Chapter 12:Oligopoly: Firms in Less Competitive Markets
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Chapter 12:Oligopoly: Firms in Less Competitive Markets
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
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CHAPTER
13
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Oligopoly:
Firms in Less
Competitive Markets
Today, in the
software and
computer
industries, fewer
than 10 firms
account for the
great majority of
sales.
Prepared by:
Fernando Quijano
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CHAPTER
13
Chapter Outline and
Learning Objectives
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Oligopoly:
Firms in Less
Competitive Markets
13.1 Oligopoly and Barriers to Entry
Show how barriers to entry explain
the existence of oligopolies.
13.2 Using Game Theory to Analyze
Oligopoly
Use game theory to analyze the
strategies of oligopolistic firms.
13.3 Sequential Games and Business
Strategy
Use sequential games to analyze
business strategies.
13.4 The Five Competitive Forces
Model
Use the five competitive forces
model to analyze competition in an
industry.
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Oligopoly: Firms in Less Competitive Markets
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Oligopoly A market structure
in which a small number of
interdependent firms compete.
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13.1 LEARNING OBJECTIVE
Oligopoly and Barriers to Entry
Show how barriers to entry explain
the existence of oligopolies.
Table 13-1
Examples of Oligopolies in
Retail Trade and Manufacturing
Chapter 12:Oligopoly: Firms in Less Competitive Markets
RETAIL TRADE
INDUSTRY
MANUFACTURING
FOUR-FIRM
CONCENTRATION
RATIO
INDUSTRY
FOUR-FIRM
CONCENTRATION
RATIO
Discount department stores
95%
Cigarettes
95%
Warehouse clubs and
supercenters
92%
Beer
91%
Hobby, toy, and game stores
72%
Aircraft
81%
Athletic footwear stores
71%
Breakfast cereal
78%
College bookstores
70%
Automobiles
76%
Radio, television, and other
electronic stores
69%
Computers
75%
Pharmacies and drugstores
53%
Dog and cat food
64%
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13.1 LEARNING OBJECTIVE
Oligopoly and Barriers to Entry
Show how barriers to entry explain
the existence of oligopolies.
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Barriers to Entry
Barrier to entry Anything that
keeps new firms from entering an
industry in which firms are earning
economic profits.
Economies of Scale
Economies of scale The
situation when a firm’s long-run
average costs fall as it increases
output.
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13.1 LEARNING OBJECTIVE
Oligopoly and Barriers to Entry
Show how barriers to entry explain
the existence of oligopolies.
Barriers to Entry
Economies of Scale
Chapter 12:Oligopoly: Firms in Less Competitive Markets
FIGURE 13-1
Economies of Scale Help
Determine the Extent of
Competition in an Industry
An industry will be competitive if the
minimum point on the typical firm’s
long-run average cost curve
(LRAC1) occurs at a level of output
that is a small fraction of total
industry sales, such as Q1.
The industry will be an oligopoly if
the minimum point comes at a level
of output that is a large fraction of
industry sales, such as Q2.
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13.1 LEARNING OBJECTIVE
Oligopoly and Barriers to Entry
Show how barriers to entry explain
the existence of oligopolies.
Barriers to Entry
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Ownership of a Key Input
If production of a good requires a
particular input, then control of that
input can be a barrier to entry.
Government-Imposed Barriers
Patent The exclusive right to a
product for a period of 20 years
from the date the product is
invented.
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Chapter 12:Oligopoly: Firms in Less Competitive Markets
Using Game Theory to
Analyze Oligopoly
13.2 LEARNING OBJECTIVE
Use game theory to analyze the
strategies of oligopolistic firms.
Game theory The study of how people make
decisions in situations in which attaining their
goals depends on their interactions with
others; in economics, the study of the
decisions of firms in industries where the
profits of each firm depend on its interactions
with other firms.
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Using Game Theory to
Analyze Oligopoly
13.2 LEARNING OBJECTIVE
Use game theory to analyze the
strategies of oligopolistic firms.
All games share three key characteristics:
Chapter 12:Oligopoly: Firms in Less Competitive Markets
1. Rules that determine what actions
are allowable
2. Strategies that players employ to
attain their objectives in the game
3. Payoffs that are the results of the
interaction among the players’
strategies
Business strategy Actions taken by a firm
to achieve a goal, such as maximizing
profits.
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Using Game Theory to
Analyze Oligopoly
13.2 LEARNING OBJECTIVE
Use game theory to analyze the
strategies of oligopolistic firms.
A Duopoly Game: Price Competition between Two Firms
FIGURE 13-2
Chapter 12:Oligopoly: Firms in Less Competitive Markets
A Duopoly Game
HP’s profits are in blue, and
Apple’s profits are in red.
HP and Apple would each
make profits of $10 million per
month on sales of desktop
computers if they both
charged $1,200.
