1. 17
Oligopoly

2. Question 1 An oligopoly is a market in which:
Answer: there are only a few sellers, each offering a product similar or identical to the products offered by other firms in the market.

3. Oligopoly Oligopoly Game theory Only a few sellers
Offer similar or identical products
Interdependent
Game theory
How people behave in strategic situations
Choose among alternative courses of action
Must consider how others might respond to the action he takes

4. Markets with Only a Few Sellers
A small group of sellers
Tension between cooperation and self-interest
Is best off cooperating
Acting like a monopolist
Produce a small quantity of output
Charge P >MC
Each - cares only about its own profit
Powerful incentives not to cooperate

5. Markets with Only a Few Sellers
A duopoly example
Duopoly
Oligopoly with only two members
Decide quantity to sell
Price – determined on the market
By demand

6. Question 2
One key difference between an oligopoly market and a perfectly competitive market is that oligopolistic firms:
Answer: can affect the profit of others firms in the market by choices they make whereas firms in perfectly competitive markets do not affect each other by choice they make.

7. Markets with Only a Few Sellers
Competition, monopolies, and cartels
Perfectly competitive firm
Price = marginal cost
Quantity = efficient
Monopoly
Price > marginal cost
Quantity < efficient quantity

8. Markets with Only a Few Sellers
Competition, monopolies, and cartels
Duopoly
Collude and form a cartel
Act as a monopoly
Total level of production
Quantity produced by each member
Don’t collude – self-interest
Difficult to agree; Antitrust laws
Higher quantity; lower price; lower profit
Not competitive allocation
Nash equilibrium

9. Markets with Only a Few Sellers
Collusion
Agreement among firms in a market
Quantities to produce or
Prices to charge
Cartel
Group of firms acting in unison

10. Question 3
If, in a particular market, firms sell identical products, then the market is
A. perfectly competitive.
B. monopolistically competitive.
C. an oligopoly.
Answer: C. Only

11. Question 4
A market structure in which there are many firms selling products that are similar but not identical is known as:
Answer: oligopoly.

12. Question 5
The equilibrium quantity in markets characterized by oligopoly is:
Answer: higher than in monopoly markets and lower than in perfectly competitive markets.

13. Markets with Only a Few Sellers
The equilibrium for an oligopoly
Nash equilibrium
Economic actors interacting with one another
Each choose their best strategy
Given the strategies that all the other actors have chosen

14. Question 6
Consider a market that is initially perfectly competitive with many firms selling an identical product. Over time, however, suppose the merging of firms results in the market being served by only three or four firms selling this same product. As a result, we would expect:
Answer: a decrease in market output and an increase in the price of the product.

15. Markets with Only a Few Sellers
How the size of an oligopoly affects the market outcome
More sellers
Form a cartel - Maximize profit
Produce monopoly quantity
Charge monopoly price
Difficult to reach & enforce an agreement

16. Markets with Only a Few Sellers
How the size of an oligopoly affects the market outcome
More sellers
Do not form a cartel – Each firm:
The output effect
P > MC
Sell one more unit: Increase profit
The price effect
Increase production: increase total amount sold
Decrease in price: Lower profit

17. Markets with Only a Few Sellers
How the size of an oligopoly affects the market outcome
As the number of sellers in an oligopoly grows larger
Oligopolistic market - looks more like a competitive market
Price - approaches marginal cost
Quantity produced – approaches socially efficient level

18. The Economics of Cooperation
The prisoners’ dilemma
Particular “game” between two captured prisoners
Illustrates why cooperation is difficult to maintain even when it is mutually beneficial
Dominant strategy
Strategy that is best for a player in a game
Regardless of the strategies chosen by the other players

19. The prisoners’ dilemma1
The prisoners’ dilemma
Bonnie’s decision
Confess
Remain silent
Clyde’s
Decision
Remain
silent
Clyde gets 8 years
Bonnie gets 8 years
Clyde goes free
Bonnie gets 20 years
Bonnie goes free
Clyde gets 20 years
Clyde gets 1 year
Bonnie gets 1 year
In this game between two criminals suspected of committing a crime, the sentence that each receives depends both on his or her decision whether to confess or remain silent and on the decision made by the other

20. Question 7
The prisoners’ dilemma is an important game to study because
Answer: it identifies the fundamental difficulty in maintaining cooperative agreements.

