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I. Oligopoly: A market where a very few large sellers dominate an industry with few sellers and
they each know how the other will react to changes in prices and quantities. They sell a product that
is similar or identical to their competitors.
A. Characteristics are.
1. Small Number of Firms: The top few firms dominate enough to set prices such as The Atlanta Journal-Constitution, they dominant the newspaper business in the Atlanta Metro area but you
also have the Marietta Journal, The Gwinnett Post, The Dekalb Neighbor and scores of smaller newspapers in the metro area. Lockheed, Boeing Aircraft dominant but you have Piper, Cessna,
Beechcraft and Mooney Aircraft companies. Another example would be the big 3 automakers.
2. Interdependence: There are many examples of industries that react to each others
pricing, output and marketing strategies..the Tobacco companies, processed food, healthcare
products, etc. automakers, aircraft companies react to each other always. Copy-Cat Marketing.
3. Oligopolies are in-between the extremes of the no competition monopolies and the dense
perfect competition. Oligopolies are imperfect competition. Another imperfect competition can be
found with monopolistic competition in a market with many firms that sell similar products but
not identical. There are much fewer firms in a Oligopoly markets than monopolistic markets.
B. Why Oligopoly Occurs:
1. Economies of Scale: Smaller firms in this situation have a tendency to be inefficient because they do not have a high volume of production to minimize costs as production increases.
Their Average Costs continue to rise and they will eventually be bought out by a larger firm or go out
of business.
2. Barriers To Entry: These prevent more competition and help a few control an
industry. Patents, control of resources, dominant success (Coca Cola vs JLs Soda Pop)
3. Oligopoly by Merger: The merged firm almost always has a greater ability to enjoy
economies of scale, effect pricing, and increase output. Horizontal Merger: 2 steel companies, 2
shoe companies, 2 computer manufacturers.
Vertical Merger: when a manufacturer acquires a retailer..shoemaker/shoe store; Delta
buys Boeing; Publix buys Coca-Cola; Sony buys Best Buy.
4. Cartels: A group of firms acting in unison, or collusion. They are illegal in the U. S. but
not in most of the world. OPEC for example, which includes Algeria, Indonesia, Iran, Iraq, Kuwait, Libya,
Table 1:
Single Industry 4
-Firm Ratio
Firm
Annual Sales ($millions)
1
150
2
100
= 400
3
80
4
70
525
50
Total Firms in
450
the Industry
400
4-Firm Concentration Ration = 450 = 88.9%
Table 2
Industry 4-Firm
Ratios
Tobacco Products
Breakfast Cereals
Domestic Motor Vehicles
Soft Drinks
Primary Aluminum
Household Vacuum Cleaners
Electronic Computers
Printing and Publishing
93%
85%
84%
69%
59%
59%
45%
23%
One
firm
Few
firms
Differentiated
products
Identical
products
Monopoly
(Chapter 15)
Oligopoly
(Chapter 16)
Monopolistic
Competition
(Chapter 17)
Perfect
Competition
(Chapter 14)
Tap water
Cable TV
Tennis balls
Crude oil
Novels
Movies
Wheat
Milk
E. The Nash Equilibrium: When firms choose their best strategy based on the strategies of their competition. Basically, one firm copying another. Home Depot copying
Lowes, Wal-Mart copying K-Mart or Pepsi copying Coca Cola. Is this legal?
I. Strategic Behavior And Game Theory: The study of how people behave in strategic
situations. Such as, card games, board games like chess or Monopoly and betting on
sports teams. Corporate or government decisions that have significant impact, taxes,
war, mergers.
A. When there are few firms in an industry, they react to each others price,
product, quality, and distribution policies..they have an interdependence.
B. Since oligopolistic firms are interdependent, they must have strategies,
usually models to predict how prices and outputs are determined.
C. Economists have developed game theory models to describe firms rational
interactions.
