Topics in oligopoly

2 Market definition The product market: –Cross price elasticities –Price correlations –The SSNIP test –Examples The geographic market

3 Market power As the number of firms in the industry increases, oligopoly solutions approach perfect competition (try with Cournot). The Lerner index of market power. Concentration measures: C k and H. The use of H in merger policy (US and EU Guidelines).

4 Market power L=H(1+  )/  The value of the conjectural variation  under several models. As  decreases (increases), competition is intensified (softened). Strategic substitutes and strategic complements and the slope of reaction curves.

5 Product differentiation Vertical differentiation Horizontal differentiation. The importance of search costs and of switching costs.

6 Advertising Informative versus persuasive advertising. Search goods, experience goods, (credence goods). Advertising as a signal of product quality. Advertising and welfare. Other examples of signaling.

7 Advertising The Dorfman-Steiner condition: a/R , where  =demand elasticity to advertising. Concentration and advertising. Market competition and advertising.

8 Entry barriers Learning. Scale economies. Free entry and social welfare. Strategic entry barriers (preemption): –Excess capacity –Product proliferation –Brand proliferation –Exclusive dealing (Coca-Cola)

9 Deterring entry / Inducing exit Predation. Difficult to prove. Other motives. Bundling and tying. Merging as means of supressing a rival and softening competition.

10 Mergers Merger motives: –Suppress rival –Generate synergies by combining assets / complementary capabilities –Increase buyer or seller power –Enter in a new market Profitability effects (upon participants) versus welfare effects (upon participants, nonparticipants, and consumers).

11 Mergers Eliminate fixed costs and increase efficiency (lower marginal cost). Merger effects under quantity competition. Merger effects under price competition. Recall: strategic substitutes and strategic complements. The Williamsom trade-off in horizontal mergers.

12 Mergers Merger defences: –Efficiency –Bargaining power –Contestable markets –Failing firm Merger waves. Collusion effects. Sequential mergers.

13 Mergers The antitrust authority’s objective: consumer surplus (look at price variation); external welfare. The concentration index H as a measure of the social desirability of the merger. The informativeness of the insiders’ market share (lower market share implies lower price increase). The antitrust authority’s decision horizon.

14 Network externalities Utility derived from consumption increases with number of users. Examples: phone, , fax, modem, a given software, a given technology. Network externalities are typical in information technology. (In fashion there is usually an upper bound to network externalities).

15 Network externalities Easier communication and more assistance. Critical mass of buyers to build up the network (snowball effect). Importance of early adopters. Introductory low price/free samples/allow copies.

16 Network externalities Excess inertia: change technology only if others do. Switching technology may become very costly (high switching costs): lock-in. Ex: Microsoft Windows. Excess momentum.

17 Network externalities Network compatibility and standardization (the videos case): –Benefits consumers, but less variety –Decreases product differentiation (less variety), so increases firm competition –Critical mass becomes less important