Imperfect Competition Market structures that fall between perfect competition and pure monopoly. 7

Imperfect Competition Industries in which firms have competitors but do not face so much competition that they are price takers. 7

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. 8

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. 9

Characteristics of an Oligopoly Market Few sellers offering similar or identical products Interdependent firms In the long run, best off cooperating and acting like a monopolist by producing a small quantity of output and charging a price above marginal cost 10

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

Outcome from Duopoly Example The duopolists may agree on a monopoly outcome. ä Collusion - The two firms may agree on the quantity to produce and the price to charge. ä Cartel - The two firms may join together and act in unison. 11

Collusion Example Apple Inc. and several major publishers were accused by the U.S. government of conspiring to fix prices of e-books and limit retail price competition, according to a lawsuit filed on Wednesday, April 11th. "Apple facilitated the publisher defendants' collective effort to end retail price competition by coordinating their transition to an agency model across all retailers," according to the complaint, filed in Manhattan federal court by the anti-trust division of the U.S. Department of Justice. The publishers include Hachette Book Group, HarperCollins, MacMillan, Penguin Group, Pearson Plc and Simon & Schuster, a unit of CBS Corp. 11

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. 21

Obstacles to Collusion Cheating Demand and Cost Differences Number of Firms Profit Incentive/Entry/Exit Recessions Legal Obstacles 21

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. 22

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 23

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. 12

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. 14

Quick Quiz! If the members of an oligopoly could agree on a total quantity to produce, what quantity would they choose? 15

Quick Quiz! If oligopolies do not act together, do they produce a total quantity more or less than in the previous question? 15

Game Theory and the Economics of Cooperation Game theory is the study of how people behave in strategic situations. 16

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. 16

Game Theory and the Economics of Cooperation Because the number of firms in an oligopolistic market is small, each firm must act strategically. 16

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. 17

The Prisoners’ Dilemma The dominant strategy is the best strategy for a player to follow regardless of the strategies pursued by other players. A strategy is dominant if, regardless of what any other players do, the strategy earns a player a larger payoff than any other. Hence, a strategy is dominant if it is always better than any other strategy, for any profile of other players' actions. (Gametheory.net) 19

The Prisoners’ Dilemma Cooperation is difficult to maintain, because cooperation is not in the best interest of the individual player. 19

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. 20

Oligopolies as a Prisoners’ Dilemma The monopoly outcome is jointly rational for the oligopoly, but each oligopolist has an incentive to cheat. 20

The Prisoners’ Dilemma Person #1 Decision Choice # 1 Choice # 2 Person # 2 Decision Payoff 1,1 2,1 1,2 2,2 18

An Oligopoly Examples of the Prisoners’ Dilemma 20

An Oligopoly Example of the Prisoners’ Dilemma Iraq’s Decision High Production Low Production Production High $40 billion for each Iraq gets $30 billion Iran gets $60 billion Iran’s Decision Iraq gets $60 billion Iran gets $30 billion $50 billion for Each Low Production

Other Examples of the Prisoners’ Dilemma U.S.’ Decision Arm Disarm U.S. at risk and weak USSR safe and powerful Arm Both countries at risk USSR’s Decision U.S. safe and powerful USSR at risk and weak Both countries safe Disarm

Other Examples of the Prisoners’ Dilemma Marlboro’s Decision Advertise Don’t Advertise Marlboro gets $2 billion profit Camel gets $5 billion profit Advertise $3 billion profit for each Camel’s Decision Marlboro gets $5 billion profit Camel gets $2 billion profit Don’t Advertise $4 billion profit for each

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. A Nash equilibrium is a set of strategies from which neither side wants to independently deviate.  13

Nash Equilibrium Brewer’s-Fries and Royal’s-Burgers is a Nash equilibrium because starting from that set of strategies, the Brewer’s wouldn’t want to independently change their strategy to Burgers because by doing so, they would receive 50 instead of 150. Similarly, the Royal’s wouldn’t want to independently change their strategy because by doing so they would go from receiving 120 to receiving 85. 13

Nash Equilibrium Named for John Nash. Game theory concept. Optimal outcome of a game is such that no player has incentive to change her action even after considering an opponent’s choice. Overall, an individual can receive no incremental benefit from changing actions, assuming other players remain constant in their strategies. Shor, Mikhael, “Nash Equilibrium," Dictionary of Game Theory Terms, Game Theory .net, <http://www.gametheory.net/dictionary/ url_of_entry.html> Web accessed: date_of_access 13

Controversies over Antitrust Policy Antitrust policies sometimes may not allow business practices that have potentially positive effects: ä Resale price maintenance ä Tying 24

Quick Quiz! What kind of agreement is illegal for businesses to make? Why are the antitrust laws controversial? 25

Conclusion An oligopoly may end up looking more like a monopoly or a competitive market, depending on the number of firms. 26

Conclusion Oligopolies can attempt to cooperate with each other but are limited by laws. 26

Conclusion Antitrust laws are used to regulate the behavior of oligopolies. 26