15
CHAPTER
DYNAMIC P OWERP OINT™ S LIDES BY S OLINA L INDAHL
Cartels, Oligopolies, and
Monopolistic Competition
CHAPTER OUTLINE
Oligopolies
Cartels
Game Theory
Monopolistic Competition
The Economics of Advertising
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To Try it!
questions
To
Video
Food for Thought….
Some good blogs and other sites to get the juices flowing:
SEE THE INVISIBLE HAND
“Our neck is stretched over the fence and
OPEC has a knife” U.S. President Jimmy Carter, 1979
Oligopoly and Monopolistic Competition
An oligopoly is a
market that is
dominated by a small
number of firms.
(Cola)
Monopolistic
competition is a
market with a large
number of firms selling
similar but not
identical products.
(Restaurants)
BACK TO
The Landscape of Firms
YOU ARE HERE
Competition
Monopolistic
Competition
More Competition
(less price control)
Oligopoly
Monopoly
Less Competition
(more price control)
BACK TO
Studying Oligopoly Behavior
Is complicated- because it’s not a single firm
considering its costs and pricing in a vacuum
(like competitive firms and monopolies)
The profits of a large firm depend heavily on
the actions taken by other large firms.
Strategic Decision-Making = decision making
in situations that are interactive.
Poker, Chess
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Studying Strategic Decision-Making
We’ll introduce Game Theory as a way of
predicting outcomes in strategic situations
like oligopolies.
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Cartels
Some oligopoly firms are competitive with
each other, some are cooperative with
each other. We’ll focus on the
cooperative ones (since all firms would
rather not compete!)
A Cartel = a group of suppliers that tries to
act as if they were a monopoly.
The goal of these suppliers? To coordinate in
order to reduce supply, raise prices, and
increase profits.
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SEE THE INVISIBLE HAND
Mariachi Plaza is a sort of day-labor center for
musicians, and the mariachis will quickly gather around
passers-by, a horde of them jostling to get their business
card into the hand of the would-be customer.
Now, roughly 200 mariachis have joined the United
Mariachi Organization of Los Angeles, a group that
formed to set a minimum price in the plaza.
OPEC Cartel
OPEC (the Organization of Petroleum Exporting
Countries) limits production for each member
nation- to raise oil prices and profits- a cartel.
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The Price of Oil, 1960-2005
BACK TO
Cartels and Profit Maximization
A Cartel Tries to Move a Market from “Competition” towards “As if
Controlled by a Monopolist”
Competition
As if Controlled by a Monopolist
P
P
Profit
Pm
Pc
S
D
Qc
Pc
Q
MC = AC
MR
Qm
D
Qc
Q
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Cartels and Cheating
Reality? Few cartels effectively control the
market price, and most tend to collapse
over time.
Reasons why cartels collapse:
1. Cheating by cartel members.
2. New entrants and demand response.
3. Government prosecution.
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Cheating on the OPEC Cartel
Every country in OPEC can earn more by
cheating than by keeping to their allotment.
So, everyone cheats, and the cartel
collapses!
Don’t let me down:
Venezuelan President Hugo
Chavez and Saudi Crown Prince
Abdullah bin Abdul Aziz Al Saud at
an OPEC summit
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Cheating on the OPEC Cartel
Cheating is also profitable when other
members do not keep their promise to
reduce production.
A single cartel member does not have
significant monopoly power.
So reducing production does not raise the
world price enough to make up for its lost
sales.
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The Incentive to Cheat
As a single seller, you
alone bear the gains
(green) and losses (red)
from lowering price.
But if there are four firms,
the losses are split- each
firm bears ¼ the loss.
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The Cheating Dilemma
A payoff matrix can show us the incentive
to cheat:
Example: assume the world oil market is
dominated by two large countries, Saudi
Arabia and Russia.
Each country has two choices or strategies:
Cooperate by reducing output and acting like a
monopolist.
Cheat and expand production.
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The Cheating Dilemma
Russia’s Strategies
Saudi Arabia’s
Strategies
Cooperate
Cheat
Cooperate
($400, $400)
($200, $500)
Cheat
($500, $200)
($300, $300)
If both countries cooperate, they each
earn $400.
