1. UNIT 4.3: IMPERFECT COMPETITION Oligopoly(Oli.)

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

3. © 2013 Pearson Is two too few?

4. What is an Oligopoly? Conditions of an Oligopoly 1)Less than 10 Firms 2)Products are generally identical (standardized) 3)High Barriers to Entry: Hard to enter the market because the competitors work together to control all the resources & prices. Plus it is very expensive to make the product. 4)The actions of one affects all the producers. 5)Behavior: either fierce competition or collusion (Price Fixing) an agreement to act together or behave in a cooperative manner. 6)Game Theory help explain why firms collude and also choose not to collude.

5. Example of Oligopoly: OPEC Organization of the Petroleum Exporting Countries

6. Game Theory The study of how people behave in strategic situations

7. Price Behavior in Oligopoly THE ICE CREAM MAN SIMULATION 1. You are a ice cream salesmen at the beach 2. You have identical prices as another salesmen. 3. Beachgoers will purchase from the closest salesmen 4. People are evenly distributed along the beach. 5. Each morning the two firms pick locations on the beach

8. Price Behavior in Oligopoly Where should you put your firm? You could choose to separate or share in the volume sale in the center of the beach.

9. Game Theory Why learn about game theory? Oligopolies are interdependent since they compete with only a few other firms.  Their pricing and output decisions must be strategic as to avoid economic losses.  Game theory helps us analyze their strategies.

10. Game Theory The Prisoner’s Dilemma Ben and Jerry have been caught stealing a car: sentence is 2 years in jail. Rules – –Players cannot communicate with one another. If both confess to the crime, each will receive a sentence of 5 years for the crime. If one confesses and the accomplice does not, the one who confesses will receive a 10-year sentence, while the accomplice receives no sentence. If neither confesses, both receive a 1-year sentence. We must find each players’ dominate strategy: – –when one strategy is better than another strategy for one player, no matter how that player's opponents may play.

11. Game Theory The Prisoner’s Dilemma Charged with a crime, each prisoner has one of two choices: Deny or Confess STEP 1: Identify the two players’ dominate strategy (if any) Ben has a dominate strategy to ….. Jerry has a dominate strategy to ….. Jerry Ben Ben = 5 Jerry = 5 Deny Confess Deny Confess Ben = 10 Jerry = 0 Ben =0 Jerry = 10 Ben = 1 Jerry = 1 …confess

12. Game Theory Equilibrium Strategy: – –Nash Equilibrium is an equilibrium in which each player takes the best possible action given the action of the other player. – –In other words, after the game has been played, the players are “stuck” in the strategy because it is more beneficial than any other strategy. – –NOT EVERY GAME HAS A NASH EQUILIBRIUM!!!

13. Game Theory The Prisoner’s Dilemma Charged with a crime, each prisoner has one of two choices: Deny or Confess STEP 2: Identify the Nash Equilibrium (if any) There is no Nash equilibrium for Jerry and Ben. Why? Jerry Ben Ben = 5 Jerry = 5 Deny Confess Deny Confess Ben = 10 Jerry = 0 Ben =0 Jerry = 10 Ben = 1 Jerry = 1 In all possible outcomes both players (one at least one player) would be better off changing his/her strategy.

14. Dominant Strategy The Dominant Strategy is the best move to make regardless of what your opponent does What is each firm’s dominate strategy? Firm 2 Firm 1 $100, $50 HighLow High Low $50, $90 $80, $40$20, $10 Firm 1 should go High Firm 2 has no dominate strategy

15. Game Theory: Market Example The Duopolists’ Dilemma – –The dilemma of Boeing and Airbus is similar to that of Jerry and Ben. – –Each firm has two strategies. It can produce airplanes at the rate of: 3 a week 4 a week Vocab: A duopoly is a market with two firms.

16. Game Theory: Market Example – –Because each firm has two strategies, there are four possible combinations of actions: Both firms produce 3 a week (monopoly outcome). Both firms produce 4 a week. Airbus produces 3 a week and Boeing produces 4 a week. Boeing produces 3 a week and Airbus produces 4 a week.

17. Game Theory: Market Example The Payoff Matrix – –This table shows the payoff matrix as the economic profits for each firm in each possible outcome.

18. Game Theory: Market Example Equilibrium of the Duopolists’ Dilemma: Both firms produce 4 a week. Like the prisoners, the duopolists fail to cooperate and get a worse outcome than the one that cooperation would deliver. The two firms may choose to collude. Remember that cartel formation & collusion is ILLEGAL.

19. Game Theory: Market Example P&G and Kimberly-Clark have two strategies: spend on R&D or do no R&D. The table shows the payoff matrix as the economic profits for each firm in each possible outcome. Another Example: Research and Development Game

20. Game Theory: Market Example Research and Development Game The Nash equilibrium for this game is for both firms to undertake R&D. But they could earn a larger joint profit if they could collude and not do R&D.

21. Kinked Demand

22. Sometimes price in the oligopoly become “stuck” Not because of collusion, but due to the elastic and inelastic nature of the demand curve. I will lower if you will? Uhhh….No!

23. Kinked Demand: Homogenous Oligopoly Sometimes price in the oligopoly becomes “stuck” Note: If price does drop then a temporary price wars may occur if other firms don’t follow price increases of the one dominant firm. $ Q O P1P1 Q1Q1 D  AR Inelastic range Stuck price Basically, NO firm will want to lower its price into the inelastic range. Elastic range

24. Graphing a Oligopoly: Price Leadership Example: Temporary price wars may occur if other firms don’t follow price increases of dominant firm.