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Harcourt Brace & Company OLIGOPOLY Chapter 16

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Harcourt Brace & Company The Spectrum of Market Structures

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Harcourt Brace & Company The Spectrum of Market Structures

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Harcourt Brace & Company Imperfect Competition n Market structures that fall between perfect competition and pure monopoly.

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Harcourt Brace & Company Imperfect Competition n Industries in which firms have competitors but do not face so much competition that they are price takers.

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Harcourt Brace & Company Types of Imperfectly Competitive Markets n Oligopoly Only a few sellers, each offering a similar or identical product to the others. n Monopolistic Competition Many firms selling products that are similar but not identical.

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Harcourt Brace & Company Oligopoly: Markets With Only a Few Sellers n 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.

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Harcourt Brace & Company Characteristics of an Oligopoly Market n Few sellers offering similar or identical products n Interdependent firms n Best off cooperating and acting like a monopolist by producing a small quantity of output and charging a price above marginal cost

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Harcourt Brace & Company Duopoly Example n A duopoly is an oligopoly with only two members. It is the simplest type of oligopoly.

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Duopoly Example: Demand Schedule for Water

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Harcourt Brace & Company Duopoly Example: Price and Quantity Supplied n The price and quantity of water in a perfectly competitive market would be: P = MC = $0 Q = 120 gallons n The price and quantity in a monopoly market would be: P = $60 Q = 60 gallons

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Harcourt Brace & Company Duopoly Example: Price and Quantity Supplied n The socially efficient quantity of water is 120 gallons, but a monopolist would produce only 60 gallons of water. n So what outcome then could be expected from duopolists?

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Harcourt Brace & Company Outcome from Duopoly Example n The duopolists may agree on a monopoly outcome. Collusion The two firms may agree on the quantity to produce and the price to charge. Cartel The two firms may join together and act in unison.

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Harcourt Brace & Company Nash Equilibrium n Nash equilibrium is a situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the others have chosen.

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Harcourt Brace & Company Nash Equilibrium n Nash Equilibrium n/(n + 1) where n is the number of firms in the industry. If n = 2, then the joint output would be 2/3 of the competitive market. Q joint = 2/3(120 gallons) = 80 gallons Q each firm = 80/2 = 40 gallons

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Harcourt Brace & Company Equilibrium for an Oligopoly n Possible outcome if oligopoly firms pursue their own self-interests: Joint output is greater than the monopoly quantity but less than the competitive industry quantity. Market prices are lower than monopoly price but greater than competitive price. Total profits are less than the monopoly profit.

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Harcourt Brace & Company Size of an Oligopoly and Market Outcome n How increasing the number of sellers affects the price and quantity: The output effect : Because price is above marginal cost, selling more at the going price raises profits. The price effect : Raising production lowers the price and the profit per unit on all units sold.

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Harcourt Brace & Company Size of an Oligopoly and Market Outcome n As the number of sellers in an oligopoly grows larger the market looks more and more like a competitive market.... the price approaches marginal cost.... the quantity produced approaches the socially efficient level.

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Harcourt Brace & Company Quick Quiz! n If the members of an oligopoly could agree on a total quantity to produce, what quantity would they choose?

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Harcourt Brace & Company Quick Quiz! n If oligopolies do not act together, do they produce a total quantity more or less than in the previous question?

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Harcourt Brace & Company Game Theory and the Economics of Cooperation n Game theory is the study of how people behave in strategic situations.

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Harcourt Brace & Company Game Theory and the Economics of Cooperation n Strategic decisions are those in which each person (firm) in deciding what actions to take, must consider how others (firms) might respond to that action.

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Harcourt Brace & Company Game Theory and the Economics of Cooperation n Because the number of firms in an oligopolistic market is small, each firm must act strategically.

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Harcourt Brace & Company Game Theory and the Prisoners’ Dilemma n The prisoners’ dilemma illustrates the difficulty in maintaining cooperation. Often people (firms) fail to cooperate with one another even when cooperation would make them better off.

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Harcourt Brace & Company 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

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Harcourt Brace & Company The Prisoners’ Dilemma n The dominant strategy is the best strategy for a player to follow regardless of the strategies pursued by other players.

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Harcourt Brace & Company The Prisoners’ Dilemma n Cooperation is difficult to maintain, because cooperation is not in the best interest of the individual player.

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Harcourt Brace & Company Oligopolies as a Prisoners’ Dilemma n Self-interest makes it difficult for the oligopoly to maintain a cooperative outcome with low production, high prices, and monopoly profits.

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Harcourt Brace & Company Oligopolies as a Prisoners’ Dilemma n The monopoly outcome is jointly rational for the oligopoly, but each oligopolist has an incentive to cheat.

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Harcourt Brace & Company An Oligopoly Examples of the Prisoners’ Dilemma

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Harcourt Brace & Company An Oligopoly Example of the Prisoners’ Dilemma Iraq’s Decision High ProductionLow Production Iran’s Decision Low Production High Production $40 billion for eachIraq gets $30 billion Iran gets $60 billion Iraq gets $60 billion Iran gets $30 billion $50 billion for Each

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Harcourt Brace & Company Other Examples of the Prisoners’ Dilemma U.S.’ Decision ArmDisarm USSR’s Decision Disarm Arm Both countries at risk U.S. at risk and weak USSR safe and powerful U.S. safe and powerful USSR at risk and weak Both countries safe

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Harcourt Brace & Company Other Examples of the Prisoners’ Dilemma Marlboro’s Decision AdvertiseDon’t Advertise USSR’s Decision Disarm Arm $3 billion profit for each Marlboro gets $2 billion profit Camel gets $5 billion profit Marlboro gets $5 billion profit Camel gets $2 billion profit $4 billion profit for each

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Harcourt Brace & Company Why People Sometimes Cooperate n Firms in oligopolies have a strong incentive to collude in order to reduce production, raise prices, and increase profits. n Firms that care about future profits will cooperate in repeated games rather than cheating in a single game to achieve a one-time gain.

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Harcourt Brace & Company Public Policy Toward Oligopolies n Cooperation among oligopolists is undesirable. It leads to production that is too low. It leads to prices that are too high.

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Harcourt Brace & Company Antitrust Laws n Antitrust laws make it illegal to restrain trade or attempt to monopolize a market. Sherman Antitrust Act of 1890 Clayton Act of 1914

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Harcourt Brace & Company Controversies over Antitrust Policy n Antitrust policies sometimes may not allow business practices that have potentially positive effects: Resale price maintenance Tying

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Harcourt Brace & Company Quick Quiz! n What kind of agreement is illegal for businesses to make? n Why are the antitrust laws controversial?

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Harcourt Brace & Company Conclusion n An oligopoly may end up looking more like a monopoly or a competitive market, depending on the number of firms.

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Harcourt Brace & Company Conclusion n Oligopolies can attempt to cooperate with each other but are limited by laws.

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Harcourt Brace & Company Conclusion n Antitrust laws are used to regulate the behavior of oligopolies.

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Harcourt Brace & Company OLIGOPOLY End of Chapter 16

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