the public, or in some diversion to raise
  prices. (Adam Smith, 1776)

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Public Policy Toward Oligopolies

• From the standpoint of society, cooperation
  among oligopolists is undesirable

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Historical Notes

• What were the trusts? How did they evolve?
• Was monopoly power necessarily less in the US
  before, say, 1840 than by 1900? Why or why not?

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Historical Notes

• The History of the Standard Oil Company
• The original trust /Standards Organization
• Horror stories
• Vacuum Oil Company explosion
• The Widow Backus
• railroad rebates turn the screws
• not in business for our health

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Public Policy Toward Oligopolies

• Antitrust Laws
• Sherman Antitrust Act of 1890
• Illegal to
• restrain trade
• try to monopolize a market.

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Public Policy Toward Oligopolies

• Antitrust Laws
• Clayton Antitrust Act of 1914 outlawed
• price fixing
• price discrimination
• tying agreements
• interlocking directorates

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Public Policy Toward Oligopolies

• Antitrust Laws
• Cellar Kefauver Act (1950) outlawed
• direct purchase of rivals assets if this
  reduces competition

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Controversies over Antitrust Policy

• Sometimes the Antitrust Policies may not allow
  business practices that have potentially positive
  effects
• Resale Price Maintenance
• Tying
• Examples...

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Historical Notes

• How many towns in 1790 larger than 10,000?
• Which trade tended to be smallest 200 years ago?
  
• International
• interstate
• intrastate

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Historical Notes

• What geographic barrier made trade with the
  interior so slow?
• What were the breakthroughs that enabled trade
  with the West (today our midwest) circa 1825?
• What was the key transport innovation circa 1850?

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Historical Notes

• What did railroads do the size of markets?
• Point While firm size rose during late 19th
  Century, so did market size.
• Hence not so obvious that economy less
  competitive by end of 19th Century than at
  mid-century

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Controversies over Antitrust Policy

• Sometimes the Antitrust Policies may not allow
  business practices that have potentially positive
  effects
• Technological Change might be slowed

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Oligopolies and Prisoners Dilemma

• Self interest makes it difficult for the
  oligopoly to maintain the cooperative outcome
  with low production, high prices and monopoly
  profits.
• May lead to cartel cheating.
• Examples
• Iran and Iraq (Table 16-3)
• International arms race (Table 16-4)
• Cigarette Advertising (Table 16-5)

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Quick Quiz!

• What kind of agreement is illegal for businesses
  to make?
• Why are the antitrust laws controversial?

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Conclusion

• Oligopoly may look like monopoly or a
  competitive market, depending on how many firms
  there are.
• Oligopolies can attempt to cooperate with each
  other but are limited by laws.
• Antitrust laws are used to regulate oligopolists
  behavior.

The End!
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The Equilibrium for an Oligopoly

• Nash Equilibrium
• n (n 1)
• where n is the number of firms in the industry.
• If n 3, then the joint output would be 3/4 or
  75 of the competitive market

• Nash Equilibrium
• the joint output of the oligopoly firms
  (industry) would be less than the output of the
  competitive market.

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Quick Quiz!

• If the members of an oligopoly could agree on a
  total quantity to produce, what quantity would
  they choose?
• If oligopolies do not act together, do they
  produce a total quantity more or less than the
  previous question?

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Game Theory The Economics of Cooperation

• Prisoners Dilemma illustrates the difficulty in
  maintaining cooperation.
• Often people (firms) fail to cooperate with one
  another even when cooperation would make them
  better off.
• The Prisoners Dilemma Story
• Bonnie and Clyde Example

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Game Theory The Economics of Cooperation

• Prisoners Dilemma illustrates the difficulty in
  maintaining cooperation.
• Often people (firms) fail to cooperate with one
  another even when cooperation would make them
  better off.

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The Prisoners Dilemma

• Dominant Strategy The best strategy for a player
  to follow regardless of the strategies pursued by
  other players.

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The Prisoners Dilemma
Person 1 Decision
Choice 1
Choice 2
Payoff 1,1
Payoff 1,2
Choice 1
Person 2 Decision
Payoff 2,1
Payoff 2,2
Choice 2
81
Advertising Game Theory Approach
Coca Cola
Ads
No Ads
C 0 P0
C -2 P 10
Ads
C 10 P -2
C 12 P 12
No Ads
Pepsi