21. The Economics of Cooperation
Oligopolies as a prisoners’ dilemma
Game oligopolists play
In trying to reach the monopoly outcome
Similar to the game that the two prisoners play in the prisoners’ dilemma
Firms are self-interest
And do not cooperate
Even though cooperation (cartel) would increase profits
Each firm has incentive to cheat

22. Figure 17-1
Katie and Taylor are roommates. On a particular day, their lawn needs to be mowed. Each person has to decide whether to take part in mowing the lawn. At the end of the day, either the lawn will be mowed (if one or both roommates take part in mowing), or it will remain un-mowed (if neither roommate mows). With happiness measured on a scale of 1 (very unhappy) to 10 (very happy), the possible outcomes are as follows:

23. Question 8 and 9
 Refer to Figure The dominant strategy for Taylor is to
 Answer: refrain from mowing, and there is no dominant strategy for Katie.
 Refer to Figure If this game is played only once, then which of the following outcomes is the most likely one?
Answer: Katie mows and Taylor does not mow.

24. The Economics of Cooperation
Other examples of prisoners’ dilemma
Arms races
After World War II, United States and the Soviet Union
Engaged in a prolonged competition over military power
Strategies
Build new weapons
Disarm
Dominant strategy: Arm

25. Decision of the United States (U.S.)3
An arms-race game
Decision of the United States (U.S.)
Arm
Disarm
Decision
of the
Soviet
Union
(USSR)
USSR at risk
U.S. at risk
USSR safe and powerful
U.S. at risk and weak
U.S. safe and powerful
USSR at risk and weak
USSR safe
U.S. safe
In this game between two countries, the safety and power of each country depend on both its decision whether to arm and the decision made by the other country

26. The Economics of Cooperation
Other examples of prisoners’ dilemma
Common resources
Two companies – own a common pool of oil
Strategies
Each company drills one well
Each company drills a second well
Get more oil
Dominant strategy
Each company drills two wells
Lower profit

27. Question 10 In a game, a dominant strategy is:
Answer: the best strategy for a player to follow, regardless of the strategies followed by other players.

28. The Economics of Cooperation
The prisoners’ dilemma and the welfare of society
Dominant strategy
Noncooperative equilibrium
May be bad for society and the players
Arms race game
Common resource game
May be good for society
Quantity and price – closer to optimal level

29. Table 17-1
Consider a small town that has two grocery stores from which residents can choose to buy a gallon of milk. The store owners each must make a decision to set a high milk price or a low milk price. The payoff table, showing profit per week, is provided. The profit in each cell is shown as (Store 1, Store 2).

30. Question 11
Refer to Table If grocery store 2 sets a low price, what price should grocery store 1 set? And what will grocery store 1’s payoff equal?
Answer: Low Price, $500

31. The Economics of Cooperation
Why people sometimes cooperate
Game of repeated prisoners’ dilemma
Repeat the game
Agree on penalties if one cheats
Both have incentive to cooperate

32. The prisoners’ dilemma tournament
Repeated prisoners’ dilemma
Encourage cooperation
Penalty for not cooperating
Better strategy
Return to cooperative outcome after a period of noncooperation
Best strategy: tit-for-tat
Player - start by cooperating
Then do whatever the other player did last time
Starts out friendly
Penalizes unfriendly players
Forgives them if warranted

33. Question 12
Which of the following statements is (are) true of the prisoners’ dilemma?
A. Rational self-interest leads neither party to confess.
B. Cooperation between the prisoners is difficult to maintain.
C. Cooperation between the prisoners is individually rational.
Answer: B Only

34. Public Policy Toward Oligopolies
Restraint of trade and the antitrust laws
Common law: antitrust laws
The Sherman Antitrust Act, 1890
Elevated agreements among oligopolists from an unenforceable contract to a criminal conspiracy
The Clayton Act, 1914
Further strengthened the antitrust laws
Used to prevent mergers
Used to prevent oligopolists from colluding

35. An illegal phone call Robert Crandall - president of American Airlines
Howard Putnam - president of Braniff Airways
CRANDALL: I think it’s dumb as hell to sit here and pound out of each other and neither one of us making a #$%& dime.
PUTNAM: Do you have a suggestion for me?
CRANDALL: Yes, I have a suggestion for you. Raise your $%*& fares 20 percent. I’ll raise mine the next morning.
PUTNAM: Robert, we . . .
CRANDALL: You’ll make more money, and I will, too.
PUTNAM: We can’t talk about pricing!
CRANDALL: Howard. We can talk about any thing we want to talk about.

