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Section A: Strategic decision making in imperfectly competitive markets Outline of sessions Monopoly, oligopoly and collusion Sustaining profitability:

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Presentation on theme: "Section A: Strategic decision making in imperfectly competitive markets Outline of sessions Monopoly, oligopoly and collusion Sustaining profitability:"— Presentation transcript:

1 Section A: Strategic decision making in imperfectly competitive markets Outline of sessions Monopoly, oligopoly and collusion Sustaining profitability: Rivalry and monopoly profits Market failures due to monopoly power and oligopoly collusion Strategic decision making - Game theory Prisoners dilemma and collusion – more game theory Prisoners dilemma and trade Entry barriers and entry deterrence Credibility– more game theory Case studies: Exception to the rule: competitive balance and collusion in sports leagues Industry case studies

2 Suggested reading For the theory and some business applications: Allen et al Managerial Economics. Norton. Chapters 7, 10-11, 16 Kreps, D. M Microeconomics for Managers. Norton. Chapters Frank, R. H Microeconomics and behaviour. McGraw Hill. Chapters Wall,S., Minocha, S. and Rees, B International Business, Pearson. Chapter 7 Dixit, A., Reiley, D. H. and Skeath, S Games of Strategy, 3 rd Edition, Norton Rasmusen, E Games and Information, Blackwell. Chapters 1-2, 4-5 Carmichael, F A Guide to Game Theory, Pearson. Chapters 1- 4, 7-8 And for the sports application: Grimes, P, Register, C. and Sharp, A Economics of Social Issues, McGraw Hill. Chapter 9 Plus sports economics texts of which there are many e.g: Sandy, Sloane and Rosentraub, The Economics of Sports, Palgrave. Chapters 1-6

3 Objectives: by the end of this section you should be able to: Collusion, cooperation and the prisoners dilemma: Use game theory and/or one detailed example to explain why economists predict that collusion between oligopolists is likely to be fragile unless particular conditions are satisfied e.g. some possibility of repetition in the longer term, and/or the specific characteristics of the market are conducive to cooperation. Use the concept of the prisoners dilemma to make predictions about trade wars Entry barriers and entry deterrence: Use one detailed example and/or sequential game theory to explain what is meant by the idea of a credible threat e.g. the threat to fight the entry of a new firm into an industry or the threat to strike/lock-out. Use sequential game theory to show how an incumbent monopolist (or oligopolistic cartel) might be able to deter entry even though fighting entry is costly.

4 Monopoly, oligopoly and collusion: Sustaining profitability Key to determination of profits of firms in an oligopoly and how they can continue to improve profits Porters 5 forces (1980) – profitability depends on: 1. Extent of rivalry among existing firms (competition) 2. Number of potential entrants (and barriers to entry) 3. Number of substitutes (and complements) 4. The bargaining power of customers 5. The bargaining power of suppliers Question: when is a firm more profitable in terms of the 5 forces?

5 Entry deterrence and entry barriers - Porters Five Forces a firm is more profitable: The less intense the rivalry among existing firms (monopoly or if oligopoly -collusion vs. strategic competition) The less the danger of potential entrants and the higher barriers to entry The fewer substitutes for the firms products (the more firms that sell complements) The weaker the bargaining power of customers The weaker the bargaining power of suppliers

6 Porters first force: Extent of rivalry; Monopoly and collusion in oligopolies Monopoly: a market dominated by one large firm Oligopoly: a market dominated by a small number of large firms that have an incentive to collude in order to make monopoly profits (i.e. aim to minimise competition and if compete, compete strategically on aspects other than price – kinked demand curve)

7 D = AR MC = S Revision: Monopoly (zero rivalry) What is the profit maximising level of output under monopoly and what are the monopolists supernormal profits? AC

8 D = AR MC = S Revision: Monopoly AC P MONOP Q MONOP = supernormal profits

9 Implications Monopolists make supernormal profits by restricting output in order to charge a higher price Oligopolists therefore have an incentive to collude by restricting output to the profit maximising level under monopoly – implying limited competition on price Porters 5 forces: Rivalry - a firm is more profitable the less intense the rivalry among existing firms (monopoly or if oligopoly -collusion vs. competition) Collusion implies restrained rivalry But monopoly and collusion are not in the interests of consumers

10 D = AR MC = S Revision: Monopoly vs. competition AC P MONOP Q MONOP What would price and output be if the market were competitive (in the short-run)? i.e. PCOMP, QCOMP

11 D = AR MC = S Revision: Monopoly vs. competition AC P MONOP P COMP Q MONOP Q COMP if the market is competitive: Price = P COMP and output = Q COMP Only normal profits

12 D = AR MC = S Revision: Monopoly as a market failure P MONOP Q MONOP Q COMP P COMP What is the DEADWEIGHT LOSS to society under monopoly?

13 D = AR MC = S Revision: Monopoly as a market failure P MONOP Q MONOP Q COMP P COMP The total DEADWEIGHT LOSS to society under monopoly is the total blue shaded area.

