Microeconomics
ECON 2302
May 2009
Marilyn Spencer, Ph.D.
Professor of Economics
Chapter 13
Chapter 13. Oligopoly: Firms in
Less Competitive Markets
LEARNING OBJECTIVES
In an oligopoly, a firm’s profitability depends crucially on
its interactions with other firms.
After studying this chapter, you should be
able to:
1
2
3
4
Show how barriers to entry explain the existence of
oligopolies.
Use game theory to analyze the actions of
oligopolistic firms.
Use a sequential games to analyze business strategies.
Use the five competitive forces model to analyze
competition in an industry.
Oligopoly
Oligopoly A market structure in which a
small number of interdependent firms
compete.
The approach we use to analyze
competition among oligopolists is called
game theory.
1 LEARNING OBJECTIVE
Oligopoly and Barriers to Entry
Barriers to Entry
Barrier to entry Anything that keeps new
firms from entering an industry in which firms are
earning economic profits.
13 - 1
Examples of Oligopolies in
Retail Trade and Manufacturing
RETAIL TRADE
INDUSTRY
MANUFACTURING
FOUR-FIRM
CONCENTRATION
RATIO
INDUSTRY
FOUR-FIRM
CONCENTRATIO
N RATIO
Warehouse Clubs and
Superstores
90%
Cigarettes
99%
Discount Department
Stores
88%
Beer
90%
Hobby, Toy, and Game
Stores
70%
Aircraft
85%
Radio, Television, and
Other Electronic Stores
62%
Breakfast Cereal
83%
Athletic Footwear Stores
62%
Automobiles
80%
College Bookstores
58%
Dog and Cat Food
58%
Pharmacies and
Drugstores
47%
Computers
45%
Oligopoly and Barriers to Entry
Barriers to Entry:
1. Economies of scale Economies of scale
exist when a firm’s long-run average costs fall
as it increases output.
13 - 1
Economies of Scale Help Determine the Extent of Competition in an Industry
Oligopoly and Barriers to Entry
Barriers to Entry:
In addition to economies of scale, other
barriers to entry include:
2. Ownership of a key input
3. Government–Imposed Barriers
 Patent The exclusive right to a product
for a period of 20 years from the date the
product was invented.
 Other government barriers?
2 LEARNING OBJECTIVE
Using Game Theory to Analyze
Oligopoly
Game theory The study of how people
make decisions in situations where attaining
their goals depends on their interactions
with others; in economics, the study of the
decisions of firms in industries where the
profits of each firm depend on its
interactions with other firms.
Game Theory

Key characteristics of all games:
 Rules that determine what actions are
allowable.
 Strategies that players employ to attain their
objectives in the game.
 Payoffs that are the results of the interaction
among the players’ strategies.

Business strategy Actions taken by a business
firm to achieve a goal, such as maximizing
profits.
Game Theory
A Duopoly Game: Price Competition between
Two Firms
 Payoff matrix A table that shows the payoffs
that each firm earns from every combination of
strategies by the firms.
Collusion An agreement among firms to charge
the same price, or to otherwise not compete.
13 - 2
A Duopoly Game
Game Theory
A Duopoly Game: Price Competition between
Two Firms
 Dominant Strategy A strategy that is the best
for a firm, no matter what strategies other firms
use.
Nash equilibrium A situation where each
firm chooses the best strategy, given the strategies
chosen by other firms.
13 - 1
A Beautiful Mind: Game
Theory Goes to the Movies
In the film, “A
Beautiful
Mind,” Russell
Crowe played
John Nash,
winner of the
Nobel Prize in
Economics.
Game Theory
Firm Behavior and the Prisoners’ Dilemma
 Cooperative equilibrium An equilibrium in a
game in which players cooperate to increase
their mutual payoff.
Noncooperative equilibrium An
equilibrium in a game in which players do not
cooperate but pursue their own self-interest.
Prisoners’ dilemma A game where pursuing
dominant strategies results in noncooperation that
leaves everyone worse off.
13 - 1
2 LEARNING OBJECTIVE
Is Advertising a Prisoners’ Dilemma for Coca-Cola and Pepsi?
Advertising is the optimal decision for both firms,
given the decision by the other firm.
13 - 2
Is There a Dominant Strategy
for Bidding on eBay?
On eBay, bidding the
maximum value you
place on an item is a
dominant strategy.
Game Theory
Can Firms
Escape the
Prisoners’
Dilemma?
13 - 3
Changing the Payoff Matrix in a
Repeated Game
13 - 3
American Airlines and
Northwest Airlines Fail to
Cooperate on a Price Increase
The airlines have
trouble raising the
price this business
traveler pays for a
ticket.
Game Theory
Cartels: The Case of OPEC
Cartel A group of firms that colludes by
agreeing to restrict output to increase prices
and profits.
13 - 4
World Oil Prices
Sustaining high prices has been difficult because members
often exceed their output quotas.
Game Theory
Cartels: The Case of OPEC
13 - 5
The OPEC Cartel with Unequal Members
 The equilibrium of this game will occur with Saudi Arabia
producing a low output and Nigeria producing a high output.
3 LEARNING OBJECTIVE
Sequential Games: Deterring Entry
13 - 6
The Decision Tree for an Entry Game
The best decision for Wal-Mart is to build a large store to deter Target’s entry.
13 - 1
4 LEARNING OBJECTIVE
Is Deterring Entry Always a Good Idea?
In this case, Wal-Mart will build a small store and Target will enter.
Deterrence is only worth pursuing if its costs are not too high.
Sequential Games: Bargaining
13 - 7
The Decision Tree for a Bargaining
Game
4 LEARNING OBJECTIVE
The Five Competitive Forces Model
13 - 7
The Five Competitive Forces Model
13 - 4
Is Business Strategy More
Important Than the Structure
of the Airline Industry?
Southwest’s
business strategy
allowed it to remain
profitable when
many other airlines
faced heavy losses.
 Barrier to entry
 Business
strategy
 Cartel
 Collusion
 Cooperative
equilibrium
 Dominant
strategy
 Economies of
scale
 Game theory
 Nash equilibrium
 Noncooperative
equilibrium
 Oligopoly
 Patent
 Payoff matrix
 Prisoners’ dilemma
Assignments for May 28:
 Study Ch. 14 and be able to answer:
Review Questions: p. 498, 1.1; p. 499, 2.1, 2.2 & 2.4;
p. 500, 3.1 & 3.2; p. 501,4.1, 4.2, 5.1, 5.2 & 5.3 (1st
edition: 1-4, & 6-12 on pp. 468-469); and
Problems and Applications: p. 498: 1.4; p. 499: 2.6 &
2.8; p. 500, 3.6; p. 501, 4.6; p. 502, 5.4, 5.5 & 5.6 (1st
edition: 3, 4, 8, 9, 10, 11, 20 & 28 on pp. 469-472);
and
Use game theory to explain why:
 (a) sometimes an innocent person will confess to a crime;
 (b) OPEC members don’t always cooperate; and
 (c) countries build stockpiles of nuclear weapons to avoid
nuclear war.