Microeconomics: Oligopoly Shaun Seidenberger “Shason” Jason Wilhelm 1B

Characteristics and Explanation ●Few large producers of differentiated or homogenous products o Number and type of firms can vary o Homogenous: Standardized products (industrial) o Differentiated: Consumer goods with non price competition and Ads ●Mutual Interdependence: Oligopolist can sets its prices but must consider how other firms will react (Burger King learns about McDonalds) ●Entry Barriers: Economies of Scale, Control of Resources, High Cost of Entry, Pricing/Advertising Strategies ●Mergers: Oligopolists merge and become more Monopolistic

Degree of Industry Concentration ●How much of an Oligopolistic Industry is based in the largest firms ●2 Ways: Concentration Ratios and Herfindahl Index o Herfindahl Index: Sum of all squared percentage market shares of all firms, gives larger weight to larger firms  (%S1)+(%S2)...+(%Sn) o CR: Reveal the percent of total output produced by the largest firms, when the largest 4 firms control at least 40% the industry is oligopolistic, shows us how competitive the industry is (4 firms have 5%) ●Interindustry Competition: When 2 products compete in different industries (Aluminum and Copper) ●Import Competition: Competition from foreign inputs

Game-Theory Model and Collusion ●Analyzes the pricing behavior of oligopolists using a payoff matrix o Payoff Matrices show the different payoffs (profits) resulting from each combination of strategies ●Based on the behavior of other firms in strategic situations ●Collusion: Cooperation with rivals, enhances profit for firms but tempts cheating for more profits

Noncollusive Oligopoly

Cartels and other Collusion ●Cartel: group of producers (collusion) that typically creates a written formal agreement specifying how much each member will produce and charge. -- Overt collusion that is open to view. Illegal in the US. -- Output must be controlled and the market must be divided up to maintain the agreed-upon price ●Covert Collusion: Cartels are illegal, so firms secretly agree to collude. --Tacit Agreement: Vocal agreement secretly and easily made for market price. Difficult to detect.

Cartels and Other Collusion ●Cartels and other collusive arrangements are usually difficult to create and maintain. ●Barriers to collusion include: o Demand and Cost Differences: the variations in cost and demand curves between firms make profit maximizing prices to differ o Number of Firms: generally, the more firms in an industry, the more difficult it is to set and keep a price o Cheating: firms are tempted to cheat and secretly cut prices to increase sales and profits o Recession: an economic recession leads to the increase in ATC, so firms will cut prices to increase sales at the expense of rivals o Potential Entry: collusion can create large profits and higher prices which entice new firms to enter the market o Legal Obstacles (Antitrust Laws): the US government has set up laws that prohibit cartels and price-fixing collusion so overt collusion is banned

Price Leadership Model

Advertising (Positive vs. Negative) ●Positive Effects: Can give consumers product characteristics and prices, increases efficiency and competition between firms ●Negative Effects: Used to manipulate or persuade consumers, advertising costs within an industry are so high they are a barrier to entry ●Self-Canceling Advertising: When two firms compete in advertising but it does not change the demand for a product since it is based off of each firm so product price just increases

Efficiency of the Oligopoly ●One view: Oligopolists always receive profit so productive (P= min ATC) and Allocative (P=MC) Efficiency are not likely to occur ●Second View: Informal Collusion (collusion that is not regulated in any way) may yield a situation similar to a pure monopoly but this view has 3 qualifications - Increased Foreign Competition, Limit Pricing, and Technological Advances