14 Implications Restricted rivalry under monopoly and oligopoly collusion, is inefficient from the perspective of society as a whole but large firms have an incentive to collude and at the very least not compete on price Rationale for competition policy in the UK, anti- trust policy in the USA; see But oligopolists are likely to participation in non-price competition: competition among the few - strategic competition But what is strategic competition and does it (1) weaken the sustainability of oligopoly collusion and (2) sustain profits by deterring entry?

15 Strategic competition among the few Oligopolists are interdependent agents (players) involved in strategic decision making - taking into account each others moves and responses when they make moves in secret they can be analysed as if moving simultaneously To predict the outcome need to use game theory Simultaneous move games and the concept of a Nash equilibrium - collusion Sequential/dynamic games – entry deterrence

16 Exercise on monopoly 1. Explain (i) how the economic analysis of monopoly shows that firms can gain from a monopoly position and (ii) how a comparative analysis of monopoly and perfect competition shows that consumers are likely to be worse off if competition in a market is reduced? As well as using diagrammatic analysis, illustrate aspects of your analysis with reference to (a) the FT letter from David McConnell on BT (British Telecom) and (b) the UK Competition Commission News Release 28 November 2007 on the Tesco sell-off. Hints: You need to use diagrammatic analysis to contrast monopoly and perfect competition and consider the role of government policy.

17 BT monopoly not in interests of a competitive telecoms market, the UK economy or users By David McConnell Published: October :00 | Last updated: October :00 From Mr David McConnell. Sir, Ben Verwaayen, BT Group's chief executive, seems to be suggesting that the only way BT can make an adequate return is if it remains a near-monopoly provider (Letters, October 6). This may be an appealing idea to BT and its shareholders, but it most certainly is not in the interests of a competitive telecommunications market, the UK economy or consumers. A healthy UK telecoms market depends not on a single provider being profitable but on there being sufficient competition from a number of players, each with equal access to the monopoly's assets (assets owned not through investment and risk but paid for by taxpayers before BT was privatised 20 years ago). A healthy market that encourages innovation from a range of network and service providers will give consumers a wider choice of improved and keenly priced communication services. UK Competitive Telecommunications Association members believe that the best way to achieve a genuinely competitive market is by establishing a genuinely level playing field where all players have the same opportunities and play by the same set of rules. What is important is that a level playing field is achieved, an objective that even BT now seems willing to address. Successful implementation of equivalence will deliver the benefits of breaking up BT but without the potential attendant disruption. It will also, crucially, avoid perpetuating a market dominated by a single company. David McConnell, Chairman, UK Competitive Telecommunications Association, London WC1B 4HP. Copyright The Financial Times Limited 2008 Copyright

18 TESCO FACES SLOUGH SELL-OFF TO COMPETITOR Competition Commission News Release 64/07 28 November 2007 The Competition Commission (CC) has decided that Tesco will be required to sell the site it acquired when it bought a former Co-op store in Slough. In its final report the CC has concluded that the acquisition of the Co-op store on Uxbridge Road, which took place in 2003, reduced competition and choice in the market for grocery retailing in Slough. This confirms the CCs provisional findings published in September. The CCs preferred solution is for another grocery retailer to buy the former Co-op site and develop a large enough store to compete effectively with the other large grocery stores in Slough, and especially with the large Tesco store at nearby Brunel Way. As a fallback, the CC would allow a retailer to move into a smaller unitor combination of unitson the current redevelopment if the first option, which would require planning permission, takes too long or if planning permission is not granted. Since the original acquisition, Tesco has demolished the Co-op store and started work on a new four-unit retail development on the site. In its report, the CC notes that a competing grocery retailer would face a number of drawbacks operating from the Tesco redevelopment, which would affect its ability to compete in Slough and in particular with Tescos Brunel Way store. A divestment trustee will be appointed to oversee the process and will report to the CC, who will assess bids on a number of criteria before giving its approval. This will ensure that the sales process is carried out objectively and that Tesco is not required to accept any offer that is unreasonable. Peter Freeman, Inquiry Group Chairman and CC Chairman, said: Our aim, as the best solution to protect competition and to help consumers in Slough, is to see a large store on the former Co-op site fully equipped to compete with Tescos existing store on Brunel Way. Tescos own internal assessments and the evidence of both stores performance shows that, under another owner, the Co-op store would have been the main competition to the Tesco store at Brunel Way. We are also concerned about further delay to a situation which has dragged on for longer than anyone would wish. As such, we are also including a fallback solution which would see another grocery retailer operating from the former Co-op site under the current redevelopment.Tesco originally bought the Co-op store nearly four years ago and so the circumstances surrounding this case are highly unusual. Our priority is to find a practical and effective solution to this complicated situation without undue delay. The Office of Fair Trading (OFT) first decided to refer the acquisition to the CC in February 2004, but suspended action while it sought to agree a remedy with Tesco in place of the reference. This arrangement would have seen a competing grocery retailer move on to the Co-op site, once Tesco had finished work to extend its existing store on nearby Brunel Way. When this did not prove possible, the OFT made the reference on 19 April During the inquiry, the CC ordered Tesco to suspend work on the ongoing retail redevelop-ment on the former Co-op site. Although the planned redevelopment includes a unit ear-marked for grocery retail, following the discussions with the OFT, concerns were expressed that it might not prove a suitable or desirable site for a competing grocery retailer.



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