Principles of Microeconomics : Ch.16 Second Canadian Edition Chapter 16 Oligopoly © 2002 by Nelson, a division of Thomson Canada Limited

Principles of Microeconomics : Ch.16 Second Canadian Edition Overview  Between Monopoly & Perfect Competition  Markets with only a Few Sellers  Game Theory and Oligopoly  Public Policy

Principles of Microeconomics : Ch.16 Second Canadian Edition The Spectrum of Market Structure

Principles of Microeconomics : Ch.16 Second Canadian Edition The Spectrum of Market Structure Pure Competition

Principles of Microeconomics : Ch.16 Second Canadian Edition The Spectrum of Market Structure Pure Competition Pure Monopoly

Principles of Microeconomics : Ch.16 Second Canadian Edition The Spectrum of Market Structure Pure Competition Pure Monopoly

Principles of Microeconomics : Ch.16 Second Canadian Edition The Spectrum of Market Structure Pure Competition Pure Monopoly Imperfect Competition

Principles of Microeconomics : Ch.16 Second Canadian Edition Imperfect Competition is... …market structures that fall between perfect competition and pure monopoly.  Characteristic of: – Industries in which the firms have competitors but... do not face so much competition that the firm is a price-taker.

Principles of Microeconomics : Ch.16 Second Canadian Edition Imperfect Competition Two types of imperfectly competitive markets:  Monopolistic Competition Many firms selling products that are similar but not identical (e.g. movies.)  Oligopoly Only a few sellers, each offering a similar or identical product to the others (e.g. hockey skates.)

Principles of Microeconomics : Ch.16 Second Canadian Edition Overview Between Monopoly & Perfect Competition  Markets with only a Few Sellers  Game Theory and Oligopoly  Public Policy

Principles of Microeconomics : Ch.16 Second Canadian Edition Markets with only a Few Sellers: Oligopoly Because of the few sellers, the actions of any one seller in the market can have a large impact on the profits of all the other sellers.

Principles of Microeconomics : Ch.16 Second Canadian Edition Markets with only a Few Sellers: Oligopoly  Characteristics of an Oligopoly Market: – Few sellers offering similar product – Interdependent on other firms in industry – Best off by co-operating and acting like a monopolist by producing a small quantity of output and charging a price above marginal cost  Duopoly Example...

Principles of Microeconomics : Ch.16 Second Canadian Edition Lessons From Duopoly Example A duopoly (and oligopoly) market structure may result in:  Collusion : The two firms (industry) agreeing on the quantity to produce and the market price to charge.  Cartel : The two firms (industry) joining together and acting in unison.  In effect, the actions may result in the market being served by a monopoly.

Principles of Microeconomics : Ch.16 Second Canadian Edition A Non-Collusive Duopoly (Oligopoly)  Oligopolies pursuing their own self- interest, but acting independently.  Production is greater than the monopoly quantity but less than the competitive industry quantity.  Market prices are lower than monopoly but greater than competitive price (marginal cost.)  Total profits are less than the monopoly profit.

Principles of Microeconomics : Ch.16 Second Canadian Edition Oligopoly Size and Market Outcome  As the size of an oligopoly increases, production will increase (i.e. the output effect) maintaining price above marginal cost.  As the number of sellers in an oligopoly grows larger, the market is more similar to a competitive market. – Price approaches marginal cost and output is more socially efficient.

Principles of Microeconomics : Ch.16 Second Canadian Edition Quick Quiz!  If the members of an oligopoly could agree on a total quantity to produce, what quantity would they choose?  If oligopolies do not act together, do they produce a total quantity more or less than the previous question?

Principles of Microeconomics : Ch.16 Second Canadian Edition Overview Between Monopoly & Perfect Competition Markets with only a Few Sellers  Game Theory and Oligopoly  Public Policy

Principles of Microeconomics : Ch.16 Second Canadian Edition Game Theory & The Economics of Co-operation  Game Theory: the study of how people behave in strategic situations. – A strategic decision is one in which each person (or firm), in deciding what actions to take, carefully considers how others (or other firms) might respond to that action. – Since there are just a few large firms in an oligopoly market, each firm must make strategic decisions.

Principles of Microeconomics : Ch.16 Second Canadian Edition Game Theory & The Economics of Co-operation  Prisoners’ Dilemma: illustrates the difficulty in maintaining co-operation. – Often people (firms) fail to co-operate with one another even when co-operation would make them better off.  The Prisoners’ Dilemma Story: – Bonnie and Clyde Example

Principles of Microeconomics : Ch.16 Second Canadian Edition The Prisoners’ Dilemma Person #1 Decision Choice # 1Choice # 2 Person # 2 Decision Choice # 2 Choice # 1 Payoff 1,1 Payoff 2,1 Payoff 1,2 Payoff 2,2

Principles of Microeconomics : Ch.16 Second Canadian Edition The Prisoners’ Dilemma  Dominant Strategy: The best strategy for a player to follow regardless of the strategies pursued by other players. – Co-operation is difficult to maintain, because co-operation is not in the best interest of the individual. – Self-interest makes it difficult for the oligopoly to maintain the co-operative outcome with low production, high prices and monopoly profits.

Principles of Microeconomics : Ch.16 Second Canadian Edition Oligopolies and Prisoners’ Dilemma  Self-interest makes it difficult for the oligopoly to maintain the co-operative outcome with low production, high prices and monopoly profits.  May lead to cartel cheating.  Examples: – Iran and Iraq – International arms race – Beer Advertising

Principles of Microeconomics : Ch.16 Second Canadian Edition Overview Between Monopoly & Perfect Competition Markets with only a Few Sellers Game Theory and Oligopoly  Public Policy

Principles of Microeconomics : Ch.16 Second Canadian Edition Public Policy Toward Oligopolies  Firms in oligopolies have a strong incentive to collude in order to: – reduce production – raise prices – increase profits “People in the same trade seldom meet together... but the conversation ends in a conspiracy against the public, or in some [diversion] to raise prices.” (Adam Smith, 1776)

Principles of Microeconomics : Ch.16 Second Canadian Edition Public Policy Toward Oligopolies From the standpoint of society, co- operation among oligopolists is undesirable because – it leads to production that is too low – prices that are too high

Principles of Microeconomics : Ch.16 Second Canadian Edition Public Policy Toward Oligopolies Competition Act:  Makes it illegal to restrain trade or attempt to monopolize a market.  Consists of: – criminal provisions – civil provisions

Principles of Microeconomics : Ch.16 Second Canadian Edition Competition Act  Criminal provisions include: – Price Fixing, Rigging Bids – Resale Price Maintenance – Price Discrimination – Predatory Pricing  Civil provisions include mergers which may not be in the public interest.

Principles of Microeconomics : Ch.16 Second Canadian Edition Controversies over Competition Policy  Sometimes the Competition Policies may not allow business practices that have potentially positive effects: – Resale Price Maintenance – Tying  Examples...

Principles of Microeconomics : Ch.16 Second Canadian Edition Quick Quiz!  What kind of agreement is illegal for businesses to make?  Why are the competition laws controversial?

Principles of Microeconomics : Ch.16 Second Canadian Edition Conclusion  An oligopoly may end up looking more like a monopoly or a competitive market, depending on how many firms there are.  Oligopolies can attempt to co-operate with each other but are limited by laws.  Competition laws are used to regulate the behaviour of oligopolies.

Principles of Microeconomics : Ch.16 Second Canadian Edition Overview Between Monopoly & Perfect Competition Markets with only a Few Sellers Game Theory and Oligopoly Public Policy