1. Oligopoly Characteristics of oligopoly –Small number of firms –Interdependence Strategic dependence Whatever you do, I shall do – the zero percent financing

2. Oligopoly Strategic Dependence –A situation in which one firms actions with respect to price, quality, advertising, and related changes may be strategically countered by the reactions of one or more other firms in the industry –LIKE PLAYING CHESS

3. Oligopoly Why oligopoly occurs –Economies of scale –Barriers to entry –Mergers Vertical mergers Horizontal mergers

4. Oligopoly Vertical Merger –The joining of a firm with another to which it sells an output or from which it buys an input Horizontal Merger –The joining of firms that are producing or selling a similar product

5. Oligopoly Measuring industry concentration –Concentration Ratio The percentage of all sales contributed by the leading four or leading eight firms in an industry

6. Computing the Four-Firm Concentration Ratio Annual Sales Firm($ Millions) 1150 2100 380 470 5 through 2550 Total450 Total number of firms in Industry = 25 Four-firm concentration ratio = 450 400 88.9%

7. Computing the Four-Firm Concentration Ratio Percentage of Value of Total Domestic Shipments Accounted IndustryFor By the Top Four Firms % Domestic motor vehicles84 Breakfast cereals85 Soft drinks69 Tobacco products93 Primary aluminum59 Household vacuum cleaners59 Electronic computers45 Printing and publishing23 Source: U.S. Bureau of the Census

8. Models of Oligopoly Game Theory –A way of describing the various possible outcomes in any situation involving two or more interacting individuals when those individuals are aware of the interactive nature of their situation and plan accordingly

9. Game Theory Cooperative Game –A game in which the players explicitly cooperate to make themselves better off Noncooperative Game –A game in which the players neither negotiate nor cooperate in any way Zero-Sum Game –A game in which any gains within the group are exactly offset by equal losses by the end of the game Negative-Sum Game –A game in which players as a group lose at the end of the game

10. Strategic Behavior and Game Theory Positive-Sum Game –A game in which players as a group are better off at the end of the game

11. Strategic Behavior and Game Theory Strategies in noncooperative games –Strategy Any rule that is used to make a choice Any potential choice that can be made by players in a game –Dominant Strategies Strategies that always yield the highest benefit

12. Prisoners Dilemma You and your partner rob a bank and get caught.

13. Prisoners Dilemma You are separated and given these options: –Both confess and get 5 years in jail –Neither confess and get 2 years –One confess and the other does not Confessor goes free One who does not confess get 10 years

14. The Prisoners Dilemma Payoff Matrix Figure 25-3

15. Strategic Behavior and Game Theory Applying game theory to pricing strategies –Would you choose a high price or a low price? Remember –No collusion

16. Strategic Behavior and Game Theory Figure 25-4

17. Strategic Behavior and Game Theory Opportunistic Behavior –Actions that ignore the possible long-run benefits of cooperation and focus solely on short-run gains

18. Strategic Behavior and Game Theory Opportunistic behavior –Implies a noncooperative game –Not realistic We make repeat transactions

19. Strategic Behavior and Game Theory Tit-for-Tat Strategic Behavior –In game theory, cooperation that continues so long as the other players continue to cooperate

20. Pakistan agreed to certain conditions for an IMF loan –In 1999, the IMF discovered that Pakistan had spent much of this loan on the development of nuclear weapons –Soon, Pakistan had to default on its debt Why would Pakistan engage in this behavior with the IMF? International Example: Strategically Relating Subsidies to Nuclear Weapons

21. d 1 is relatively elastic if one firm raises its price the others will not and it will lose market share d 2 is relatively inelastic if one firm lowers its price the others lower their price so gain in sales is small Price Rigidity and the Kinked Demand Curve Figure 25-5, Panel (a)

22. The kinked demand curve indicates the possibility of price rigidity Price Rigidity and the Kinked Demand Curve Figure 25-5, Panel (b)

23. Price Rigidity and the Kinked Demand Curve Figure 25-6 Changes in cost do not impact output and prices as long as MC remains in the vertical portion of MR

24. d1d1 d2d2 MR 2 P0P0 q0q0 Criticisms of the Kinked Demand Curve Quantity per Time Period Price and Marginal Revenue per Unit MR 1 Cannot determine P 0 Empirical evidence does not confirm the kinked demand theory

25. Strategic Behavior Do pet products have nine lives? –H.J. Heinzs Pet Products Company Dropped its price of 9-Lives cat food by 22% to meet increased competition from Nestle, Quaker, Grand Metropolitan, and Mars Heinz then decided to raise prices Its competition did not and Heinzs market share dropped from 23 to 15 percent

26. Price Leadership –A practice in many oligopolistic industries in which the largest firm publishes its price list ahead of its competitors, who then match those announced prices Strategic Behavior with Implicit Collusion: A Model of Price Leadership

27. Price War –A pricing campaign designed to drive competing firms out of a market by repeatedly cutting prices Strategic Behavior with Implicit Collusion: A Model of Price Leadership

28. Markets where price wars are common –Cigarettes –Long-distance telephone companies –Airlines Strategic Behavior with Implicit Collusion: A Model of Price Leadership

29. Markets where price wars are common –Diapers –Frozen foods –PC hardware and software Strategic Behavior with Implicit Collusion: A Model of Price Leadership

30. Cigarette price wars –Philip Morris cut Marlboro by 40 cents a pack –RJR Nabisco matched the cut for Camel –Marlboros market share rose from 22.1% to 27.3% –Profits and stock prices fell Strategic Behavior with Implicit Collusion: A Model of Price Leadership

31. Cigarette price wars –Phillip Morris reduced prices by 18% and sales went up by only 12.5% Profits fell by 25% Strategic Behavior with Implicit Collusion: A Model of Price Leadership

32. Entry Deterrence Strategy –Any strategy undertaken by firms in an industry, either individually or together, with the intent or effect of raising the cost of entry into the industry by a new firm Deterring Entry Into an Industry

33. Increasing entry cost –Threat of price wars –Government regulations Environmental regulation Safety standards Deterring Entry Into an Industry

34. Limit-Pricing Strategies –A model that hypothesizes that a group of colluding sellers will set the highest common price that they believe they can charge without new firms seeking to enter that industry in search of relatively high profits Deterring Entry Into an Industry

35. Raising customers switching cost –Examples Non-compatible software Non-transferability of college courses Deterring Entry Into an Industry