Chapter 9 Market Structure: Oligopoly

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Economics for Managers
by
y Paul Farnham
Chapter 9
Market Structure: Oligopoly
© 2005 Prentice Hall, Inc.
9.1
Oligopoly
A market structure characterized by
competition among a small
number of large
g firms that have
market power, but that must take
their rivals’ actions into
consideration
id
ti when
h developing
d
l i
their competitive strategies
© 2005 Prentice Hall, Inc.
9.2
Characteristics
off an Oli
Oligopoly
l
ƒ Firms have market power derived
from barriers to entry
y
ƒ However, a small number of firms
compete with each other
ƒ Each firm doesn’t have to
consider the actions of other
firms, thus, behavior is
interdependent
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9.3
Noncooperative
Oli
Oligopoly
l Models
M d l
Assumes that firms pursue profitmaximizing
g strategies
g
based on
assumptions about rivals’ behavior
and the impact of this behavior on
th given
the
i
firm’s
fi ’ strategies
t t i
1. Kinked demand curve model
2. Game theory models
3 Strategic entr
3.
entry deterrence
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9.4
Kinked Demand
C
Curve
Model
M d l
ƒ Assumes that a firm is faced with
two demand curves, assuming
that other firms
f
will not match
price increases but will match
price decreases
ƒ If the firm considers raising the
price above P1, its quantity
demanded will depend upon the
beha ior of rival
behavior
ri al firms
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9.5
Kinked Demand
C
Curve
Model
M d l
ƒ Assumes that managers will inflict
maximum damage
g on other firms
ƒ Implies oligopoly prices tend to
be “sticky”
sticky and not change as
they would in other market
structures
ƒ Does not explain why price P1
exists initially
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9.6
Kinked Demand Curve
Figure
g
9.1
MC
P1
MR2
D2 = Rivals
don’t follow
MR1
0
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Q1
D1 = rivals follow
Q
9.7
Game Theory Models
ƒ Mathematically analyzes situations in
which players make various strategic
moves and have different outcomes or
payoffs associated with those moves
ƒ Dominant
o
a t strategy:
st ategy results
esu ts in best
outcome to a given player
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9.8
Nash Equilibrium
ƒ Strategies for which all players
are choosing
g their best strategy,
gy,
given actions of other players
ƒ Proves useful when there is only
one unique equilibrium in the
g
game
ƒ There may be multiple Nash
equilibrium
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9.9
Strategic Entry
D t
Deterrence
Policies that prevent rivals from
entering
g the market
• Limit pricing: charging a price
lower than the profit-maximizing
profit maximizing
price
• Predatory pricing: lowering prices
below cost to drive out existing
competitors and scare off
potential entrants
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9.10
Limit Pricing Model
Figure 9.2
Potential Entrant
Established Firm
MC
ATCEN
PM
PL
0
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A C
PL
ATCM
ATCL
0
ATC
B
F
Q1
Q2
Q
9.11
Limit Pricing Model
ƒ Assumes existing firms have
lower costs
ƒ Attracts other firms into the
industry
ƒ Established firms can thwart entry
by charging the limit price (or a
lower price) rather than profitmaximization price
© 2005 Prentice Hall, Inc.
9.12
Predatory Pricing
Figure 9.3
K
PUS
PJ
PC
PP
T
R S
N
L
J
G
LRAC = LRMC
M
Demand
MR
0
QUS QPP QC QP
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E
Q
9.13
Determinates of Successful
P d t
Predatory
Pricing
P i i
ƒ How far the predatory price is below
cost
ƒ Period of time in which the predatory
price is in effect
ƒ Rate of return used for judging the
investment in predatory pricing
ƒ How many rivals enter the industry
after predation ends
ƒ Time over which recouping
p g of profits
p
occurs
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9.14
Cooperative Oligopoly
M d l
Models
ƒ Focus on cooperative behavior
among
g rivals
ƒ Two types
• Cartels
C t l
• Tacit collusion
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9.15
Cartels
ƒ Firms that get together and agree to
coordinate behavior regarding pricing
and output decisions
ƒ Joint profit maximization: strategy that
maximizes
a
es p
profits
o ts for
o a ca
cartel
te but may
ay
create incentives for individual
members to cheat
ƒ Horizontal
H i
t l summation
ti
off marginal
i l costt
curve: calculated from marginal cost
curve for the cartel
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9.16
Allocation Rule for Joint
P fit M
Profit
Maximization
i i ti
MC1 = MC2 = MC3
where
MC1 = Firm
Fi
#1’s
#1’ marginal
i l costt
MC2 = Firm #2
#2’s
s marginal cost
MCC = Cartel’s marginal cost
© 2005 Prentice Hall, Inc.
9.17
When a Cartel
i Successful
is
S
f l
ƒ It can raise market price without
inducing significant competition
f
from
non-cartel
t l members
b
ƒ The expected punishment from
f
forming
i the
th cartel
t l is
i low
l
relative
l ti
to the expected gains
ƒ The
Th costs
t off establishing
t bli hi and
d
enforcing agreement are low
relative to the gains
© 2005 Prentice Hall, Inc.
9.18
Tacit Collusion
ƒ Tacit collusion: coordinated behavior
that is an achieved without a formal
agreement
ƒ Tacit collusion practices:
• Uniform prices
• Penalty for price discounts
• Advantage notice of price changes
• Information exchanges
• Swaps and exchanges
© 2005 Prentice Hall, Inc.
9.19
Managerial Rule of Thumb:
Coordinated
di
d Actions
i
Managers must
• Coordinate efforts, but within
constraints of antitrust legislation
• Recognize
g
incentives for cheating
g
in coordinated behavior
• Remember that even coordinated
efforts
ff
are fl
fleeting,
i
given
i
the
h
dynamic and competitive nature of
a market environment
© 2005 Prentice Hall, Inc.
9.20
Summary of Key Terms
ƒ Cartel
C t l
ƒ Cooperative oligopoly models
ƒ Dominant strategy
ƒ Game theory
ƒ Horizontal summation of marginal
cost curves
ƒ Joint profit maximization
ƒ Kinked demand curve model
© 2005 Prentice Hall, Inc.
9.21
Summary of Key Terms
ƒ Limit pricing
ƒ Nash equilibrium
ƒ Noncooperative oligopoly models
ƒ Oligopoly
g
y
ƒ Predatory pricing
ƒ Strategic entry deterrence
ƒ Tacit collusion
© 2005 Prentice Hall, Inc.
9.22
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© 2005 Prentice Hall, Inc.
9.23
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