Oligopoly Microeconomics

TPS  Write down the name of an industry which has just a few huge companies. Think of two firms which use ads to ‘steal’ consumers from each other.  Coke and Pepsi  Apple and Microsoft  United Airlines and Delta

Defining Oligopoly  Oligopolists are … A few firms which are the only producers of a good.  These firms set the P of their products  They have a degree of Market Power.  A monopoly is …  An industry controlled by oligopolists.

Defining Oligopoly  Key characteristics are …  A few large firms  Produce almost all the total output in the industry  Strong barriers to entry  Product could be …  Identical (oil)  Differentiated (cars)  Strategic behavior and mutual interdependence  advertising

Defining Oligopoly  Key characteristics are …  Strategic behavior and mutual interdependence  The actions of one firm have an impact on another large firm  Honda v. Toyota  Advertising  Super Bowl ads

Is It an Oligopoly or Not?  Level of Concentration in the Market  Concentrated OJ  Very dense  100% of market share  Monopoly

Is It an Oligopoly or Not?  Level of Concentration in the Market  Concentrated OJ in swimming pool  Very diluted – taste little OJ  Small % of market share  Perfect Competition

Is It an Oligopoly or Not?  Level of Concentration in the Market  Concentrated OJ in a pitcher with little water  Thick and syrupy  Very concentrated  Auto industry  Oligopoly  Large portions of market share  Ologopoly

Is It an Oligopoly or Not?  Statistical Measure  Four-firm Concentration Ratio (CR4)  Sum of the market share of the 4 largest firms in the industry  Industry A is closer to being an oligopoly AB 30%12% 20%10% 8% 5%4% CR4 = 65%CR4 = 34%

Oligopoly Question Which of the following is true for an oligopoly? I. There are a few firms, each with a large market share. II. The firms in the industry are interdependent. III. The industry experiences diseconomies of scale. a.I only b.II only c.III only d.I and II only e.I, II, and III

Defining Oligopoly  A Duopoly is …  Two firms which have most of the market share.  Colluding is …  to act together through a secret understanding, especially with evil or harmful intent.  to conspire in a fraud.

A Duopoly Example There are only two gas stations in the small rural town of Boonetuckey. These gas stations, Alyssa’s Quickee Stop and Oscar’s Pump Station, are duopolists in the gasoline market. They each sell 50% of all the gas in town.

Boonetuckey Gasoline Demand Schedule MC = $1/gallon of gas PC Market – P = MC = $1 What is the TR these firms would split? $1400 How much TR would each firm receive? 1400/2 = $700 P/GallonQdTR $8.000$

Boonetuckey Gasoline Demand Schedule MC = $1/gallon of gas Oligopoly Market Alyssa and Oscar decide to collude. They decide to charge $4/gallon. They decide to sell 800 gallons total. How many gallons does each one sell? 800/2 = 400 gallons What is the total TR? $3200. How much TR does each receive? 3200/2 = $1600 P/GallonQdTR $8.000$

Boonetuckey Gasoline Demand Schedule What is one of them cheats?!!! Alyssa decides she can secretly sell an additional 100 gallons of gas! Consequences????? How many gallons now being sold? 900 = Price is now equal to ????? $3.50/gallon What is Alyssa’s new TR? Is it more or less? $3.50 * 500 = $1750 What is Oscar’s new TR? Is it more or less? $3.50 * 400 = $1400 P/GallonQdTR $8.000$

Collusion Agreements ILLEGAL

Games Oligopolists Play  Close Rivals compete with each other.  Choices made by each player affect the outcomes for both.  They are mutually interdependent.  Game Theory is …  The study of how interdependent decision makers make choices.  Payoff Matrix shows …  How the payoff to each player depends on the actions of both.

Games Oligopolists Play  Dominant Strategy is one that …  Outperforms any other strategy  NO MATTER WHAT strategy your opponent selects.  It is possible to NOT HAVE a dominant strategy!!  What is Player 1’s dominant strategy?  defect  What is Player 2’s dominant strategy?  No dominant strategy

Games Oligopolists Play  A Nash Equilibrium is when …  The game ends with both players happy with the outcome, given the choice made by their rival.  What is GM’s dominant strategy?  confess  What is FORD’s dominant strategy?  Confess GM AdvertiseDon’t Advertise FORDAdvertiseFord: $100 GM: $100 Ford: $150 GM: $50 Don’t Advertise Ford: $50 GM: $150 Ford: $50 GM: $50

Games Oligopolists Play  A Prisoners’ Dilemma is when …  Players pursue their dominant strategy  The game comes to a Nash Equilibrium.  The outcome is undesirable.  Could have been avoided with a cooperative agreement (collusion). Rivals have an opportunity to cooperate (collusion) but someone chooses to cheat on the agreement.

Games Oligopolists Play  Two crooks have been caught by the police on suspicion of a major crime. However, the cops cannot prove they are the robbers without a confession.  What is Crook 1’s dominant strategy?  confess  What is Crook 2’s dominant strategy?  Confess Crook 2 ConfessSilent Crook 1Confess#1: 5 years #2: 5 years #1: 1 #2: 20 Silent#1: 20 #2: 1 #1: 2 #2: 2

PUBLIC POLICY TOWARD OLIGOPOLIESRestraint of Trade and the Antitrust Laws  Antitrust laws make it illegal to restrain trade or attempt to monopolize a market.  Sherman Antitrust Act of 1890  Clayton Act of 1914

Tacit Collusion and Price Wars  Tacit Collusion is …  Firms agree to keep the price above competitive levels  Tacit Collusion does not usually work because …  Large number of firms =  easier to ‘cheat’  Easier for other firms to enter the industry  Complex Products and Pricing Schemes  Too many options  Think Verizon and AT&T phones and service plans

Tacit Collusion and Price Wars  Tacit Collusion does not usually work because …  Firms have quite diverse characteristics and interests  Varied countries, states, labor union agreements, suppliers  Bargaining power of buyers  Breakfast cereal companies sell to large grocery chains