ECON 202: Principles
of Microeconomics
Chapter 13
Oligopoly
Oligopoly
1.
2.
3.
4.
Oligopoly and Barriers to Entry.
Using Game Theory to Analyze Oligopoly.
Sequential Games and Business Strategy.
The Five Competitive Forces Model.
ECON 202: Princ. of Microeconomics
Oligopoly
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Introduction
„
Oligopoly is market structure where:
Few competitors.
Identical or differentiated products.
Restrictions to entry.
„
„
In case of oligopolistic markets, revenues of the firms
depend on actions of other competitors.
If a firm cut its price, number of units sold depends on
how other firms react.
If other firms don’t do anything, sell more.
If other firms also cut prices, sales will not increase much or can
even decrease.
„
„
Marginal revenue depends on actions of other firms.
Approach to analyze oligopolies: game theory.
ECON 202: Princ. of Microeconomics
Oligopoly
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1. Oligopoly and Barriers to Entry
„
Oligopolistic markets have few firms
„
US Bureau of Census publishes 4-firm concentration
ratios per industry.
„
How many firms is “few”?
More than 40% indicates oligopolistic market.
Critics
Consider only sales by national firms
In some industries, competition is mainly local. (restaurants)
Some firms compete in different industries. (Wal Mart in discount
department stores, supermarkets and retail toy stores)
„
Herfindahl-Hirschman Index (HHI)
Sum of squared shares: 302 + 302 + 202 + 202 = 2,600
HHI > 1,800 : oligopolistic markets.
ECON 202: Princ. of Microeconomics
Oligopoly
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1. Oligopoly and Barriers to Entry
RETAIL TRADE
INDUSTRY
MANUFACTURING
FOUR-FIRM
CONCENTRATION
RATIO
INDUSTRY
FOUR-FIRM
CONCENTRATION
RATIO
Discount Department Stores
95%
Cigarettes
95%
Warehouse Clubs and Supercenters
92%
Beer
91%
Hobby, Toy, and Game Stores
72%
Breakfast Cereal
82%
Athletic Footwear Stores
71%
Aircraft
81%
College Bookstores
70%
Automobiles
76%
Radio, Television, and Other
Electronic Stores
69%
Dog and Cat Food
76%
Pharmacies and Drugstores
53%
Dog and Cat Food
64%
ECON 202: Princ. of Microeconomics
Oligopoly
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1. Oligopoly and Barriers to Entry
Barriers to entry
„ Economies of scale
ECON 202: Princ. of Microeconomics
Oligopoly
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1. Oligopoly and Barriers to Entry
„
Ownership of a Key Input
Aluminum Company of America (Alcoa) access to high-quality
bauxite.
De Beers Company of South Africa access to diamonds.
„
Government-imposed barriers
Occupational licensing (doctors and dentists)
Restrictions to international trade (tariffs and quotas)
„
Since entry is restricted, firms can sustain economic
profits over a long period.
ECON 202: Princ. of Microeconomics
Oligopoly
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2. Using Game Theory to Analyze Oligopoly
„
Game theory:
„
The study of how people make decisions in situations in which
attaining their goals depends on their interactions with others.
Games have three characteristics:
Rules.
Strategies.
Payoffs.
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Oligopoly
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2. Using Game Theory to Analyze Oligopoly
„
Duopoly: price competition between two firms.
„
Firms can collude, but is against the law. (Sherman Act)
ECON 202: Princ. of Microeconomics
Oligopoly
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2. Using Game Theory to Analyze Oligopoly
„
For each firm, to charge $400 is a dominant strategy.
„
The best strategy for a player, regardless of what the other
players decide.
($400, $400) is a Nash equilibrium.
A situation where each player is choosing its best strategy, given
the others players’ strategies.
A situation where no player has an incentive to change of
strategy.
„
Equilibrium is not best possible result for the firms, but it
results because each firm pursues its own interest.
„
Noncooperative equilibrium.
If firms decide to cooperate and play ($600, $600), then
result increases their mutual payoff.
Cooperative equilibrium.
ECON 202: Princ. of Microeconomics
Oligopoly
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2. Using Game Theory to Analyze Oligopoly
„
Types of games where individual maximization of payoff
leaves everyone worse off are called prisoner’s
dilemma.
„
Nash Equilibrium is (defect, defect).
Challenge to Adam Smith’s idea of self-interest.
„
ECON 202: Princ. of Microeconomics
Oligopoly
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2. Using Game Theory to Analyze Oligopoly
„
In most business situations games are played
repeatedly.
„
Firms can collude implicitly to reach the cooperative equilibrium.
Example: “lowest price guarantee”
Firms send a signal to competitors that if they charge lower
price, its strategy will be the same.
Firms have the incentive to keep the high price.
ECON 202: Princ. of Microeconomics
Oligopoly
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2. Using Game Theory to Analyze Oligopoly
ECON 202: Princ. of Microeconomics
Oligopoly
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2. Using Game Theory to Analyze Oligopoly
„
„
When firms can collude: cartels (OPEC)
However, firms can have incentives to stop cooperation,
which makes difficult to sustain agreements.
ECON 202: Princ. of Microeconomics
Oligopoly
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3. Sequential Games and Business Strategy
„
Oligopolistic firms can deter the entry of new firms.
„
Best strategy for WalMart is to build the large store,
deterring entry from Target.
ECON 202: Princ. of Microeconomics
Oligopoly
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3. Sequential Games and Business Strategy
„
Best strategy for firm is to build the small store and let
Target entry the market.
ECON 202: Princ. of Microeconomics
Oligopoly
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3. Sequential Games and Business Strategy
„
Bargaining
„
If TruImage says that will not accept a deal at $20:
noncredible threat.
ECON 202: Princ. of Microeconomics
Oligopoly
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4. The Five Competitive Forces Model
„
Forces that determine the level of competition in an
industry.
ECON 202: Princ. of Microeconomics
Oligopoly
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4. The Five Competitive Forces Model
„
Competition from existing firms.
„
Threat from potential entrants.
„
Train vs. flight
Bargaining power of buyers.
„
Railways.
Competition from substitute goods or services.
„
Educational testing service: SAT and ACT vs. GRE.
Automobile makers and tire suppliers.
Bargaining power of suppliers.
Technicolor and color movies.
ECON 202: Princ. of Microeconomics
Oligopoly
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ECON 202: Principles
of Microeconomics
Chapter 13
Oligopoly