OLIGOPOLY Chapter 16 1

The Spectrum of Market Structures 3

The Spectrum of Market Structures 2

Imperfect Competition Market structures that fall between perfect competition and pure monopoly. 7

Imperfect Competition Industries in which firms have competitors but do not face so much competition that they are price takers. 7

Types of Imperfectly Competitive Markets Oligopoly ä Only a few sellers, each offering a similar or identical product to the others. Monopolistic Competition ä Many firms selling products that are similar but not identical. 8

Oligopoly: Markets With Only a Few Sellers 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. 9

Characteristics of an Oligopoly Market Few sellers offering similar or identical products Interdependent firms Best off cooperating and acting like a monopolist by producing a small quantity of output and charging a price above marginal cost 10

Duopoly Example A duopoly is an oligopoly with only two members. It is the simplest type of oligopoly.

Duopoly Example: Demand Schedule for Water

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

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

Outcome from Duopoly Example The duopolists may agree on a monopoly outcome. ä Collusion â The two firms may agree on the quantity to produce and the price to charge. ä Cartel â The two firms may join together and act in unison. 11

Nash Equilibrium 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. 13

Qjoint = 2/3(120 gallons) = 80 gallons Nash Equilibrium Nash Equilibrium n/(n + 1) â 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. Qjoint = 2/3(120 gallons) = 80 gallons Qeach firm = 80/2 = 40 gallons 13

Equilibrium for an Oligopoly Possible outcome if oligopoly firms pursue their own self-interests: ä Joint output is greater than the monopoly quantity but less than the competitive industry quantity. ä Market prices are lower than monopoly price but greater than competitive price. ä Total profits are less than the monopoly profit. 12

Size of an Oligopoly and Market Outcome How increasing the number of sellers affects the price and quantity: ä The output effect: Because price is above marginal cost, selling more at the going price raises profits. ä The price effect: Raising production lowers the price and the profit per unit on all units sold. 14

Size of an Oligopoly and Market Outcome 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. 14

Quick Quiz! If the members of an oligopoly could agree on a total quantity to produce, what quantity would they choose? 15

Quick Quiz! If oligopolies do not act together, do they produce a total quantity more or less than in the previous question? 15

Game Theory and the Economics of Cooperation Game theory is the study of how people behave in strategic situations. 16

Game Theory and the Economics of Cooperation 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. 16

Game Theory and the Economics of Cooperation Because the number of firms in an oligopolistic market is small, each firm must act strategically. 16

Game Theory and the Prisoners’ Dilemma The prisoners’ dilemma illustrates the difficulty in maintaining cooperation. ä Often people (firms) fail to cooperate with one another even when cooperation would make them better off. 17

The Prisoners’ Dilemma Person #1 Decision Choice # 1 Choice # 2 Person # 2 Decision Payoff 1,1 2,1 1,2 2,2 18

The Prisoners’ Dilemma The dominant strategy is the best strategy for a player to follow regardless of the strategies pursued by other players. 19

The Prisoners’ Dilemma Cooperation is difficult to maintain, because cooperation is not in the best interest of the individual player. 19

Oligopolies as a Prisoners’ Dilemma Self-interest makes it difficult for the oligopoly to maintain a cooperative outcome with low production, high prices, and monopoly profits. 20

Oligopolies as a Prisoners’ Dilemma The monopoly outcome is jointly rational for the oligopoly, but each oligopolist has an incentive to cheat. 20

An Oligopoly Examples of the Prisoners’ Dilemma 20

An Oligopoly Example of the Prisoners’ Dilemma Iraq’s Decision High Production Low Production Production High $40 billion for each Iraq gets $30 billion Iran gets $60 billion Iran’s Decision Iraq gets $60 billion Iran gets $30 billion $50 billion for Each Low Production

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

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

Why People Sometimes Cooperate Firms in oligopolies have a strong incentive to collude in order to reduce production, raise prices, and increase profits. Firms that care about future profits will cooperate in repeated games rather than cheating in a single game to achieve a one-time gain. 21

Public Policy Toward Oligopolies Cooperation among oligopolists is undesirable. ä It leads to production that is too low. ä It leads to prices that are too high. 22

Antitrust Laws Antitrust laws make it illegal to restrain trade or attempt to monopolize a market. ä Sherman Antitrust Act of 1890 ä Clayton Act of 1914 23

Controversies over Antitrust Policy Antitrust policies sometimes may not allow business practices that have potentially positive effects: ä Resale price maintenance ä Tying 24

Quick Quiz! What kind of agreement is illegal for businesses to make? Why are the antitrust laws controversial? 25

Conclusion An oligopoly may end up looking more like a monopoly or a competitive market, depending on the number of firms. 26

Conclusion Oligopolies can attempt to cooperate with each other but are limited by laws. 26

Conclusion Antitrust laws are used to regulate the behavior of oligopolies. 26

OLIGOPOLY End of Chapter 16 1

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