II. Some Basic Notions and Characteristics About Game Theory:
A. Example of Cooperative firms: Firms that collude for results...Publix & Kroger
price fixing, Airlines price-fixing, any two firms price-fixing or engaging in turf
protection...this also called restraint of trade and is illegal.
B. Example of Non Cooperative firms: total open competition with competing firms
having the ability to change prices.due to efficient management or demand.
C. Zero sum games are when any gains by a group are exactly offset by equal
losses by the end of the game.
D. Negative sum games: when players as a group at the end of a game lose, possibly one more than another, and it is possible for one or more players to win.
E. Positive sum games are when both players end up better off, voluntary exchange
are an example.
III. Strategies in Non-Cooperative Games:
A. Decision makers have to devise a strategy, or a rule used to make a choice.
Strategies like Targeting advertising to certain age, income, ethnic, gender
group. One may have more demand for a product than another..toys for
children, jewelry for women, grits for Southerners, yachts for the rich, or
different clothes, food & music for different groups, etc.
B. The goal is to come up with successful strategies & when they come up with one
that always yields the highest benefit, it is called a dominant strategy. Whatever competitors do, a dominant strategy will yield the most benefit for the player using it.
C. Dominant strategies are rare over the long-run because of competition, Why?
IV. Public Policy Toward Oligopolies: The government recognizes that cooperation between oligopoly firms is harmful
to society and prefers that competition be the policy between firms.
a. Restraint of Trade and the Antitrust Laws:
A.
Characteristics are.
1. Small Number of Firms: The top few firms dominate enough to set prices
such as The Atlanta Journal-Constitution, they dominant the newspaper business in the
Atlanta Metro area but you also have the Marietta Journal, The Gwinnett Post, The
Dekalb Neighbor and scores of smaller newspapers in the metro area.
2. Interdependence: There are many examples of industries that react to each
others pricing, output and marketing strategies..the Tobacco companies, processed
food, healthcare products, etc. Carmakers, aircraft companies react to each other always.
B.
26-2
4-Firm
Ratios
Industry
Tobacco Products
Breakfast Cereals
Domestic Motor Vehicles
Soft Drinks
Primary Aluminum
Household Vacuum Cleaners
Electronic Computers
Printing and Publishing
Sam
Confess
The Prisoners Dilemma
Confess
5 Years
Dont Confess
10 Years
Dont Confess
Carol
Low
High
$6 million
$6 million
$8 million
$2 million
Low
II. Strategic Behavior And Game Theory: Card games such as poker,
board games like chess, Monopoly are examples and even betting on sports teams.
A. When there are few firms in an industry, they react to each others price,
product, quality, and distribution policies..they have an interdependence.
B. Since oligopolistic firms are interdependent, they must have strategies,
usually models to predict how prices and outputs are determined.
C. Economists have developed game theory models to describe firms rational
interactions.
III. Some Basic Notions and Characteristics About Game Theory:
A. Example of Cooperative firms: Firms that collude for results...Publix &
Kroger price fixing, Airlines price-fixing, any two firms price-fixing or engaging in turf
protection...this also called restraint of trade and is illegal.
B. Example of Non Cooperative firms: total open competition with competing
firms having the ability to change prices.due to efficient management or demand.
C. Zero sum games are when one players losses are offset by anothers gains.
D. Negative sum games are when both players in a game lose.
E. Positive sum games are when both players end up better off.
IV. Strategies in Non-Cooperative Games:
A. Decision makers have to devise a strategy, or a rule used to make a choice.
B. The goal is to come up with successful strategies & when they come up with
one that is a winner regardless of the competition does, its called a dominant strategy.
C. Dominant strategies are rare over the long-run because of competition.
V. Applying Game Theory to Pricing Strategies: We apply game strategy to two
firms, who must decide on their pricing strategy.
A. If both choose high prices on products, their revenue will be $6 million...
B. and if they both choose low prices their revenue will be $4 million each.
C. If one goes low and the other high, the high-priced firm will make $2
million and the low-priced firm will make $8 million.
