1. Unit 4: Imperfect Competition
Oligopoly

2. Characteristics of Oligopolies: A Few Large Producers (Less than 10)
Perfect
Competition
Pure
Monopoly
Monopolistic
Oligopoly
Characteristics of Oligopolies:
A Few Large Producers (Less than 10)
Identical or Differentiated Products
High Barriers to Entry
Control Over Price (Price Maker)
Mutual Interdependence
Firms use Strategic Pricing
Examples: OPEC, Cereal Companies, Car Producers

3. HOW DO OLIGOPOLIES OCCUR?
Oligopolies occur when only a few large firms start to control an industry.
High barriers to entry keep others from entering.
Types of Barriers to Entry
1. Economies of Scale
Ex: The car industry is difficult to enter because only large firms can make cars at the lowest cost
2. High Start-up Costs
3. Ownership of Raw Materials

4. The study of how people behave in strategic situations
Game Theory
The study of how people behave in strategic situations
An understanding of GAME THEORY helps firms in an OLIGOPOLY MAXIMIZE PROFIT.

5. Game theory helps predict human behavior THE ICE CREAM MAN SIMULATION
You are a ice cream salesmen at the beach.
You have identical prices as another salesmen.
Beachgoers will purchase from the closest salesmen.
People are evenly distributed along the beach.
Each morning the two firms pick locations on the beach.
Where is the best location?

6. Firm A decides where to goes first.
Where should you put your firm?
Firm A decides where to goes first.
What is the best strategy for choosing a location each day?
Can you predict the end result each day?
How is this observed in the “real-world”? B A

7. Where should you put your firm? Firm A decides where to goes first.
*Note to teachers* (delete)
Assign one student firm A and another student firm B.
Ask firm A to put their ice cream anywhere along the beach. (the best place is right in the middle)
Ask firm B to put theirs in the most profitable location. (the best place is right next to firm A)
Explain that if firm B puts theirs anywhere other than right next to firm A they will be less profitable
Repeat with firm B choosing first.
Students learn that game theory explain why fast food restaurants and gas stations are often located near each other A B
Firm A decides where to goes first.
What is the best strategy for choosing a location each day?
Can you predict the end result each day?
How is this observed in the “real-world”?

8. 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.
SIMULATION!

9. Prisoner’s Dilemma
I am innocent…

10. Situation
Two suspects are arrested by the police. The police have sufficient evidence for a conviction, and have separated both prisoners, visit each of them to offer the same deal. If one testifies for the prosecution against the other (“betrays”) and the other remains silent (“cooperates”), the betrayer goes free and the silent accomplice receives the full twenty-year sentence. If both remain silent, both prisoners are sentenced to only five years in jail for a minor charge. If both betray each other, each receives a nine-year sentence. Each prisoner must choose to betray or to remain silent. Each one is assured that the other would not know about the decision before the end of the investigation. How would you act if you were one of the prisoners?

11. Directions You cannot communicate with your partner in crime.
If the you decide to betray your partner- in-crime, you should place your black card on the table. If you decide to remain silent, you should place red card.
When everyone has made a decision, then look at the two cards and add (+) or subtract (-) the requisite number of years on your sheet.
The winner is who walks away with more life time left at the 10th round.

12. Number of Turns
Your Action
Partner’s Action
Amount of Life Left
Start
-----
100 years 1 2 3 4 5 6 7 8 9 10

13. Prisoner’s Dilemma Confess Remain (Betray) Silent Confess (Betray)
9 years / 9 years
Free / 20 years
20 years / Free
5 years / 5 years

14. Reflection Questions
If you only played the game once with your partner and both of you are trying to minimize your individual jail sentences, what is more rationally beneficial, remaining silent or testifying against your partner? Why?
If you and your partner had been able to communicate, would your decision have changed? If so, why?
What was your strategy when you repeatedly played games with the same partner? Who ended up spending a shorter amount of time in jail? Why?
Would you have chosen a different strategy if you were to repeatedly play against your partner again? If so, which strategy would you adopt? If not, why not?
Did your moral or personal values play a part in your strategy? If so, do you think they put you at an advantage or a disadvantage? Why?

