Econ 201
Spring 2009
7.2b
Market Failure:
Oligopolies (more)
1
Cooperative Oligopolies
•
Cartels (highly cooperative)
– Firms act as single-firm monopolist
•
Stackelberg Price Leader (passive
cooperation)
-
leader firm moves first and then the follower
firms move sequentially
– Stackelberg leader is sometimes referred to
as the Market Leader.
2
Where We’re Going
• How do we tell if a market is an oligopoly?
– Market Concentration
• CR4: market share for the 4 largest firms
• Herfindahl Index (HHI): computed from the
squares of the market shares
• Strategic behavior (how do they behave in
the market place)
– Collusive: act together
– Non-collusive: act separately and/or
stratgeicially
3
How do we tell?
• Market concentration refers to the size
and distribution of firm market shares and
the number of firms in the market.
• Economists use two measures of industry
concentration:
– Four-firm Concentration Ratio
– The Herfindahl-Hirschman Index
4
Four-Firm Concentration Ratio
• The four-firm concentration ratio (CR4)
measures market concentration by adding
the market shares of the four largest firms
in an industry.
– If CR4 > 60, then the market is likely to
be oligopolistic.
5
Example
Firm
Nike
Market Share
62%
New Balance
15.5%
Asics
10%
Adidas
4.3%
CR 4 = 62 15.5 10  4.3  91.8
6
The Herfindahl-Hirschman
Index
• The Herfindahl-Hirschman index (HHI) is
found by summing the squares of the
market shares of all firms in an industry.
– Advantages over the CR4 measure:
• Captures changes in market shares
• Uses data on all firms
7
Example
Firm
Market Share
Nike
62%
New Balance
15.5%
Asics
10%
Adidas
4.3%
HHI  62 15.5 10  4.3  4,202.74
2
2
2
2
8
Example (cont’d)
What happens if market shares are evenly distributed?
Firm
Market Share
Nike
22.95%
New Balance
22.95%
Asics
22.95%
Adidas
22.95%
HHI  22.95 2  22.95 2  22.95 2  22.95 2  2,106.81
CR 4  91.8
9
Cartel Pricing Tactic
• Reduce Qs to monopoly levels in order to:
– a) obtain a higher price
– b) earn monopoly rents
10
How do Cartels Operate?
• Firms in the cartel need to agree on:
– 1) Market price
– 2) Quantity supplied by the Industry
– 3) Each firm’s “quota”
– 4) “Not to cheat” on either price or quantity
supplied
11
How Does a Cartel Set
Output and Price?
• Just like a monopolist
– Qty supplied set at point where MR = MC
– Except: that it is set for the industry
• MC(ind) = MC(firm 1) + MC(firm 2) + ..
• Quotas are assigned such that
– Marginal Costs at optimal Qs is the same for all firms
in the cartel
• MC(1) = MC(2) = MC(3) = …
• Price is set along the Industry Demand Curve at
the Cartel’s output
12
Figure 12.4 Duopoly Equilibrium in
a Centralized Cartel
13
Conditions for cartel success
• the cartel can significantly raise price
• cartel controls market
• low organizational costs
– few firms (or a few large ones)
– industry association
• many small buyers: no monopsony power
• cartel can be maintained
– cheating can be detected and prevented
– low expectation of severe government punishment
14
Firms “cheat”
• luckily for consumers, cartels often fail
because each firm in a cartel has an
incentive to cheat on the cartel agreement
• cheating firm
– produces extra output or lowers its price
– ignores the negative effect of its extra output
on other firms’ profits
15
Factors that work against a Cartel
- in the long run
• Each firm has an incentive to cheat
– Price that firm receives is still above MC of
production
• Could earn additional profits by slightly expanding
output
• However, when all firms do this
– -> back at competitive market outcome
• Qs up to point where MV=MC
• See “prisoners dilemma”
16
An Example of a Cartel
• Organization of the Petroleum Exporting Countries (OPEC) is an
international cartel made up of Algeria, Angola, Ecuador, Indonesia,
Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United
Arab Emirates, and Venezuela.
• Principal aim of the organization, according to its Statute, is the
determination of the best means for safeguarding their interests,
individually and collectively; devising ways and means of ensuring
the stabilization of prices in international oil markets with a view to
eliminating harmful and unnecessary fluctuations
• OPEC triggered high inflation across both the developing and
developed world using oil embargoes in the 1973 oil crisis.
• OPEC's ability to control the price of oil has diminished due to the
subsequent discovery/development of large oil reserves in the Gulf
of Mexico and the North Sea, the opening up of Russia, and market
modernization.
• OPEC nations still account for two-thirds of the world's oil reserves,
and, in 2005, 41.7% of the world's oil production,
17
Cartels
•
A cartel is a formal (explicit) agreement among firms.
–
–
•
Cartel members may agree on such matters
–
–
–
–
–
•
•
as price fixing,
total industry output,
market shares,
allocation of customers,
allocation of territories
aim of such collusion is to increase individual member's profits by reducing
competition.
–
•
usually occur in an oligopolistic industry, where there are a small number of sellers
usually involve homogeneous products.
Competition laws forbid cartels.
Several economic studies and legal decisions of antitrust authorities have found that
the median price increase achieved by cartels in the last 200 years is around 25%.
Private international cartels (those with participants from two or more nations) had an
average price increase of 28%, whereas domestic cartels averaged 18%. Less than
10% of all cartels in the sample failed to raise market prices
18
What market conditions make
Cartels more likely?
• Market demand is inelastic
– higher prices lead to increase revenues for the cartel
• Homogenous goods
– easier to initially set/enforce cartel price
• Small number of firms/high concentration of
market share (easier to monitor, collude)
– Fringe players could defeat cartel
– More equal shares -> increase incentive to cheat
19