If one cheats while the other doesn’t, the
cheater earns $500 and the non-cheater
earns $200.
If they both cheat, they each earn $300.
BACK TO
Try it!
If Sundance keeps quiet, what’s the best
choice (highest payoff) for Butch: keep quiet
or testify?
(Butch’s payoffs are on the left)
a)
b)
Keep quiet
Testify
To next
Try it!
The Cheating Dilemma
Russia’s Strategies
Saudi Arabia’s
Strategies
Cooperate
Cheat
Cooperate
($400, $400)
($200, $500)
Cheat
($500, $200)
($300, $300)
A Dominant Strategy is a strategy that has a higher
payoff than any other strategy no matter what the
other player does.
The dominant strategy for Saudi Arabia? Cheat.
If Russia cooperates? Best to cheat.
Cheating pays $500 while cooperating pays $400.
If Russia cheats? Also best to cheat.
Cheating pays $300 while cooperating pays $200.
BACK TO
Try it!
what is Butch's “dominant strategy”? What is
Sundance's?
a) Butch's dominant strategy is to testify;
Sundance's dominant strategy is to testify.
b) Butch has no dominant strategy; Sundance's
dominant strategy is to keep quiet.
c) Butch's dominant strategy is to testify;
Sundance's dominant strategy is to keep quiet.
d) Butch's dominant strategy is testify; Sundance
To next
has no dominant strategy.
Try it!
The Cheating Dilemma
Russia’s Strategies
Saudi Arabia’s
Strategies
Cooperate
Cheat
Cooperate
($400, $400)
($200, $500)
Cheat
($500, $200)
($300, $300)
The dominant strategy for Russia? You decide…
If Saudi Arabia cooperates? Cheat.
Cheating pays $500 while cooperating pays $400.
If Saudi Arabia cheats? Cheat.
Cheating pays $300 while cooperating pays $200.
No matter what the other player does, each
player is better off cheating.
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The Prisoner’s Dilemma
The Prisoner’s Dilemma describes situations
where the pursuit of individual interest leads
to a group outcome that is in the interest of
no one.
The equilibrium outcome: both firms cheat
on the agreement.
Each firm’s strategy is based on its own selfinterest, but the outcome is in the interest of
neither firm.
Cooperation would give both firms a bigger
payoff.
BACK TO
New Entrants and Demand Response
Break Down Cartels
Cheating is not the only reason for cartels to
fail.
The high prices of a cartel attract new
entrants.
Supply will increase and push down the price.
Consumers will favor the new firms with lower
prices.
More substitutes will be available in the long run.
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How to Sustain a Cartel
Possess access to natural resources that are
difficult to duplicate
can avoid this problem of new entrants.
E.g. Oil, diamonds, nutmeg
Is the diamond cartel forever?
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How to Sustain a Cartel
Control access to some key input that
can’t be easily duplicated
E.g. the NBA buyer’s cartel uses a salary cap
is enforced by kicking out teams that don’t
comply.
No substitutes exist for the NBA league.
Who wins and who loses under this structure?
Home of the Indiana Pacers
BACK TO
Try it!
Do you support the idea of
salary caps for sports teams in
general?
a) Yes
b) No
To next
Try it!
Try it!
In game theory, the strategy that has
a higher payoff than any other
strategy, no matter what the other
player does, is also known as the
a)
b)
c)
d)
superior strategy.
Nash equilibrium.
dominant strategy.
best possible outcome.
To next
Try it!
Try it!
Bill and Ted are assigned to do a group project. Ted
does excellent work. Bill struggles. Suppose that each
of the students can choose two levels of work: work
hard or take it easy. They will get the same group
grade and therefore they have the same payoff for
each strategy combination.
a) Ted does not have a dominant strategy.
b) Ted's dominant strategy is to Work Hard.
c) Ted's dominant strategy is to Take It Easy.
d) both are dominant strategies for Ted.
B
A CK
T O
Government Prosecution and Regulation
Most cartels are illegal in the United
States since the Sherman Antitrust Act
of 1890.
