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 Firms have market power derived from barriers to entry y However, a small number of firms compete with each other Each firm doesn’t have to consider the actions of other firms, thus, behavior is interdependent © 2005 Prentice Hall, Inc. 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 © 2005 Prentice Hall, Inc. 9.4 Kinked Demand C Curve Model M d l 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 If the firm considers raising the price above P1, its quantity demanded will depend upon the beha ior of rival behavior ri al firms © 2005 Prentice Hall, Inc. 9.5 Kinked Demand C Curve Model M d l Assumes that managers will inflict maximum damage g on other firms Implies oligopoly prices tend to be “sticky” sticky and not change as they would in other market structures Does not explain why price P1 exists initially © 2005 Prentice Hall, Inc. 9.6 Kinked Demand Curve Figure g 9.1 MC P1 MR2 D2 = Rivals don’t follow MR1 0 © 2005 Prentice Hall, Inc. Q1 D1 = rivals follow Q 9.7 Game Theory Models Mathematically analyzes situations in which players make various strategic moves and have different outcomes or payoffs associated with those moves Dominant o a t strategy: st ategy results esu ts in best outcome to a given player © 2005 Prentice Hall, Inc. 9.8 Nash Equilibrium Strategies for which all players are choosing g their best strategy, gy, given actions of other players Proves useful when there is only one unique equilibrium in the g game There may be multiple Nash equilibrium © 2005 Prentice Hall, Inc. 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 © 2005 Prentice Hall, Inc. 9.10 Limit Pricing Model Figure 9.2 Potential Entrant Established Firm MC ATCEN PM PL 0 © 2005 Prentice Hall, Inc. A C PL ATCM ATCL 0 ATC B F Q1 Q2 Q 9.11 Limit Pricing Model Assumes existing firms have lower costs Attracts other firms into the industry 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 © 2005 Prentice Hall, Inc. E Q 9.13 Determinates of Successful P d t Predatory Pricing P i i How far the predatory price is below cost Period of time in which the predatory price is in effect Rate of return used for judging the investment in predatory pricing How many rivals enter the industry after predation ends Time over which recouping p g of profits p occurs © 2005 Prentice Hall, Inc. 9.14 Cooperative Oligopoly M d l Models Focus on cooperative behavior among g rivals Two types • Cartels C t l • Tacit collusion © 2005 Prentice Hall, Inc. 9.15 Cartels Firms that get together and agree to coordinate behavior regarding pricing and output decisions 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 Horizontal H i t l summation ti off marginal i l costt curve: calculated from marginal cost curve for the cartel © 2005 Prentice Hall, Inc. 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 It can raise market price without inducing significant competition f from non-cartel t l members b The expected punishment from f forming i the th cartel t l is i low l relative l ti to the expected gains 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 Tacit collusion: coordinated behavior that is an achieved without a formal agreement 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 Cartel C t l Cooperative oligopoly models Dominant strategy Game theory Horizontal summation of marginal cost curves Joint profit maximization Kinked demand curve model © 2005 Prentice Hall, Inc. 9.21 Summary of Key Terms Limit pricing Nash equilibrium Noncooperative oligopoly models Oligopoly g y Predatory pricing Strategic entry deterrence Tacit collusion © 2005 Prentice Hall, Inc. 9.22 Do you have any questions? © 2005 Prentice Hall, Inc. 9.23
