Oligopolyslide 1 OLIGOPOLY Market in which there are few firms, so individual firms can affect market price. Interdependence of firms is an important characteristic. The demand curves for the individual firms are dependent on the pricing and marketing decisions of competitors. Strategy becomes important to firms in oligopoly.

Oligopolyslide 2 Barriers to entry are an especially important part of oligopoly behavior: 1) Xerox and patents 2) Aluminum and control of bauxite deposits 3) Breakfast cereals,beer, and economies of scale in advertising 4) Daily newspapers

Oligopolyslide 3 Of the many different models of oligopoly, we will examine only two in class: 1) The collusion or cartel model. 2) Cooperation games based on the Prisoners' Dilemma.

Oligopolyslide 4 CARTELS Cartels are usually illegal in the U.S. because of antitrust laws, but some industries and kinds of firms are exempt. In addition, some instances of cartel-like behavior may simply not have been prosecuted. Cartel is a form of collusion in which the member firms in an industry try to agree on all aspects of pricing and output for the individual firms.

Oligopolyslide 5 EXAMPLES OF CARTELS OR COLLUSIVE BEHAVIOR OPEC DeBeers Some professional sports, including the NCAA. Labor unions (legal in the U.S.). Agricultural cooperatives (legal in the U.S.).

Oligopolyslide 6 A cartel that wants to maximize the collective profits of the members should operate just like a monopolist with more than one plant. Marginal cost (for each cartel member) must equal marginal revenue in the market.

Oligopolyslide 7  MC $/Q Q D MR P* Q* COFFEE MARKET A coffee cartel would set price and quantity at P* and Q*. Quotas would be ideally allocated to the members by having them produce at the same level of marginal cost. This is the sum of the MC curves of the members.

Oligopolyslide 8 Cartels are not without their problems. The most important problem is keeping members from striking out on their own, that is, cheating on the cartel agreement. Examples:

Oligopolyslide 9 Prisoners' Dilemma A crime is committed, and two suspects are arrested. The police separate the suspects, John and Alice, into separate interrogation rooms. The cops give John and Alice the following "deal":

Oligopolyslide 10 "If you both remain silent, we can only get you on the lesser charge of trespassing, and you get 3 months in jail each." "If you remain silent, and your partner confesses and implicates you, you'll get 5 years in jail. Your partner will go free." ”If you both confess, you'll each get 2 years in jail."

Oligopolyslide 11 Here's a summary of the outcomes: 2 years 3 months 5 years go free Confess Don't confess John Alice

Oligopolyslide 12 The Dominant Strategy for both people is to confess. But they both could be better off not confessing. Cooperation (agreeing between themselves not to confess) is very difficult because there is an incentive for each to cheat.

Oligopolyslide 13 Here's a real world pricing problem that can be studied using the Prisoners' Dilemma. P&G and Unilever are pricing a uniform product (like bleach). The "payoff matrix" is given on the next slide. What should P&G's pricing policy be?

Oligopolyslide 14 The payoffs are dollars of profit per month. Unilever's payoffs are at the top right of each cell. 12,000 20,000 11,000 3,000 29,000 21,000 P=$1.40 P=$1.50 Unilever P&G

Oligopolyslide 15 Note that cooperation leads to the most profits, but the dominant strategy may well be chosen. Should P&G just charge $1.50 and hope for the best? What if they are entering a new market with these payoffs?