Antitrust Laws give the government
the power to regulate or prohibit
business practices that may be anticompetitive.
empowers the government to prosecute
and punish collusive behavior.
BACK TO
Watch the international Lysine cartel discuss
their conspiracy to raise prices by clicking
below. ( 3:23 minutes)
http://www.youtube.com/watch?v=E21YYoxRs5g&feature=play
er_embedded
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Video
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Government-Supported Cartels
Surprisingly, governments do not always
prosecute cartels, and often they support
cartels.
In the U.S.: many cartels are supported by the
government, including milk.
In many poor nations, governments regularly
enrich themselves through cartels.
The most successful cartels operate with the
explicit support of (and enforcement by) the
government.
BACK TO
SEE THE INVISIBLE HAND
Think-pair-share:
What are the effects of cartels on a
nation?
How do you think economic growth and
cartel prevalence are related? Why?
Summary: Successful Cartels
Cartels are more likely to be stable and
successful if they can prevent new
entrants through:
Control of natural resources or
Control of access to some key input that
can’t be easily duplicated
Weak enforcement of antitrust laws (or lack of
laws)
Achieving government support
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Oligopolies
Cartels may be tough to keep together…
BUT oligopoly can still maintain prices
(and profits) that are higher than
competitive firms.
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The Incentive and Ability to Raise Price in
Oligopoly
A firm in oligopoly who reduces quantity by the amount
Q0–Q1 increases the market price to P1 (which is greater
than MC.)
The increase in price increases the profits of the firm that
cuts output (the green area),as well as increasing the
profits of the other firms in the industry.
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Oligopoly Pricing
Can we be more specific? Economists
have developed many models of
oligopolistic pricing.
A lot depends on factors specific to the
industry; We leave further discussion for
intermediate and advanced
microeconomics studies.
Let’s turn now to a different form of market
structure, monopolistic competition.
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Monopolistic Competition
Monopolistic Competition is a market
structure that’s a little like monopoly and a
little like competition. Specifically:
many competitors
products are similar but not identical
downward-sloping demand curve
each firm earns zero profit
Restaurants: Monopolistic Competitors
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Monopolistic Competition and
Profit Maximization
Same profit maximizing rule as competitive and monopoly
firms: produce where MR = MC
Price
MC
P
AC
Profit
But…. This
profit will
attract new
entrants.
Demand
Q
MR
Quantity
BACK TO
Zero Profit in the Long Run
If firms are earning economic profits,
new firms will want to enter the
industry.
This will reduce the demand curve
facing each individual producer.
In the long run, each supplier will
earn normal profits, and price will
equal ATC.
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Monopolistic Competition and
Profit Maximization
Entrance of new firms reduces demand for existing firms…
Until profits erode to zero in the Long Run (Economic profits, remember!)
Price
P
P
MC
AC
Profit
Demand
QLR Q
MR
Quantity
BACK TO
Comparing Monopolistic Competition
with Competition
Firms in both industries produce where P = AC and earn zero profits.
However, firms under monopolistic competition charge prices
above marginal cost, they produce a smaller quantity, and Q* is
not at minimum average cost.
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The Economics of Advertising
Oligopolies and Monopolistically
Competitive Firms advertise….
Is advertising good or bad? It’s
Complicated.
(There are different types of advertising)
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Types of Advertising
“Informative” Advertising:
price, quality and availability information
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Types of Advertising
Advertising as Signaling
“If they’re spending so
much $$$ on advertising
for this product, they must
expect it to be profitable
and around a long time.
Must be good.”
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Types of Advertising
Advertising as Part of the Product:
Even if NO information is given, does
“Branding” make the product more
enjoyable?
Tasters enjoy the cola more if it’s labeled
as “Coke”…
BACK TO
Click below for a peek at some of the funniest
Superbowl commercials of the past several years.
You decide: did they do more than entertain? (8:00
minutes)
http://www.youtube.com/watch?v=caZTCDTif_I
BACK TO
SEE THE INVISIBLE HAND
In your opinion, is advertising
“worth it” for society?
a) Yes
b) No