OLIGOPOLY

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OLIGOPOLY

• Chapter 16

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The Spectrum of Market Structures
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The Spectrum of Market Structures
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Imperfect Competition

• Market structures that fall between perfect
  competition and pure monopoly.

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Imperfect Competition

• Industries in which firms have competitors but do
  not face so much competition that they are price
  takers.

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Types of Imperfectly Competitive Markets

• Oligopoly
• ä Only a few sellers, each offering a similar
  or identical product to the others.
• Monopolistic Competition
• ä Many firms selling products that are similar
  but not identical.

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Oligopoly Markets With Only a Few Sellers

• Because of the few sellers, the actions of any
  one seller in the market can have a large impact
  on the profits of all the other sellers.

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Characteristics of an Oligopoly Market

• Few sellers offering similar or identical
  products
• Interdependent firms
• Best off cooperating and acting like a monopolist
  by producing a small quantity of output and
  charging a price above marginal cost

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Duopoly Example

• A duopoly is an oligopoly with only two members.
  It is the simplest type of oligopoly.

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Duopoly Example Demand Schedule for Water
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Duopoly Example Price andQuantity Supplied

• The price and quantity of water in a perfectly
  competitive market would be
• P MC 0
• Q 120 gallons
• The price and quantity in a monopoly market would
  be
• P 60
• Q 60 gallons

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Duopoly Example Price andQuantity Supplied

• The socially efficient quantity of water is 120
  gallons, but a monopolist would produce only 60
  gallons of water.
• So what outcome then could be expected from
  duopolists?

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Outcome from Duopoly Example

• The duopolists may agree on a monopoly outcome.
• ä Collusion
• â The two firms may agree on the quantity to
  produce and the price to charge.
• ä Cartel
• â The two firms may join together and act in
  unison.

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Nash Equilibrium

• Nash equilibrium is a situation in which economic
  actors interacting with one another each choose
  their best strategy given the strategies that all
  the others have chosen.

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Nash Equilibrium

• Nash Equilibrium
• n/(n 1)
• â where n is the number of firms in the
  industry.
• If n 2, then the joint output would be 2/3 of
  the competitive market.
• Qjoint 2/3(120 gallons) 80 gallons
• Qeach firm 80/2 40 gallons

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Equilibrium for an Oligopoly

• Possible outcome if oligopoly firms pursue their
  own self-interests
• ä Joint output is greater than the monopoly
  quantity but less than the competitive
  industry quantity.
• ä Market prices are lower than monopoly price
  but greater than competitive price.
• ä Total profits are less than the monopoly
  profit.

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Size of an Oligopoly and Market Outcome

• How increasing the number of sellers affects the
  price and quantity
• ä The output effect Because price is above
  marginal cost, selling more at the going price
  raises profits.
• ä The price effect Raising production lowers
  the price and the profit per unit on all units
  sold.

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Size of an Oligopoly and Market Outcome

• As the number of sellers in an oligopoly grows
  larger . . .
• . . . the market looks more and more like a
  competitive market.
• . . . the price approaches marginal cost.
• . . . the quantity produced approaches the
  socially efficient level.

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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?

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Quick Quiz!

• If oligopolies do not act together, do they
  produce a total quantity more or less than in the
  previous question?

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Game Theory and the Economics of Cooperation

• Game theory is the study of how people behave in
  strategic situations.

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Game Theory and the Economics of Cooperation

• Strategic decisions are those in which each
  person (firm) in deciding what actions to take,
  must consider how others (firms) might respond to
  that action.

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Game Theory and the Economics of Cooperation

• Because the number of firms in an oligopolistic
  market is small, each firm must act
  strategically.

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Game Theory and the Prisoners Dilemma

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

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The Prisoners Dilemma
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The Prisoners Dilemma

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

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The Prisoners Dilemma

• Cooperation is difficult to maintain, because
  cooperation is not in the best interest of the
  individual player.

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Oligopolies as a Prisoners Dilemma

• Self-interest makes it difficult for the
  oligopoly to maintain a cooperative outcome with
  low production, high prices, and monopoly profits.

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Oligopolies as a Prisoners Dilemma

• The monopoly outcome is jointly rational for the
  oligopoly, but each oligopolist has an incentive
  to cheat.

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An Oligopoly Examples of the Prisoners Dilemma
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An Oligopoly Example of the Prisoners Dilemma
Iraqs Decision
40 billion for each
Iraq gets 30 billion Iran gets 60 billion
High Production
Irans Decision
Iraq gets 60 billion Iran gets 30 billion
50 billion for Each
Low Production
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Other Examples of the Prisoners Dilemma
U.S. Decision
Arm
Disarm
U.S. at risk and weak USSR safe and powerful
Both countries at risk
Arm
USSRs Decision
U.S. safe and powerful USSR at risk and weak
Both countries safe
Disarm
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Other Examples of the Prisoners Dilemma
Marlboros Decision
Advertise
Dont Advertise
Marlboro gets 2 billion profit Camel gets 5
billion profit
3 billion profit for each
Arm
USSRs Decision
Marlboro gets 5 billion profit Camel gets 2
billion profit
4 billion profit for each
Disarm
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Why People Sometimes Cooperate

• Firms in oligopolies have a strong incentive to
  collude in order to reduce production, raise
  prices, and increase profits.
• Firms that care about future profits will
  cooperate in repeated games rather than cheating
  in a single game to achieve a one-time gain.

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Public Policy Toward Oligopolies

• Cooperation among oligopolists is undesirable.
• ä It leads to production that is too low.
• ä It leads to prices that are too high.

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Antitrust Laws

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

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Controversies over Antitrust Policy

• Antitrust policies sometimes may not allow
  business practices that have potentially positive
  effects
• ä Resale price maintenance
• ä Tying

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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

• An oligopoly may end up looking more like a
  monopoly or a competitive market, depending on
  the number of firms.

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Conclusion

• Oligopolies can attempt to cooperate with each
  other but are limited by laws.

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Conclusion

• Antitrust laws are used to regulate the behavior
  of oligopolies.

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OLIGOPOLY

• End of Chapter 16

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Number of Firms?
Many
firms
Type of Products?
Identical
Differentiated
One
Few
products
products
firm
firms
Monopolistic
Perfect
Monopoly
Competition
Oligopoly
Competition
(Chapter 15)
(Chapter 17)
(Chapter 16)
(Chapter 14)
Tap water
Novels
Wheat
Tennis balls
Cable TV
Movies
Milk
Crude oil
Figure 16-1