Oligopoly in Practice A.P. Microeconomics Ms. McRoy

“Aim”  How important are oligopolies in “real life”?

How do oligopolies work in practice?  That depends on: The legal framework The firms’ abilities to cooperate without formal agreements (e.g. tacit collusion vs. price wars)

The Legal Framework  Oligopolies first became an issue in the 2 nd half of the 19 th century. Growth of railroads created a national market for oil and steel. These industries quickly formed cartels. Sherman Antitrust Act of  Antitrust policy: efforts by the government to prevent oligopolistic industries from becoming or acting like monopolies.

Anti-Trust Law Actions  The breakup of Standard Oil (1911) Standard Oil Co. of NJ v. United States  Standard Oil of NJ  Exxon  Standard Oil of NY  Mobil  The breakup of Bell Telephone United States v. AT&T (1982) “Ma Bell” broken up into “22 Baby Bells”  Bell Atlantic (now Verizon Communications)  BellSouth (acquired by AT&T in 2006)  Southwestern Bell (acquired by AT&T in 2005)

Recent Actions Against Cartels  Amnesty programs allowing price-fixers to receive a much-reduced penalty if it provides information on co-conspirators.  Congress has substantially increased fines levied upon conviction.

Factors Affecting Tacit Collusion  Large Number of Firms Difficult to monitor price and quantity levels Provides less incentive to behave cooperatively  Complex Products and Pricing Schemes Oligopolists don’t typically sell one, identical product (e.g. Walmart)  Differences in Interest How to split industry profit? What if a new entrant has lower MC? What is the profit maximizing level of output?

Factors Affecting Tacit Collusion (cont’d)  Bargaining Power of Buyers Often oligopolists are B-to-B marketers Their “consumers” are in a position of power And when communication breaks down…  Price wars: when tacit collusion breaks down and aggressive price competition causes market prices to collapse.

Other Strategies  Product Differentiation: an attempt by a firm either create a differentiated product or to convince buyers that its product is different from the products of other firms in the industry. E.g. TV Networks: ABC, CBS, and FOX. Or Clorox vs. standard bleach.  Price Leadership: One firm sets its price first and other firms then follow. E.g. Walmart (but low price leadership!)

Other Strategies  Non-price competition: the use of advertising or the addition of special features to try to increase their sales. Typically happens among firms who have a tacit agreement about price. Branding - gain a unique edge over competitors Advertising - build up brand loyalty Packaging - appeal visually to the market Service - good customer service leads to repeat purchasing Information - such as ingredients, where produced etc... so consumers feel well informed

Final Note…  Much more common than perfect competition or monopoly

“Aim”  How important are oligopolies in “real life”?