Strategic Decisions Making in Oligopoly Markets Today's lectures will look at Oligopoly markets Features of Oligopoly Interdependence between Oligopoly firms Game theory

Oligopoly Competition between the few May be a large number of firms in the industry but the industry is dominated by a small number of very large producers Concentration Ratio – the proportion of total market sales (share) held by the top 3,4,5, etc firms: A 4 firm concentration ratio of 75% means the top 4 firms account for 75% of all the sales in the industry

Oligopoly Example: Music sales – The music industry has a 5-firm concentration ratio of 75%. Independents make up 25% of the market but there could be many thousands of firms that make up this ‘independents’ group. An oligopolistic market structure therefore may have many firms in the industry but it is dominated by a few large sellers. Market Share of the Music Industry 2002. Source IFPI: http://www.ifpi.org/site-content/press/20030909.html

Oligopoly Features of an oligopolistic market structure: Price may be relatively stable across the industry – kinked demand curve? Potential for collusion Behaviour of firms affected by what they believe their rivals might do – interdependence of firms Goods could be homogenous or highly differentiated Branding and brand loyalty may be a potent source of competitive advantage Non-price competition may be prevalent Game theory can be used to explain some behaviour AC curve may be saucer shaped – minimum efficient scale could occur over large range of output High barriers to entry

Strategic Decisions Making in Oligopoly Markets What is Strategic behavior???? NB Interdependence of firms profits the distinguishing characteristics of oligopoly markets arises when the number of firms in a market is small enough that every firms output and decision affects the demand and MR condition of every other firm

Decision Making when Rivals make simultaneous decisions What is Game Theory????? What is a game???? What is a simultaneous decision game????

Decision Making when Rivals make simultaneous decisions What is the prisoners dilemma??? What is the payoff table?????

Decision Making when Rivals make simultaneous decisions Don’t Confess Confess A 2 year, 2 years B 12 years, 1 year C 1 year, 12 years D 6 years, 6 years

Decision Making when Rivals make simultaneous decisions What is common knowledge???? What is dominant strategy?????

Decision Making when Rivals make simultaneous decisions NB When a dominant strategy exists an action that always provides a manager with the best outcome no matter what action the managers rival chooses to take A rational decision maker always chooses to follow its dominant strategy and predict that if its rivals have dominant strategies they also choose to follow their dominant strategies

Decision Making when Rivals make simultaneous decisions What is dominant strategy equilibrium??? NB A prisoners dilemma arises when all rivals possess dominant strategies and in dominant strategy equilibrium they all are are worse off than if they colluded

Decision Making when Rivals make simultaneous decisions High ($10) Low ($6) A ($1000,$1000) B ($500,$1200) Low($6) C ($1200,$300) D ($400,$400)

Decision Making when Rivals make simultaneous decisions Dominant strategy for Palace is to charge $6 however castle does not have a dominant strategy. B is the dominant strategy. NB When a firm does not have a dominant strategy but at least one its rivals does have a dominant strategy the firms manager can predict with confidence that its rival will follow its strategy.

Decision Making when Rivals make simultaneous decisions The manager can choose its own best strategy knowing the actions that will almost certainly be taken by those rivals possessing dominant strategies. What are dominated strategies????

Successive Elimination of Dominated Strategies What is successive elimination of dominated strategies????? Study table 13.3 Dominant strategy C

Making Mutually Best Decisions What is Nash Equilibrium???? NB In order for all firms in an oligopoly to be predicting correctly each others decision. Managers cannot make best decisions without correct predictions- all firms be choosing individually best actions given the predicted actions of their rivals which they can then believe are correctly predicted.

Making Mutually Best Decisions NB Nash decisions are likely to be chosen because Nash sets are mutually best and thus strategically stable. No firm can do better unilaterally its decision Non- Nash are unlikely to be chosen because at least one firm can do better by unilaterally changing its actions

Making Mutually Best Decisions Study table 13.4 Nash equilibrium is A $50, $40 Why doesn’t coke and pepsi collude????

Making Mutually Best Decisions NB When managers faces a simultaneous decision possessing a unique Nash equilibrium set of decisions rivals can be expected to make the decisions to lead to the Nash equilibrium. If there are multiple Nash equilibria there is generally no way to predict the likely outcome.

Strategic Moves Commitments, Threats and Promises What is a strategic move???? What is credible???? What is commitments????

Strategic Moves Commitments, Threats and Promises What is a threat???? What is a promise?????

Cooperation in Repeated Strategic Decisions What is cooperation???? What are repeated decisions????? Lets study table 13.5

Cooperation in Repeated Strategic Decisions What is cheating????? What is punishment for cheating???? NB Cooperation is possible in every prisoners dilemma decision but cooperation is not strategically stable when the decision is made only once.

Cooperation in Repeated Strategic Decisions In one time prisoners dilemma there can be no future consequences from cheating so both firms expect the other to cheat which then makes cheating their best response. What is the punishment for cheating????

Trigger Strategies for Punishing Cheating What are trigger strategies????? What are tit for tat strategies???? What are grim strategies????

Pricing Strategies that Facilitate Cooperation Facilitating practices What are price matching???? What are sale price guarantee????

Pricing Strategies that Facilitate Cooperation What is public pricing???? What is price leadership???? What is a cartel????

Pricing Strategies that Facilitate Cooperation What is tacit collusion???? What is strategic entry deterrence????