D. With the absence of collusion, they will both choose low prices because they
do not know what the other chooses and a high price can hurt, a low price is safe.
VI. Opportunistic Behavior: Live for today and forget tomorrow...someone who
spurns insurance and doesnt plan ahead...take a higher salary today by accepting a
job that has short-term implications versus a lower paying job for longer job security.
A. Opportunistic behavior for a firm would be to charge higher prices today and
not worry about tomorrow, they would make short-term gains but long-term losses.
This behavior could also entail cheating, or collusion.
VI. Price Rigidity And The Kinked Demand Curve: This is when rivals all match price decreases but not
price increases to try and get a competitive edge over each other. There is no collusion and the results are rigid
prices and a kinked demand curve.
1. We draw a kinked demand curve which assumes that the oligopoly firm matches price
decreases but not price increases.
Characs:
2. We start with a price of Po and a quantity of Qo which are stable economic levels that
*Econ/scale
prompts the assumption that rivals will not react with a price change since they are already there.
*Barriers/
3. If rivals do not change their price, the firm will face demand curve d1d1 with a marginal
Entry
revenue curve of MR1.
*InterD
4. But if the assumption is they will react, it will face demand curve d2d2 and MR2 curve
*small#
because more competition lowers their demand and MR.
firms
5. If the firm lowers its price it will assume that rivals will lower prices to match them and avoid
*smaller
losing market share.
#w/higher
6. The firm that initially lowers its price will not greatly increase its quantity demanded because its competitor
%/indus
will follow suit quickly, before the market can react dramatically to the price decrease.
*similar
7. So, when it lowers its price it will expect to face demand curve d2d2
8. but if it increases prices past Po its rivals will probably not follow.
9. As a result, a higher price than Po will cause quantity demanded to decrease rapidly.
10. The demand schedule to the left of and above point E will be elastic as shown by d1d1. Remember, elastic range is
the position above equilibrium.
11. At prices above Po the relevant demand curve is d1d1, which allows for a rapid decline in QD with a price increase, but below Po it
would be d2d2, which allows for a gradual QD increase because the competition will keep it from being rapid.
12. As a result, at point E there will be a kink in the demand curve, rotates down because the QD will be low for an inelastic OLI because others will lower their price too. They also do not have as much leverage to differentiate their product as in monopolistic and perfect competition markets.
13. This is shown in panel B as d1d2. The marginal revenue curve is MR1MR2, shows a discontinuous portion or gap.
14. The MR will stay the same for a while because Demand is inelastic, response is low.
15. The kinked demand curve explains why price changes are rare in oligopolies. If price goes up, demand falls, if prices go down,
competition follows and profits go down if elasticity is below 1.
16. A larger demand will increase output and production costs will go up.
17. The theoretical reason for the price inflexibility under the kinked demand curve has to do with the discontinuous portion of the MR
curve in Panel B.
18. Look at 26-4, The marginal cost is represented by MC & the profit maximizing output is qo, sold at Po. If the MC shifts up to
MC, nothing will happen to the price or quantity.stays the same.
19. Remember, the profit maximizing rate is still where MC=MR. The shift in the MC to MC does not change the profit maximizing
rate of output because MC still cuts the MR curve in the discontinuous portion.
20. The result is when firms in an OLI industry have cost increase & decreases, price will not change as long as MC=MR.
21. Prices are therefore rigid as long as OLIs react the way we assume they will.
D2
D1
D1
Po
D1
Po
MC1
MR1
MC
MR1
MC2
D2
D2
MR2
Qo
MR2
Qo
VI. Price Rigidity And The Kinked Demand Curve: This is when rivals all match price decreases but not price
increases to try and get a competitive edge over each other. There is no collusion and the results are rigid prices
and a kinked demand curve.
