1. Oligopoly 1

2. Oligopoly
For a Market to be Described as Oligopolistic, it must satisfy the following conditions:
Few Sellers
Mutual Interdependence
The Firm’s products may be identical or unique (Homogeneous or Differentiated)
The are Barriers to Entry (like monopoly)
non-price competition 19

3. Where Does Oligopoly “fit in?”
Perfect Competition Monopoly
Monopolistic
Competition
Oligopoly 20

4. Oligopoly Model
Oligopoly is a market in which a small number of firms supply the entire market and where natural barriers to entry prevent other firms from entering
Examples: beer, breakfast cereals, automobiles, long-distance telephones, airplanes, database software,...

5. Concentration Ratios
One Way to Determine Whether a Market is Oligopolistic is to look at a Concentration Ratio
A Concentration Ratio Let’s Us Know if the Whole Industry’s Sales are Dominated by the Sales of a Few Firms. 21

6. Oligopolies and Collusion
Overt Collusion
OPEC Cartel
Covert Collusion
Electrical Equipment
Price Fixing
Tacit Collusion
Price Leadership

7. Models of Oligopoly 1 - Kinked Demand Curve 2 - Collusive Pricing
No Standard Model due to...
Diversity
Interdependence
1 - Kinked Demand Curve
2 - Collusive Pricing
3 - Price Leadership

8. Kinked Demand Curve
Each Oligopolist believes that if it raises its price, other firms will keep their prices constant, so the quantity demanded will fall by a large amount (demand is elastic).
Each firm also believes that if it cuts its price, other firms will cut their prices too, so the quantity demanded will rise by a small amount (demand is inelastic).

9. Kinked Demand Curve Effectively creating P a kinked demand curve
This is an attempt to explain the “sticky prices” in oligopoly industries. P P D2 D1 Q
Quantity

10. The Kinked Demand Curve Theory
The current price is P
And at this price, the firm is selling the quantity Q P

11. The Kinked Demand Curve Theory
The marginal revenue curve from “b” down.
The marginal revenue curve for a price increase runs from “a” up.

12. The Kinked Demand Curve Theory
Between a and b, there is no marginal revenue curve
Cost can increase considerably without causing the firm to increase price.
So long as the MC curve passes through the break in the MR curve, the firms keeps its price and quantity constant.

13. The Kinked Demand Curve Theory
Summary:
The demand curve has a kink at the current price
The marginal revenue curve is discontinuous
Price is sticky and remains at the kink point unless a large enough change in marginal cost occurs
The elasticity of demand indicates a decrease in TR for any price change.

14. Cartels and Collusion Oligopoly is conducive to collusion
If a few firms face identical or
highly similar demand and costs...
They will seek joint profit
maximization...

15. Collusive Pricing Model
The Cartel Model:
The Oligopolists Get Together (Since There are So Few of Them) and Act As If They Were One Monopolist.
Collectively Produce the Monopolistic Quantity (establish quotas) - Thus Maximizing Profit as a group.
Example: OPEC 23

16. Cartel Model
Collusive agreement --a cartel--is an agreement between two (or more) producers to restrict output in order to raise prices and make bigger profits (act like a monopoly).
Strategies for a firm in a cartel
comply with the agreement
cheat on the agreement

17. Problems With Cartels
10 sellers produce oils 150 barrels/day (Total 1,500 b/day)
If each firm is in perfect competitive market
Each firm will get normal profit
But if they decide to collude as one monopoly such as OPEC 24

18. Maximizing OPEC Profits
Market
Single producer $ $ MC MC AC 20 20 MR
D = AR MR Q Q
1,500
Firm
150
Oil (Barrels/Day)
Oil (Barrels/Day) 27

19. Maximizing OPEC Profits
Single producer
Market
If one seller cheats $ $ MC MC AC 30 30 a b 22 20 20 MR
D = AR MR Q
1,000 Q
1,500
1,800
Qquota =100
150
Qcheater
= 180
Firm
Oil (Barrels/Day)
Oil (Barrels/Day) 27

20. Problems With Cartels Generally, They Are Not Legal (Price Fixing)
They Are Difficult to Organize and Monitor
Can’t Force New Firms to Join
Usually there is Cheating 24

21. The Incentive to Cheat On A Cartel
If the Cartel Maintains the Monopoly Price, The Individual Member of the Cartel Can Act Like a Price Taker (They Can Sell the Quota amount at the Market Price)
As a Price Taker, They Maximize Profit Where MC = MR.
This Quantity is Greater Than the Cartel Wants the Individual Firm to Produce.
All Firms in the Cartel Do This and the Cartel Falls Apart 25

22. Obstacles to Collusion
Demand & Cost Differences
Number of Firms
Cheating
Recession
Potential Entry (or new)Entry
Legal Obstacles: Antitrust

23. Dominant Firm Price Leadership
One dominant firm (largest or lowest cost) and several other rival firms
Dominant firm determines price to maximize profit
Other firms take price and sell what they can at that price.
All firms watch output to prevent excess supply and the need to reduce price.

24. Dominant Firm Oligopoly
A dominant firm oligopoly may exist if one firm:
Has a big cost advantage over the other firms.
Sells a large part of the industry output.
Sets the market price.
Other firms are price takers. 38

25. Dominant Firm Oligopoly
Let’s use Big-G as an example.
Big-G is the dominant
gas station in a city. 39

26. Dominant Firm Oligopoly
Ten small firms and market demand
Big-G’s price and output decision
S10 MC
1.50
1.50 MR
Price (dollars per gallon) a b a b
1.00
1.00 D
0.50
Instructor Notes:
The other 10 firms take this price and each firm sells 1,000 gallons per week.
0.50 XD 10 20 10 20
Quantity (thous. of gal./week)
Quantity (thous. of gal./week) 43

28. G A M E T H O R Y

29. GAME THEORY AND THE ECONOMICS OF COOPERATION
Game theory is the study of how people behave in strategic situations.
Strategic decisions are those in which each person, in deciding what actions to take, must consider how others might respond to that action.

30. GAME THEORY AND THE ECONOMICS OF COOPERATION
Because the number of firms in an oligopolistic market is small, each firm must act strategically.
Each firm knows that its profit depends not only on how much it produces but also on how much the other firms produce.

31. The Prisoners’ Dilemma
The prisoners’ dilemma provides insight into the difficulty in maintaining cooperation.
Often people (firms) fail to cooperate with one another even when cooperation would make them better off.

32. The Prisoners’ Dilemma
The prisoners’ dilemma is a particular “game” between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial.

33. The Prisoners’ Dilemma
Nisit’ s Decision
Confess
Remain Silent
Nisit gets 8 years
Dom gets 8 years
Nisit gets 20 years
Dom goes free
Confess
Dom’s
Decision
Nisit goes free
Dom gets 20 years
gets 1 year
Nisit
Dom gets 1 year
Remain
Silent

34. Oligopolies as a Prisoners’ Dilemma
The dominant strategy is the best strategy for a player to follow regardless of the strategies chosen by the other players.
Cooperation is difficult to maintain, because cooperation is not in the best interest of the individual player.

35. Figure shows Warm Up and Monkey Club play Oligopoly Game
350 person
300 person
WU gets $1,600 profit
MKC gets $1,600 profit
WU gets $1,500 profit
MKC gets $2,000 profit
350 person
Monkey ‘s
Club
WU gets $2,000 profit
MKC gets $1,500 profit
WU gets $1,800 profit
MKC gets $1,800 profit
300 person