1. 13-1 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Chapter 13 Oligopoly

2. 13-2 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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 Survey four models of the possible courses of price–output behaviour that oligopolistic industries might follow

3. 13-3 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Learning objectives (cont.) 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

4. 13-4 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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

5. 13-5 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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

6. 13-6 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Characteristics of oligopoly (cont.) High barriers to entry Causes –Economies of scale –Mergers  The combining of two or more competing firms, with a resulting increase in size, market share and economic power –Ownership of patents, copyrights –Control of strategic raw materials –Technological progress

7. 13-7 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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

8. 13-8 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Oligopoly behaviour: a game theory approach (cont.) Incentives to collude through some formal or informal arrangement to coordinate pricing strategies or fix prices Incentive to cheat on a collusive agreement

9. 13-9 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Profit payoffs for a duopoly Giant’s pricing strategy HighLow Big’s pricing strategy High Low $12m $6m $8m $15m A C B D

10. 13-10 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Maximum strategies and optimal pricing strategy Maximum strategies Strategies chosen by players in a game to maximise their minimum expected pay-off from the game The equilibrium pair of strategies under this rule will result in a Nash equilibrium, which is for each firm to charge a low price, regardless of the choice the other firm makes

11. 13-11 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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

12. 13-12 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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

13. 13-13 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia The kinked demand curve P Q D1D1 MR 1 The firm’s demand and marginal revenue curves

14. 13-14 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia The kinked demand curve P Q D1D1 MR 1 The rival’s demand and marginal revenue curves MR 2 D2D2

15. 13-15 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia The kinked demand curve (cont.) P Q D1D1 MR 1 MR 2 D2D2 Rivals tend to follow a price cut

16. 13-16 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia The kinked demand curve (cont.) P Q D1D1 MR 1 MR 2 D2D2 Rivals tend to follow a price cut or ignore a price increase

17. 13-17 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia The kinked demand curve (cont.) P Q D1D1 MR 1 MR 2 D2D2 Effectively creating…

18. 13-18 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia The kinked demand curve (cont.) P Q D1D1 MR 1 Effectively creating a kinked demand curve P X Q D2D2 MC 2 MC 1 MR 2

19. 13-19 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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

20. 13-20 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Economic profit Collusion and profit maximisation Q MC ATC P MR Price Q MR = MC D

21. 13-21 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Obstacles to collusion Demand and cost differences between firms Numbers of firms Cheating Recession Legislative obstacles: Trade Practices Law

22. 13-22 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Price leadership: tacit collusion model Price leadership: tacit collusion A type of gentlemen’s agreement in which oligopolists automatically follow the price initiatives of the dominant firm in an industry

23. 13-23 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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

24. 13-24 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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

25. 13-25 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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

26. 13-26 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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

27. 13-27 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Oligopoly and economic efficiency (cont.) Dynamic efficiency Long-term improvements in product quality and production methods may occur –Competitive view –Schumpeter–Galbraith view  Oligopolists have both the incentive and financial and technical resources to be more technologically progressive than competitive firms

28. 13-28 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Oligopoly and economic efficiency (cont.) Technical advance — what is the evidence? –Giant corporate oligopolies are probably not the leaders in technological advance –In Australia in the 1980s and 1990s more than half of the research and development efforts were supported by government rather than business –The private sector has imported much of the technology through parent overseas companies –Technological advances in Australian industry is science- based and research-orientated rather than market driven

29. 13-29 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Next chapter: The demand for economic resources