NON Collusive Oligopoly
Imagine an oligopolistic industry made up of three firms A, B, & C each having 1/3 of the total market of a differentiated product.
Assume the firms are independent, meaning they do not engage in price fixing.
Suppose the price is at Po and sales are at Qo. What does the firms demand curve look like? This depends on how
its rivals will react to a price change by firm E
There are two plausible assumptions about the reaction of Es rivals.
1. Match price changes: One possibility is firms B & C will exactly match any price change initiated by A.
A. In this case As demand curve will look like the straight line D1 & MR1. Why are they so steep? Because if
price A cuts its price, its sales will increase only modestly because its two rivals will also cut their prices to prevent A from gaining an advantage over them.
B. The small increase in sales that A, B, & C will realize is at the expense of other industries.
C. A will gain no sales from B & C.
D. If A raises its price its sales will fall only modestly because B & C will match its price increase. The industry
will lose sales to other industries but A will lose no customers to B & C.
2. Ignore price changes: The other possibility is that firms B & C will ignore any price change by A.
A. In this case, the demand and marginal-revenue curves faced by A will resemble the straight lines D2 and MR2
in figure A.
B. Demand in this case is considerably more elastic than under the previous assumption.
C. The reasons are clear: if A lowers its price and its rivals do not, A will gain sales significantly at the expense of
its two rivals because it will be underselling them.
D. Conversely, if A raises its price and its rivals do not, A will lose many customers to B & C, which will be underselling it..
E. Because of product differentiation, however, As sales will not fall to zero when it raises its price; some of As
customers will pay the higher price because they have strong preferences for As product.
3. A Combined Strategy: Now what is the most logical assumption for A to make about its rivals reaction to any
price change it has? Some of each.
A. Common sense suggests that price declines below Po will be matched as a firms rivals act to prevent the price
cutter from taking their customers.
B. But price increases above Po will be ignored because rivals of the price-increasing firm stand to gain the business lost by the price booster. In other words, D2 seems relevant for price increases and D1 seems relevant for
price cuts.
C. It is logical, or a reasonable assumption, to that the noncollusive oligopolist faces the kinked demand curve
D2eD1, as in panel B.
D. Demand is very elastic above price Po but less elastic below that price.
E. Note also that if it is correct to suppose that rivals will follow a price cut but ignore an increase, the MR curve
will also have an odd shape. It will have two segments.
F. Because of the difference in elasticity of demand above & below the going price, there is a gap in the curve.
4. On the demand side: The kinked demand curve gives the oligopolist reason to believe that any change in price
will be for the worse.
A. If is raises prices customers leave. If it lowers price sales will rise slightly because rivals match price.
B. Even if a price-cut increases the oligopolists TR, its costs will increase by a greater amount.
C. And if demand is inelastic, to the right of Qo, the firms profit will fall.
D. A price decrease in the inelastic region, lowers the firms TR & more production increases TC.
5. On the Cost Side
A. The broken MR curve suggests that even if an oligopolists cost changesa lot, the firm may have no reason to
change its price.
B. In partcular, all positions of the MC Curve between MC1 & MC2 in 4-B will result in the firm deciding on the
same price & output. At all positions, MC = Qo and Po is charged.
VII. Price Rigidity: The kinked demand curve analysis may help explain why price changes might be
infrequent in an oligopolistic industry without collusion..Each oligopolist can only see harm in a price
change.
1. If price is increased, the Oli. Firm will lose many of its customers to rivals who do not raise prices.
2. This is shown in panel B, figure 25-5, where the Oli. firm move up from point E along d1.
3. If the Oli. Firm lowers price, the rivals will lower prices too and sales will not increase much.
4. Moving down along d2 from E in panel B we see that the price is inelastic and if it is less than one,
total revenues will fall rather than increase with a price decrease.
