1. Oligopoly

2. Characteristics of Oligopolies:
FOUR MARKET MODELS
Perfect
Competition
Monopolistic
Competition
Pure
Monopoly
Oligopoly
Characteristics of Oligopolies:
A Few Large Producers
High Barriers to Entry
Control Over Price (Price Maker)
Mutual Interdependence
Firms use Strategic Pricing
Examples: OPEC, Computer Operating Systems, Cell Service Providers

3. HOW DO OLIGOPOLIES OCCUR?
Oligopolies occur when only a few large firms control an industry.
High barriers to entry keep other firms from entering.
Types of Barriers to Entry
1. Economies of Scale
Ex: The car industry is difficult to enter because only large firms can make cars at the lowest cost
2. High Start-up Costs
3. Ownership of Raw Materials

4. The study of how people behave in strategic situations
Game Theory
The study of how people behave in strategic situations
An understanding of game theory helps firms in an oligopoly maximize profit.

5. Why learn about game theory?
Oligopolies are interdependent since they compete with only a few other firms.
To maximize profit, firms must strategize
Game theory helps us analyze their strategies.

6. Game Theory Payoff Matrices
A payoff matrix represents the known payoffs to individuals (players) in a strategic situation given choices made by other individuals in the same situation

7. Example
Suppose Bert and Ernie are arrested on suspicion of manufacturing and distributing crystal meth.
They are taken in for questioning in separate rooms.
How many years they’ll spend in jail for their crimes depend on whether they confess or deny

8. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
The payoff matrix below shows the number of years in jail that Bert and Ernie will spend in jail based on their decisions
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

9. Dominant Strategy
A player’s dominant strategy is the best move for a him/her to make regardless of what the other player does
A player may or may not have a dominant strategy depending on the potential payoffs

10. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What is Ernie’s dominant strategy (if any)?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

11. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What is Ernie’s dominant strategy (if any)?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

12. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What is Ernie’s dominant strategy (if any)?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

13. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What is Bert’s dominant strategy (if any)?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

14. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What is Bert’s dominant strategy (if any)?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

15. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What is Bert’s dominant strategy (if any)?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

16. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What will happen if both Bert and Ernie follow their dominant strategies?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

17. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
Is this the best outcome for both?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

18. Without talking, write down your choice
Example 2:
You and your partner are competing firms. You have one of two choices: Price High or Price Low.
Without talking, write down your choice
Firm 2
High
Low
High
$20K, $20K
$0, $30K
Firm 1
$30K, $0
$10K, $10K
Low

19. What is Firm 1’s dominant strategy?
Example 2:
What is Firm 1’s dominant strategy?
Firm 2
High
Low
High
$20K, $20K
$0, $30K
Firm 1
$30K, $0
$10K, $10K
Low

20. What is Firm 1’s dominant strategy?
Example 2:
What is Firm 1’s dominant strategy?
Firm 2
High
Low
High
$20K, $20K
$0, $30K
Firm 1
$30K, $0
$10K, $10K
Low

21. What is Firm 2’s dominant strategy?
Example 2:
What is Firm 2’s dominant strategy?
Firm 2
High
Low
High
$20K, $20K
$0, $30K
Firm 1
$30K, $0
$10K, $10K
Low

22. Example 2:
Notice that you have an incentive to collude (work together) but also an incentive to cheat
Firm 2
High
Low
High
$20K, $20K
$0, $30K
Firm 1
$30K, $0
$10K, $10K
Low

23. Split or Steal

24. What is each player’s dominant strategy?
Video: Split or Steal
What is each player’s dominant strategy?
Player 2
Split
Steal
Split
50K, 50K
0, 100K
Player 1
100K, 0
0, 0
Steal

25. What did we learn?
Oligopolies must use strategic pricing (they have to worry about the other guy)
Oligopolies have a tendency to collude to gain profit.
(Collusion is the act of cooperating with rivals in order to “rig” a situation)
Collusion results in the incentive to cheat.
Firms make informed decisions based on their dominant strategies

26. Warm Up
There are two pizza restaurants in College Town, PieCrust and LaPizza. Each company must decide whether to advertise or to not advertise. In the payoff matrix below, the first entry in each cell indicates PieCrust’s daily profit, and the second entry indicates LaPizza’s daily profit. Both firms have complete information.
What strategy should PieCrust choose if LaPizza chooses to advertise?
What is the dominant strategy, if any, for LaPizza?
(c) In the Nash equilibrium (the result if both firms follow their dominant strategies, or if a firm without a dominant strategy follows its best strategy given the other firm following its dominant strategy), determine each of the following.
(i) PieCrust’s daily profit
(ii) LaPizza’s daily profit

27. Oligopoly Graphs

28. There are 3 types of Oligopolies
1. Price Leadership (no graph)
2. Colluding Oligopoly
3. Non Colluding Oligopoly

29. #1. Price Leadership

30. Price Leadership
Price leadership is a strategy used by firms to coordinate prices Typically occurs when outright collusion is ILLEGAL
General Process:
“Dominant firm” initiates a price change
Other firms follow the leader

31. Price Leadership Breakdowns in Price Leadership
If other firms don’t follow price increases of dominant firm, temporary price wars occur when each firm tries to undercut the others

32. #2. Colluding Oligopolies

33. Cartel = Colluding Oligopoly
A cartel is a group of producers that create an agreement to fix prices high.
Cartels set price and output at an agreed upon level
Firms require identical or highly similar demand and costs
Cartel must have a way to punish cheaters
Together they act as a monopoly

34. Firms in a colluding oligopoly act as a monopoly and share the profitMC
ATC D MR Q

35. Market Structures Venn Diagram

36. Perfect Competition
Monopolistic Competition
No Similarities
Oligopoly
Monopoly

37. Name the market structure(s) that it is associated with each concept
Price Maker (Demand > MR)
Collusion/Cartels
Identical Products
Price Taker (Demand = MR)
Excess Capacity
Low Barriers to Entry
Game Theory
Differentiated Products
Long-run Profits
Efficiency
Normal Profit
Dead Weight Loss
High Barriers to Entry
Firm = Industry
MR=MC Rule

38. Perfect Competition
Monopolistic Competition
No Similarities
Oligopoly
Monopoly

39. Avocados T.J. Hammocks Retail Stores Local Utilities
Identical Products
No advantage
D=MR=AR=P
Both efficiencies
Price-Taker
1000s
Avocados
T.J. Hammocks
Perfect Competition
Monopolistic Competition
Retail Stores
Excess Advertising
Differentiated Products
Excess Capacity
More Elastic Demand than Monopoly
100s
Low barriers to entry
No Long-Run Profit
Price = ATC
MR = MC
Shut-Down Point
Cost Curves
Motivation for Profit
Price Maker (D>MR)
Some Non-Price Competition
Inefficient
No Similarities
Collusion
Strategic Pricing (Interdependence)
Game Theory
10 or less
Price Maker (D>MR)
High Barriers
Ability to Make LR Profit
Inefficient
Unique Good
Price Discrimination 1
Appliances
Cars
Local Utilities
Oligopoly
Monopoly