Chapter 25
Oligopoly
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Chapter Objectives
•
•
•
•
•
Concentration Ratios
The Herfindahl-Hirschman index
The competitive spectrum
The kinked demand curve
Administered prices
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Oligopoly Defined
• An oligopoly is an industry with just a few
sellers
• How few? So few that at least one firm is
large enough to influence price
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Oligopoly
• Oligopoly is the prevalent type of
industrial competition in the United
States as well as in most of the
noncommunist industrial west
• In terms of production, the vast majority
of our GDP is accounted for by firms in
oligopolistic industries
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Oligopoly
• The crucial factor under oligopoly is the
small number of firms
• Because there are so few firms, every
competitor must think continually about
the actions of its rivals
– What each does could make or break the others
• Thus, there is a kind of interdependance
among oligopolists
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Oligopoly
• When we talk about big business in the
United States,we’re talking about
oligopolies. Some examples are
– GM, Ford, ExxonMobil, IBM, Boeing, CBS,
NBC, Kellog, and General Mills
– We can also include all the other industrial
giants that have become household names
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Oligopoly
• The graph of the oligopolist is similar to that of
the monopolist
– The oligopolist is analyzed in the same manner as
the monopolist with respect to price, output, profit,
and efficiency
– Price is higher than the minimum point of the ATC
curve, therefore the oligopolist is not as efficient as
the perfect competitor
– The oligopolist has a higher price and a lower
output than does the perfect competitor
– The oligopolist, like the monopolist, makes a profit
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Concentration Ratios
• The concentration ration is the
percentage share of industry sales of the
four leading firms in the industry
– Industries with high concentration ratios are
very oligopolistic
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Calculate the Concentration Ratio
Firm
Percent of sales
A
14 %
B
4
C
D
The concentration ratio is
23 + 17 + 15 + 14 = 69
23
5
E
2
F
8
G
17
H
10
I
2
J
15
Total
100 %
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Concentration Ratio Shortcomings
• Concentration ratios do not include imports
– This ignores 2 million Japanese imports as well as
the hundreds of thousands of Volkswagens, Saabs,
BMWs, Audis, Jaguars, Porsches, and Rolls Royces
the United States imports
• Concentration ratios tell us nothing about the
competitive structure of the rest of the industry
– Are all the firms relatively large or are they small?
– When the remaining firms are large, they are not as
easily dominated by the top four as are dozens of
relatively small firms
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Concentration Ratio Shortcomings
• Concentration rations have become less
meaningful as imports have increased
– The United States gets 80% of its consumer
electronics and 53% of its oil from abroad
• Imports tend to make the automobile
industry’s concentration ration less
relevant
– Transplants reduce this ratio
– As a result, the American car buyers have
reaped the benefits of lower prices and
much higher quality
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
25-11
Herfindahl- Hirschman Index
(HHI)
• The HHI is the sum of the squares of the
market shares of each firm in the
industry
– A monopoly has 100 percent of the market
share
2
100 = (100 X 100) = 10,000
You can’t get a bigger HHI number than 10,000. Every monopoly
would have an HHI of 10,000
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
25-12
Herfindahl- Hirschman Index
(HHI)
• The HHI is the sum of the squares of the
market shares of each firm in the
industry
Find the HHI in an industry with just two firms
Each firm has 50 percent of the market
2
2
50 + 50 = 2,500 + 2,500 = 5,000
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Herfindahl- Hirschman Index
(HHI)
• The HHI is the sum of the squares of the
market shares of each firm in the
industry
Find the HHI in an industry that has four firms
Each firm has 25 percent of the market
2
2
2
2
25 + 25 + 25 + 25
625 + 625 + 625 + 625
2500
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
25-14
The Competitive Spectrum
Cartel
Open
collusion
Covert
collusion
Price
leadership
Weak
Strong
Cutthroat
competition competition competition
The possible degrees of competition in an oligopolistic market
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
25-15
Cartels
• A cartel is a combination of firms that acts as if
it were a monopoly
– The leading firms in an industry band together to
restrict output, share out markets and,
consequently, increase prices and profits
– If the demand is there, oligopolistic firms can openly
collude to control supply and, to a large degree,
market price
– OPEC did this in 1973 when the price of oil
quadrupled