5. Given that the production of more output will increase total costs, the Oli. Firm profits will fall.
6. A possible outcome of a price decrease by an Oli. Firm is a price war.
Figure 25-6
1. The theory for the price inflexibility shown in the kinked demand curves in 25-5 & 25-6 has to do
with the discontinuous portion of the MR curve.
2. Assume the marginal cost is represented by MC.
3. The profit-maximizing rate of output is qo, which can be sold at price Po.
4. Also assume that that marginal cost curve rises to MC where the quantity & price will remain the
same.
5. The MC curve and MR curve is still profit-maximization output.
6. The shift in the marginal cost curve to MC does not change that because MC still cuts the marginal
revenue curve in the discontinuous portion.
7. As a result, the equality between marginal revenue and marginal cost still holds at output rate qo
even when the marginal cost curve shifts upward.
8. When the marginal costs fall to MC the Oli. Firm will still produce at a rate of output of Po.
9. Whenever the marginal cost curve cuts the discontinuous portion of the marginal revenue curve,
fluctuations in marginal cost generally will not affect output or price because the profit-maximization
condition MR=MC will hold.
10. The result is that when Oli. Firms experience increases or decreases in costs, their prices do not
change as long as MC cuts MR at the discontinuous portion. This is why prices are seen as rigid in
Oligopolistic firms.
Date:
Period:
7. Some say the best advertising is word-of-mouth. Explain a similar concept that can help a firm prosper.
8. Explain how and why the telecommunications industry has suffered financial losses in recent years.
10. Name and explain the characteristics of the industry structure my company is in if I have a lot of
competition producing a similar product?
Date:
Period:
Date:
Period:
D. tit-for-tat game
8. Managers in oligopolistic firms that make decisions on price and output usually.
A. erect barriers to entry to protect their turf.
C. consult the antitrust division of the Justice Department.
B. anticipate the reaction of competitors.
D. inform regulators of their plans.
9. Which of the following is not a reason why some industries are oligopolies?
A. economies if scale.
B. barriers to entry
C. regulation
D. mergers
10. When General Motors purchased Fisher Body & Auto Repair Company, it was an example of a
A. horizontal merger.
B. vertical merger.
C. monopoly.
D. excess capacity.
11. Oligopoly is a situation when there
A. is one firm in an industry that is large
C. are too many firms in an industry and there is excess capacity
B. are a few large firms in the industry
D. is one giant firm and many small ones.
12. An example of a cooperative game would be
A. oligopoly
B. monopolistic competition
C. a cartel
D. perfect competition
Firm
Annual Sales
A
B
C
D
E
F
$1000
800
220
75
50
40
$800
$1500
$1050
$ 90
$ 75
$ 300
G
H
I
J
K
L
Graph E
MC
D
C
B
A
ATC
MR
D. prisoners dilemma
21. If oligopolist Bs rivals ignore its price increases but match price decreases, then Bs demand will be
A. Discontinuous
B. kinked at the going price C. below MR curve D. equal to the industry demand
22. In long-run equilibrium for the oligopolist,
A. MR=MC
B. P>MR
C. economic profits are zero D. all of the above
23. The kinked demand curve theory.
A. is supported by research
B. Requires that rivals match prices
F
F
F
F
F
F
F
25.
26.
27.
28.
29.
30.
31.
C. advertising
D. competition
Price wars result because all players are in a positive sum game.
Concentration ratios provide an accurate measure of monopoly power in an industry.
If an oligopolists rivals match its price changes, the demand curve will kink.
The limit-pricing model suggests oligopolists set price at the highest priced they can.
A dominant strategy is always favored by a player, regardless of what others do.
A main characteristic oligopolies is an oligopolist must consider the reaction of rivals.
Interdependence results in oligopoly firms copying each others strategies.
D. Cooperative games
D. a negative-sum firm
D. Cooperative games
Confess
Confess
Dont Confess
CAROL
SAM
Dont Confess
5 years
5 years
10 years
Goes Free
Goes Free
10 years
2 years
2 years