Comparison of Market Structures Competitive Monopoly Oligopoly Large number of firms One firm Small number of interdependent firms* Free entry and exit Barriers to entry Homogenous product One product / no substitutes Could be homogenous or differentiated products * “Interdependent” means that the actions of one firm affect the other firms.

Comparison of Market Structures Pure Competition Monopolistic Competition Oligopoly Monopoly Tacit Collusive More Competitive Less Competitive Common in the real world Rare in the real world

Collusive Oligopoly Collusion: An agreement among firms to fix prices, or divide the market between them, so as to limit competition and maximize profit Cartel (or formal collusion) a formal agreement between firms in an industry to form a collusive oligopoly, i.e., to take action to limit competition in the industry The best known cartel is OPEC, the Organization of Petroleum Producing Nations Some sports leagues (e.g., the National Football League in the US) are also cartels There aren’t many other examples because formal collusion is illegal in most countries

Collusive Oligopoly Draw a diagram showing how a cartel determines its output quantity. (Hint: this is the same as asking “how does a cartel maximize its profits”.)

Cartel Price & Output Decisions Price and Output Decision – Collusive Oligopoly Cartel Price & Output Decisions How do you think this cartel could allocate production capacity among its members?

Cartel Price & Output Decisions Price and Output Decision – Collusive Oligopoly Cartel Price & Output Decisions How do you think this cartel could allocate production capacity among its members? Many methods: historical output, size of assets, size of local market, etc. They could also agree compete for market share on a non-price basis

Collusive Oligopoly Using a diagram, explain why cartels are illegal in most countries.

Efficiency Loss in Collusive Oligopoly Social Surplus In Pure Competition Social Surplus In Collusive Oligopoly TR Quantity is reduced and price is increases, relative to pure competition This hurts consumers (reduced surplus) and creates deadweight loss The reduced output also means that resources are being under-allocated to this product

Pure Competition is Productively Efficient in the Long Run Efficiency Loss in Collusive Oligopoly Pure Competition is Productively Efficient in the Long Run Monopoly Is Not TR Not at minimum Because a cartel produces at a point where average total costs (ATC) are not minimized, it is also productively inefficient I.e., It is not producing at the lowest possible cost (the economy will be inside the production possibilities frontier)

Obstacles to Forming and Maintaining Cartels Threat of legal sanctions Incentive to cheat Recessions Lack of a dominant firm Potential entry into the market Cost differences among firms Product differentiation leads to different demand curves Larger numbers of firms are harder to control

Game Theory – The Prisoner’s Dilemma You are in the space travel industry. There is one rival company. You are trying to determine what price to charge for a moon trip. Moon trips are very expensive luxury goods, so customers are price sensitive. Therefore, if charge a bit less than your rival, you can take many of his/her customers.

Game Theory – A Beautiful Mind http://www.youtube.com/watch?v=CemLiSI5ox8

Comparison of Market Structures Competitive Monopoly Oligopoly Large number of firms One firm Small number of interdependent firms* Free entry and exit Barriers to entry Homogenous product One product / no substitutes Could be homogenous or differentiated products * “Interdependent” means that the actions of one firm affect the other firms.

Game Theory: a mathematical technique used to analyze competitive situations where the outcome of a participant’s choice depends on the actions of other participants E.g., the prisoners dilemma; the blonde or the brunettes Can you think of any others?

Game Theory: a mathematical technique used to analyze competitive situations where the outcome of a participant’s choice depends on the actions of other participants This is one of the characteristics of oligopoly – “small number of interdependent firms” This interdependence leads to conflicting incentives: Incentive to collude: leads to reduced uncertainty (re: competitor behavior) and higher total industry profit => a bigger total pie Incentive to compete: to capture market share from rivals => a larger slice of the pie

Strategic Interdependence In summary, oligopolies are characterized by strategic interdependence Firms plan their actions based on guesses about what their rivals will do

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= Economic Growth Less Government Revenues Government Expenditures Budget Surplus or Deficit* = Less * Surplus if positive, deficit if negative