– A cartel is the most extreme case of oligopoly
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Withholding Supply to Raise Price
S2
P2
S1
P1
D
Quantity
When supply is lowered from S1 to S2, price rises from P1 to P2
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
25-17
Open Collusion
• Open collusion operates like the alleged Mafia
– This would be some type of territorial
division of the market among the firms in
the industry
• This type of arrangement gives each firm in the market a
regional monopoly
• The firm may have only 15 or 20% of the market, but
under this type of arrangement, its pricing behavior is that
of the monopolist
– Open collusion is slightly less extreme than a
cartel
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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The Colluding Oligopolist
120
MC
105
90
ATC
75
60
D
40
35
MR
30
25
0
100
200
300
Output
400
500
600
This graph could also belong to the monopolist or the monopolistic
competitor in the short run
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Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Covert Collusion
• This usually involves price-fixing
– In the late 1950s General Electric, Westinghouse,
Allis-Chalmers and other leading electrical firms
conspired to fix the price of electrical transformers,
turbines, and other electrical equipment
– They rigged government bids by taking turns
making (high) low bids bilking the public of
hundreds of millions of dollars
• In 1961 the U.S. Supreme court found 7 high ranking
corporate officials guilty of illegal price fixing and market
sharing agreements
• Their employers paid their fines
• They got short jail sentences
• Their employers paid their salaries while in jail, and they
got their old job back after they got out
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Other Cases of Collusion
• In 1996 Archer Daniels Midland Company
pleaded guilty and paid a $100 million criminal
fine for its role in two international price-fixing
conspiracies
• In 1999 an arrangement was uncovered that
fixed worldwide vitamin prices as much as 25%
above the market level
• A worldwide price-fixing conspiracy led by
Swiss and German companies was prosecuted
by the U.S Department of Justice
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Price Leadership
• Price leadership is playing follow the leader
– One company raises prices and shortly after, the
other companies in the same market do the same
• The prime rate set by the big banks is a form of
price leadership
• Collusion is most likely to succeed when there
are few firms and high barriers to entry
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Cutthroat Competition
• Cutthroat competition is an extreme case
• The cutthroat competitor’s actions are based on
assumptions about their rivals behavior
• The cutthroat competitor assumes that if I raise
my price my competitors won’t raise their price
• The cutthroat competitor assumes that if I
lower my price, my competitors will also lower
their price
• Therefore the cutthroat competitor keeps the
price just where it is
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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The Cutthroat Oligopolist
48
MC
44
40
36
32
ATC
28
24
20
D
16
12
8
4
MR
0
1
2
3
4
Output
5
6
7
No cutthroat oligopolist will raise or lower price. It keeps the price just where it is
and that is at the kink in the demand curve
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
25-24
The Cutthroat Oligopolist
48
MC
44
40
36
32
Price is $27
ATC
28
24
20
D
16
12
8
4
MR
0
1
2
3
4
Output
5
6
7
At an output of 4 MC=MR
How much is the price and output for this firm?
Output is 4
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
25-25
The Cutthroat Oligopolist
48
MC
44
40
36
32
Price is $27
ATC is $24
ATC
28
24
20
D
16
12
8
4
MR
Total Profit = (Price – ATC) X Output
= ($27 – 24) X 4
= 3 X 4 = 12
0
1
2
3
4
Output
5
6
7
At an output of 4 MC=MR
Output is 4
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
25-26
Conclusion
Cartel
Open
collusion
Covert
collusion
Price
leadership
Weak
Strong
Cutthroat
competition competition competition
At one of the spectrum we have the cartel, which no longer operates
within the American economy, although it may be found in world
markets
At the other end of the spectrum, we have the cutthroat competitor,
the firm that will stop at nothing to beat out its rivals
Near the middle are the mildly competing oligopolists and the
occasionally cooperating oligopolists.
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
25-27
Conclusion
Cartel
Open
collusion
Covert
collusion
Price
leadership
Weak
Strong
Cutthroat
competition competition competition
Where is the spectrum in American industry? The answer is that
there is no answer.
First, there is no one place where American industry is located
because different industries have different competitive situations.
Second, there is widespread disagreement about the degree of
competition in any given industry
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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