36. Public Policy Toward Oligopolies
Controversies over antitrust policies
Resale price maintenance (fair trade)
Require retailers to charge customers a given price
Might seem anticompetitive
Prevents the retailers from competing on price
Defenders:
Not aimed at reducing competition
Legitimate goal
Some retailers offer service

37. Public Policy Toward Oligopolies
Controversies over antitrust policies
Predatory pricing
Charge prices that are too low
Anticompetitive
Price cuts may be intended to drive other firms out of the market
Skeptics
Predatory pricing – not a profitable strategy
Price war - to drive out a rival
Prices - driven below cost

38. Public Policy Toward Oligopolies
Controversies over antitrust policies
Tying
Offer two goods together at a single price
Expand market power
Skeptics
Cannot increase market power by binding two goods together
Form of price discrimination
Tying may increase profit

39. FRQ 1
Describe the source of tension between cooperation and self-interest in a market characterized by oligopoly. Use an example of an actual cartel arrangement to demonstrate why this tension creates instability in cartels.

40. FRQ 1 Answer
The source of the tension exists because total profits are maximized when oligopolists cooperate on price and quantity by operating as a monopolist. However, individual profits can be gained by individuals cheating on their cooperative agreement. This is why cooperative agreements among members of a cartel are inherently unstable. This is evident in the problem OPEC experiences in enforcing the cooperative agreement on production and price of crude oil.

41. FRQ 2
Ford and General Motors are considering expanding into the Vietnamese automobile market. Given the payoffs in the box, answer the following questions.
A. Does GM have a dominant strategy? Explain.
B. Does Ford have a dominant strategy? Explain.
C. If both GM and Ford only play this game one time, what will be each of their payoffs?

42. FRQ 2 Answer
A. Yes, the dominant strategy for GM is to expand. Expansion is better for GM regardless of what Ford does.
B. Yes, the dominant strategy for Ford is to expand. Expansion is better for Ford regardless of what GM does.
C. They will each follow their dominant strategy and wind up with two each.

43. U.S. government’s suit against the Microsoft Corporation, 1998
The Microsoft case
U.S. government’s suit against the Microsoft Corporation, 1998
Central issue: tying
Should Microsoft be allowed to integrate its Internet browser into its Windows operating system
The government’s claim:
Microsoft was bundling - to expand market power into the market of Internet browsers
Would deter other software companies from entering the market and offering new products

44. The Microsoft case Microsoft responded
New features into old products - natural part of technological progress
Cars - include CD players, air conditioners
Cameras - built-in flashes
Operating systems - added many features to Windows
Previously stand-alone products
Computers - more reliable and easier to use
Integration of Internet technology,
The next natural next step

45. The Microsoft case Disagreement The government Microsoft
Extent of Microsoft’s market power
The government
More than 80% of new personal computers
Use a Microsoft operating system
Substantial monopoly power
Microsoft
Software market is always changing
Competitors: Apple Mac & Linux operating systems
Low price – limited market power

46. The Microsoft case November 1999 ruling June 2000 2001, appeals court
Microsoft - great monopoly power
Illegally abused that power
June 2000
Microsoft – to be broken up into two companies
Operating system & Applications software
2001, appeals court
Overturned the breakup order
September 2001
Justice Department - wanted to settle the case quickly

47. Private antitrust suits Suits brought by the European Union
The Microsoft case
Settlement: November 2002
Microsoft – some restrictions
Government – browser would remain part of the Windows operating system
Private antitrust suits
Suits brought by the European Union
Alleging a variety of anticompetitive behaviors