16. Play Station will follow XBox’s Strategy
Xbox will remain the same price;
and PS will raise the price.
Raise Price Remain the Same 60 54 45 52 60 54 50 51 55 64 45 52 60 54 50 51 55 64
Raise Price
Remain the Same 50 64

17. 15 18 36 32 20 14 34 33 Advertise Don’t Advertise Advertise

18. Raise Price Maintain
Raise Price
Maintain
Advertise Don’t Advertise
Advertise
Don’t Advertise

19. Payoff matrix for two competing bus companies
2009 FRQB #3
Payoff matrix for two competing bus companies

20. What did we learn?
Oligopolies must use strategic pricing (they have to worry about the other guy)
Oligopolies have a tendency to collude to gain profit.
Collusion is the act of cooperating with rivals in order to “rig” a situation.
Collusion results in the incentive to cheat.
Firms make informed decisions based on their dominant strategies

21. Payoff matrix for two competing bus companies
2007 FRQ #3
Payoff matrix for two competing bus companies

23. Oligopoly Because firms are interdependent
There are 3 types of Oligopolies
1. Price Leadership
2. Colluding Oligopoly
3. Non-Colluding Oligopoly

24. Example: Small Town Gas Stations To maximize profit what will they do?
#1. Price Leadership
Example: Small Town Gas Stations
To maximize profit what will they do?
OPEC does this with OIL

25. #1. Price Leadership Collusion is ILLEGAL. Firms CANNOT set prices.
Price leadership is a strategy used by firms to coordinate prices without outright collusion
General Process:
“Dominant firm” initiates a price change
Other firms follow the leader

26. #1. Price Leadership Breakdowns in Price Leadership
Temporary Price Wars may occur if other firms don’t follow price increases of dominant firm.
Each firm tries to undercut each other.
Example: Employee Pricing for Ford

27. Cartel = Colluding Oligopoly
#2. Colluding Oligopolies
Cartel = Colluding Oligopoly
Definition: A cartel is a group of producers that create an agreement to fix prices high.
Cartels set price and output at an agreed upon level
Firms require identical or highly similar demand and costs
Cartel must have a way to punish cheaters
Together they act as a monopoly

28. #2. Colluding Oligopolies
Firms in a colluding oligopoly act as a monopoly and share the profit P
ATC MC D MR Q

29. Kinked Demand Curve Model
#3. Non-Colluding Oligopolies
Kinked Demand Curve Model
Not on AP Test anymore ,
So don’t worry about it.
The kinked demand curve model shows how non-collusive firms are interdependent
If firms are NOT colluding they are likely to react to competitor’s pricing in two ways:
Match price-If one firm cuts it’s prices, then the other firms follow suit causing inelastic demand
Ignore change-If one firm raises prices, others maintain same price causing elastic demand

30. Not on AP Test anymore , So don’t worry about it. P P1 Pe Qe P2 D Q Q1
If this firm increases it’s price,
other firms will ignore it & keep prices the same
As the only firm with high prices,
Qd for this firm will fall a lot
Not on AP Test anymore ,
So don’t worry about it. P
If this firm decreases it’s price,
other firms will match it & lower their prices P1
Elastic
Since all firms have lower prices,
Qd for this firm will increase only a little Pe Qe P2
Inelastic D Q Q1 Q2

31. Not on AP Test anymore , So don’t worry about it.
Where is Marginal Revenue?
MR has a vertical gap at the kink.
The result is that MC can move and Qe won’t change.
Price is sticky.
Not on AP Test anymore ,
So don’t worry about it. P MC MR Pe D Q Q

32. Market Structures Venn Diagram
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly
No Similarities

33. Name the market structure(s) that it is associated with each concept
Price Maker (Demand>MR)
Collusion/Cartels
Identical Products
Price Taker (Demand=MR)
Excess Capacity
Low Barriers to Entry
Game Theory
Differentiated Products
Long-run Profits
Efficiency
Normal Profit
Dead Weight Loss
High Barriers to Entry
Firm = Industry
MR=MC Rule

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