Monopolistic Competition and Product
Differentiation
Outline for Lectures 20 and 21. Read Chapters 12
and 13 and the assigned class reading.
Announcements
http://www.theonion.com/content/news/pepsi_to_cease_advertising
Oligopoly
2
An oligopoly is an industry with only a small number of
producers.
†
It is a common market structure.
„
„
What is an oligopoly and why it occurs.
Collusion.
Game theory and the “prisoners’ dilemma”
Tacit collusion
Antitrust policy.
†
Cigarettes, batteries, breweries, breakfast cereals, autos, and airlines,
among others.
It arises from the same forces that lead to monopoly, but in weaker
form.
When no one firm has a monopoly, but producers
nonetheless realize that they can affect market prices, an
industry is characterized by imperfect competition,
Possible behaviors (discussed last class)
„ Cartel:
http://theinformantmovie.warnerbros.com/
on price “Bertrand equilibrium”
„ Game theory
„ Compete
The Prisoners’ Dilemma
Clearly better
Definitions
Strategic interactions of Duopolists:
the market for Lysine
Best response:
highest payoff given
other player’s
strategies
Dominant
strategy: always
the best response
Nash equilibrium
Nash equilibrium:
all players play
their best
responses, given
other player’s
actions.
Nash outcome
1
5
There are a rich range of possible behaviors in
even simple games.
†
Left (player D)
Right (Player D)
D wins $0
C wins
$100
Bottom
(player C)
C wins
$100
D wins
$100
Bottom
(player C)
C wins
$200
†
D wins
$100
C wins
$100
D wins $0
C loses
$10,000
Player C does not have a dominant strategy. But
player D does, so C can predict that D will play
“right.” Thus C will play “bottom” and this is the
Nash equilibrium.
Right (Player D)
D wins $0
D wins
$100
C wins
$200
Player C does not have a dominant strategy. But
player D does. But player C may not be willing to
risk the possibility that D will play “left,” so C may
choose to minimize potential losses by choosing
“top.”
How Repeated Interaction Can Support Collusion
8
Not all games have dominant strategies – it depends
on the structure of the game.
†
Top
(player C)
C wins
$100
A Couple Further Words on Prisoners
Dilemma Games
Left (player D)
D wins
$100
D wins $0
C loses
$100
7
Perhaps firms will play a “maximin” strategy
(maximize the minimum gain).
A Nash equilibrium even with no dominant strategy
Top
(player C)
†
6
Today’s homework gives an example.
So far we have just talked about one-shot games.
M t oligopolists
Most
li
li t will
ill iinteract
t
t repeatedly
t dl in
i th
the market.
k t
A “tit for tat” strategy involves playing cooperatively at
first, and then doing whatever the other player did in the
previous period.
† Firms can make greater short-term profits by cheating, but
long-term profits will be higher if they cooperate implicitly.
†
„
This is referred to as “tacit collusion.”
2
The Kinked Demand Curve
9
Oligopoly in Practice
10
Raise prices, others
won’t, so you lose
lots of sales
(elastic demand).
Lower prices,
others retaliate, so
demand is very
steep to the right
of Q*.
Antitrust laws.
Sherman Act of 1890 (forbids conspiring to restrict trade
and forbids attempts at monopolization).
† Clayton Act (1914) allows private suits, restricts mergers.
†
„
Abundant case law (complex area).
Life can be hard for would-be colluders
Hard with many firms.
Hard with complex products and pricing schemes.
† Differences in “seniority” or costs.
† Bargaining power of buyers (like Walmart…)
†
†
Changes in MC
may have little
effect on output!
So What Should You Make of
Oligopoly?
11
http://www.youtube.com/watch?v=aS_d0Ayjw4o
In economics we typically ask how self-interested
individuals would behave and analyze their
interactions.
This approach is unfortunately limited in the case of
oligopoly, because we do not know the extent (and nature)
of noncooperati
noncooperative
e interactions or whether oligopolists will
collude.
† The perfectly competitive model and the logic of supply and
demand can be very useful in analyzing oligopolistic
markets, however.
†
„
In cases where this isn’t enough, economists write down models of the
strategic interactions of firms, recognizing complications the arise from
price wars, anti-trust policy and other issues. These models can be
complicated!
3
Public Policy and Competition
13
Common issues of market structure and competition.
†
14
the merger allow the companies to operate more efficiently,
creating benefits for consumers?
„ Or will the merger hinder competition?
Size of the market – 4-firm concentration ratios, or the
Herfindahl-Hirshman index (sum of shares, squared).
† What is the market? Globalization and the internet has
expanded markets.
„ Office
Depot and Staples – what is the effect of competition on
Potential entrants.
What substitutes are there for products?
†
†
Potential substitutes will limit the ability to earn high profit.
Airlines purchase planes from oligopolists, leading to
interesting strategic issues.
Do customers have market power?
†
Cartels hinder competition
How “contestable” are markets?
Who are suppliers?
†
prices?
15
Concentration ratios, HHI indices; the amount of product
differentiation.
Many issues arise when considering these questions.
†
The rivalry among existing firms.
†
Exxon-Mobil wants to merge. Exxon is the 4th largest and
Mobil is the 13th largest U.S. company (measured in sales).
„ Will
What factors will regulators consider?
Intel sells to Dell. Proctor and Gamble sells to Walmart.
Two final competition thoughts
16
Therefore, cartels are illegal. But firms will engage
in other practices that may be anti-competitive.
†
Throughout the world, there has been a wave of
deregulation. This has delivered important benefits
to consumers.
†
†
Minimum resale price maintenance agreements.
Exclusive dealings
g
† Tie-in sales (bundling)
† Predatory pricing.
But some regulation is necessary – airline safety, bank
soundness, food safety.
† We need to be constantly vigilant about “regulatory
capture.”
4