Rhett Smith Jon Michael Brooks Oligopoly Rhett Smith Jon Michael Brooks

Characteristics Dominated by a few large producers Large control over price Homogeneous or Differentiated products Mutual Interdependence Entry barriers: Economies of Scale Legal barriers Ownership and control of resources Pricing and strategic barriers

Industry Concentration % concentration ratio- reveals percentage of total output by an industry’s largest firms Considered an oligopoly when the 4 largest firms control more than 40% of the market Shortcomings: Localized market- ratios to nation as a whole, some products have highly localized markets Inter-industry competition- competition between two industries with similar products (aluminum and copper) World trade- Concentration ratios may overstate %s because they do not account for imported products Dominant firms- Ratios do not show the production of each firm in the concentration ratio Herfindahl index- shows the percentage of market shares by all firms (%S1)^2+(%S2)^2…..

Game Theory Model Shows the profit each firm can receive based on its own pricing strategy and the strategy of its rival. Remember: oligopolies are mutually interdependent so the decision of one firm affects the other.

Collusion Shows cooperation between rivals Adopts the strategy which gives the firms the highest profits There is a strong incentive to cheat from both firms. The price will most likely settle into the lower right corner because both will cheat.

Kinked Demand: Non-collusive Oligopoly Firms are rivals, do not cooperate Work against eachother Price increase, competitor ignores-Elastic demand Price decrease, competitor matches- Inelastic demand curve

Cartels and other Collusion If both firms have identical demand and cost conditions they can collude to set single common price Then each firms acts independently like a monopoly. This is assuming all firms charge at MR=MC

Types of Collusion Overt Collusion: Covert Collusion: Forms a cartel- creates a written agreement to divide up how much each producer will produce and charge Ex: OPEC Covert Collusion: Cartels are illegal in US but still exists in secret Consists of under the table collusion that is illegal

Obstacles to Collusion Demand and Cost differences- the costs and demands of even homogeneous products are different, causing a dispute on one acceptable price. Number of Firms- The more firms involved and the amount of market they control makes it difficult to collude Cheating- Firms secretly change prices in order to gain more profit Recession- firms become more desperate, cut prices and gain sales at the expense of rivals Potential Entry- Large profits that result from collusion attracts new firms which would reduce profits. Successful collusion requires blocking the entry of new firms Legal: Anti-trust laws: prohibits cartels and price-fixing

Price Leadership Model A implicit understanding by which oligopolist can coordinate prices without engaging in outright collusion based on formal agreements and secret meetings. Price adjustments are made infrequently because there is always the risk that rivals will not follow the lead. The price leader communicates price adjustments by publicizing the price change, and therefore seeks an agreement among competitors. The price leader try's to set prices at certain points so that other firms can not enter the market.

Advertising Positive & Negative Firms use advertising because they are less easily duplicated than price cuts. Positive Effects: Advertising reduces monopolies by putting smaller brand names out into the public so more people become familiar with them. Causing there to be more choices for a certain product. Negative Effects: Advertising can cause consumers to be mislead through false information and therefore buy a product that is sold at a higher price but is a worse product than one not advertised and better and sold at a lower price. If two firms in the same industry advertise equally they will gain little to no customers and they will lose profits.

Efficiency of the Oligopoly Productive efficiency- firms produce any good in the most cost efficient way. Allocated efficiency- firms produce the most popular good.