Ch. 17 - Oligopoly
A Few (too few) Competitors
May Lead to Monopoly-like Behavior
What is an Oligopoly?
• market in which the industry is dominated by a small number of
sellers
• Derived from the Greek for few sellers.
• Since there are few participants, each oligopolist (firm) is aware of the actions
of the others
• decisions of one firm influence, and are influenced by the decisions of other
firms
• i.e., firms’ behave strategically taking into account the likely responses of the other
market participants (game theory)
2
Oligopoly
• Oligopoly markets are more concentrated than monopolistically
competitive markets,
but less concentrated than monopolies.
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
3
Oligopolies - Characteristics
• Businesses that are part of an oligopoly share some common characteristics:
• They are less concentrated than in a monopoly, but more concentrated than in a competitive
system.
• There is still competition within an oligopoly, as in the case of airlines. Airlines match
competitor’s air fares when sharing the same routes. Also, automobile companies compete in the
fall as the new models come out. One will reduce financing rates and the others will follow suit.
• The businesses offer an identical product or services.
• This creates a high amount of interdependence which encourages competition in non price-
related areas, like advertising and packaging. The tobacco companies, soft drink companies, and
airlines are examples of an imperfect oligopoly.
Oligopolistic Industries - Examples
Industries which are examples of oligopolies include:
• Steel industry
• Aluminum
• Film
• Television
• Cell phone
• Gas
Examples of Oligopoly
• Four music companies control 80% of the market - Universal Music Group, Sony
•
•
•
•
Music Entertainment, Warner Music Group and EMI Group
Six major book publishers - Random House, Pearson, Hachette, HarperCollins,
Simon & Schuster and Holtzbrinck
Four breakfast cereal manufacturers - Kellogg, General Mills, Post and Quaker
Two major producers in the beer industry - Anheuser-Busch and MillerCoors
Two major providers in the healthcare insurance market - Anthem and Kaiser
Permanente
Pros and Cons of Oligopolies
• Pros
• Pro: Prices in an oligopoly are usually lower than in a monopoly, but higher than it
would be in a competitive market.
• Pro: Prices tend to remain stable because if one company lowers the price too
much, then the others will do the same. The result lowers the profit margin
for all the companies, but is great for the consumer
Pros and Cons of Oligopolies
• Con: Output would be less than in a competitive market and more than in a monopoly. Most competition
between companies in an oligopoly is by means of research and development (or innovation), location,
packaging, marketing, and the production of a product that is slightly different than the other company
makes.
• Con: Major barriers keep companies from joining oligopolies. The major barriers are economies of scale, access to
technology, patents, and actions of the businesses in the oligopoly. Barriers can also be imposed by the
government, such as limiting the number of licenses that are issued.
• Con: Oligopolies develop in industries that require a large sum of money to start. Existing companies in
oligopolies discourage new companies because of exclusive access to resources or patented processes, cost
advantages as the result of mass production, and the cost of convincing consumers to try a new product.
• Lastly, companies in oligopolies establish exclusive dealerships, have agreements to get lower prices from
suppliers, and lower prices with the intention of keeping new companies out.
Are US Industries Becoming More
Concentrated?
• Abstract – AEA Nov 2015
• More than 90% of U.S. industries have experienced an increase in concentration
levels over the last two decades. Firms in industries with the largest increase in
product market concentration have enjoyed higher profit margins, positive
abnormal stock returns, and more profitable M&A deals, suggesting that market
power is becoming an important source of value. This phenomenon has been
mainly driven by the consolidation of publicly-traded firms into larger entities. The
increased level of concentration due to public firms' consolidation has not been
offset by a larger presence of private or foreign firms. Overall, our findings suggest
that the nature of U.S. product markets has undergone a structural shift that has
weakened competition.
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
10
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.
11
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
• HHI > 1800 - > Potentially Too Concentrated
12
Figure 12.11 Four-Firm Concentration Ratio (CR4)
for Selected Industries in 1997
13
Non-competitive Oligopolies
• Non-competitive/collusive behavior (cooperative oligopolies)
• Cartels: firms may collude to raise prices and restrict production in the same way as a
monopoly. Where there is a formal agreement for such collusion, this is known as a cartel.
• Dominant Firm/Price Leader:
• collude in an attempt to stabilize unstable markets, so as to reduce the risks inherent in these
markets for investment and product development.
• does not require formal agreement
• although for the act to be illegal there must be a real communication between companies
• for example, in some industries, there may be an acknowledged market leader which informally sets prices
to which other producers respond, known as price leadership.
• Stackleberg price-leader model
14
Duopoly Equilibrium in a Centralized Cartel
15
Cartel Pricing Tactic
• Reduce Qs to monopoly levels in order to:
• a) obtain a higher price
• b) earn monopoly rents
16
Competition Versus Cartel
(a) Firm
(b) Market
Price, p,
$ per unit
Price, p,
$ per unit
MC
S
pm
pm
AC
pc
pc
MC m
MCm
em
ec
Market demand
MR
q m q c q*
Quantity, q, Units
per year
Qm
Qc
Source: Jeffrey M. Perloff, Microeconomics, 3rd Ed., 2004, p. 435
Quantity, Q, Units
per year
17
Strategic Behavior
• Perfect Competition
• Only strategy is to reduce costs
• Price-taker => output decisions do not affect market price
• cross-price elasticity = -1 (perfect substitutes)
• Own-price = -∞
• Monopoly
• Price-Searcher: output decision determines price
• Cross-price = 0 (no substitutes)
• Own-price: >= |1|
• Oligopoly
•
•
•
•
Cross-price elasticity near -1
Own-price elasticity > |1|
Will have to take into account actions of other similar firms when making output/pricing decisions
Much more strategy
18
Oligopoly Behavior
• Cooperative Oligopoly
• Cartels
• Agree to collude; act/price like a single firm monoploist
• Price leadership (Stackleberg leader)
• Dominant firm establishes the price; other firms react to “leader”
• Non-cooperative Oligopolies
• Sticky prices (kinked demand curve)
• Sticky upward
• Nash equilibrium
• Characterized by stable prices
• Perfect competition
• Completely rivalarous
19
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.
20