Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 1 Chapter 13 Oligopoly

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 2 Learning Objectives Define oligopoly in greater detail than in Chapter 8, assess its occurrence, and note the reasons for its existence. Examine the behaviour of oligopoly in terms of a simple game theory framework.

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 3 Learning Objectives (cont.) Survey four models of the possible courses of price–output behaviour that oligopolistic industries might follow. Discuss the role of non-price competition, that is, competition on the basis of product development and advertising in oligopolistic industries. Provide some comments on the economic efficiency and social desirability of oligopoly.

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 4 Characteristics of Oligopoly ‘Fewness’: few firms dominate the market – Firms are mutually interdependent and must consider the possible reactions of rivals to its price and product development decisions – Firms may collude or act independently

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 5 Characteristics of Oligopoly (cont.) Product differentiation? – Homogeneous or differentiated product – Examples:  Petroleum products  Aluminium  Insurance  Motor vehicles Concentration ratios: the percentage of total industry sales accounted for by a given number of the largest firms in each industry

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 6 Characteristics of Oligopoly (cont.) High Barriers to Entry Causes – Economies of scale – Mergers  Give firms more market power, influence, etc. – Ownership of patents, copyrights – Control of strategic raw materials – Technological progress

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 7 Oligopoly Behaviour: A Game Theory Approach Compare the behaviour of oligopolists to a simple duopoly game of strategy, actions and pay-offs as shown in the profit pay-off matrix Mutual interdependence – the fate of one firm lies partially or wholly with the performance or decisions of other firms in that same industry Incentives to collude Incentive to cheat

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 8 Profit Pay-offs for a Duopoly Giant’s pricing strategy HighLow Big’s pricing strategy High Low $12m $6m $8m $15m A C B D

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 9 Maximin Strategies and Optimal Pricing Strategy Maximin strategies Strategies chosen by players in a game to maximise their minimum expected pay-off from the game

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 10 Price–Output Behaviour in Four Models Four Models of Oligopoly – the kinked demand curve – collusive pricing – price leadership models – cost-plus pricing No standard model of oligopoly due to: – diversity – interdependence

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 11 Kinked Demand: Non- Collusive Oligopoly Model Output occurs where MR = MC Price remains stable over a variety of cost scenarios – Avoiding price wars – Firms ignore price increases – Firms match price decreases Criticisms – How is the current price set? – Prices may not be as inflexible as model suggests

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 12 The Kinked Demand Curve P Q D1D1 MR 1 The firm’s demand and marginal revenue curves

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 13 The Kinked Demand Curve P Q D1D1 MR 1 The rival’s demand and marginal revenue curves MR 2 D2D2

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 14 The Kinked Demand Curve P Q D1D1 MR 1 MR 2 D2D2 Rivals tend to follow a price cut

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 15 The Kinked Demand Curve P Q D1D1 MR 1 MR 2 D2D2 Rivals tend to follow a price cut or ignore a price increase

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 16 The Kinked Demand Curve P Q D1D1 MR 1 MR 2 D2D2 Effectively creating…

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 17 The Kinked Demand Curve P Q D1D1 MR 1 Effectively creating a kinked demand curve P X Q D2D2 MC 2 MC 1 MR 2

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 18 Collusion and Cartels Overt or covert agreements to fix prices, divide up or share the market or limit competition between firms Output and price: same as a monopolist Forms – Cartels  groups of firms that agree either formally or informally to set prices and output levels of a product among members – ‘Gentlemen’s agreements’  groups of firms agree verbally to set prices and output levels, usually in an informal setting such as a golf course

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 19 Economic Profit Collusion and Profit Maximisation Q MC ATC P MR Price Q MR = MC D

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 20 Obstacles to Collusion Demand and cost differences between firms Numbers of firms Cheating Recession Legislative obstacles: Trade Practices Law

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 21 Price Leadership: Tacit Collusion Model Price leadership A type of gentlemen’s agreement in which oligopolists automatically follow the price initiatives of the dominant firm in an industry

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 22 Price Leadership: Tacit Collusion Model (cont.) Infrequent price changes by price leader Price announcements often made through indirect channels such as trade publications Price leader may choose strategies to block potential entrants: limit-pricing or price blocking

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 23 Cost-Plus Pricing Model An oligopolist uses a standard formula to estimate cost per unit of output and adds a mark-up to determine price Advantages for multi-product firms Consistent with outright collusion

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 24 Non-Price Competition Oligopolists dislike competing on price Oligopolists must rely on non-price competition – advertising – product development Oligopolists typically have substantial resources to support non-price competition

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 25 Oligopoly and Economic Efficiency Productive inefficiency – Minimum ATC is not necessarily chosen  under-allocation of resources Allocative inefficiency: – Price does not necessary equal MC  output is restricted

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 26 Oligopoly and Economic Efficiency (cont.) Dynamic efficiency: Long-term improvements in product quality and production methods may occur – competitive view – Schumpeter–Galbraith view Technical progress: the evidence

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 27 Next Chapter: The Demand for Economic Resources