However, each firm has an
incentive to undercut the other
by charging a lower price.
If both firms charge $1,000,
they would each make a profit
of only $7.5 million per month.
Don’t Let This Happen to YOU!
Don’t Misunderstand Why Each Manager Ends Up Charging a Price of $1,000
YOUR TURN: Test your understanding by doing related problem 2.14 at the end
of this chapter.
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Using Game Theory to
Analyze Oligopoly
13.2 LEARNING OBJECTIVE
Use game theory to analyze the
strategies of oligopolistic firms.
A Duopoly Game: Price Competition between Two Firms
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Payoff matrix A table that shows the payoffs that each firm
earns from every combination of strategies by the firms.
Collusion An agreement among firms to charge the same
price or otherwise not to compete.
Dominant strategy A strategy that is the best for a firm, no
matter what strategies other firms use.
Nash equilibrium A situation in which each firm chooses the
best strategy, given the strategies chosen by other firms.
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Using Game Theory to
Analyze Oligopoly
13.2 LEARNING OBJECTIVE
Use game theory to analyze the
strategies of oligopolistic firms.
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Firm Behavior and the Prisoner’s Dilemma
Cooperative equilibrium An equilibrium in a
game in which players cooperate to increase their
mutual payoff.
Noncooperative equilibrium An equilibrium in a
game in which players do not cooperate but pursue
their own self-interest.
Prisoner’s dilemma A game in which pursuing
dominant strategies results in noncooperation that
leaves everyone worse off.
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13.2 LEARNING OBJECTIVE
Solved Problem
13-2
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Is Advertising a Prisoner’s Dilemma
for Coca-Cola and Pepsi?
Use game theory to analyze the
strategies of oligopolistic firms.
Given that Coca-Cola is advertising, Pepsi’s best strategy is to advertise.
Therefore, advertising is the optimal decision for both firms, given the
decision by the other firm.
YOUR TURN: For more practice, do related problems 2.11, 2.12, and 2.13 at the
end of this chapter.
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13.2 LEARNING OBJECTIVE
Making
the
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Connection
Is There a Dominant Strategy
for Bidding on eBay?
Use game theory to analyze the
strategies of oligopolistic firms.
On eBay, bidding the maximum value you place on an
item is a dominant strategy.
YOUR TURN: Test your understanding by doing related problem 2.15 at the end
of this chapter.
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Using Game Theory to
Analyze Oligopoly
13.2 LEARNING OBJECTIVE
Use game theory to analyze the
strategies of oligopolistic firms.
Can Firms Escape the Prisoner’s Dilemma?
FIGURE 13-3
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Changing the Payoff Matrix in
a Repeated Game
Wal-Mart and Target can change the
payoff matrix for selling PlayStation 3
game consoles by advertising that they
will match their competitor’s price. This
retaliation strategy provides a signal that
one store charging a lower price will be
met automatically by the other store
charging a lower price.
In the payoff matrix in panel (a), there is
no matching offer, and each store
benefits if it charges $300 when the
other charges $500.
In the payoff matrix in panel (b), with the
matching offer, the companies have only
two choices: They can charge $500 and
receive a profit of $10,000 per month, or
they can charge $300 and receive a
profit of $7,500 per month. The
equilibrium shifts from the prisoner’s
dilemma result of both stores charging
the low price and receiving low profits to
both stores charging the high price and
receiving high profits.
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Using Game Theory to
Analyze Oligopoly
13.2 LEARNING OBJECTIVE
Use game theory to analyze the
strategies of oligopolistic firms.
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Can Firms Escape the Prisoner’s Dilemma?
Price leadership A form of implicit
collusion in which one firm in an
oligopoly announces a price change
and the other firms in the industry
match the change.
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13.2 LEARNING OBJECTIVE
Making American Airlines and
the
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Connection
Use game theory to analyze the
strategies of oligopolistic firms.
Northwest Airlines
Fail to Cooperate on a Price Increase
Airlines therefore continually
adjust their prices while at the
same time monitoring their rivals’
prices and retaliating against them
either for cutting prices or failing to
go along with price increases.
The airlines have trouble
raising the price this business
traveler pays for a ticket.
YOUR TURN: Test your understanding by doing related problems 2.17 and 2.18
at the end of this chapter.
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Using Game Theory to
Analyze Oligopoly
13.2 LEARNING OBJECTIVE
Use game theory to analyze the
strategies of oligopolistic firms.
Cartels: The Case of OPEC
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Cartel A group of firms that collude by agreeing
to restrict output to increase prices and profits.
FIGURE 13-4
Oil Prices, 1972 to mid–2009
The blue line shows the price of a
barrel of oil in each year.
The red line measures the price of
a barrel of oil in terms of the
purchasing power of the dollar in
2009.
By reducing oil production, OPEC
was able to raise the world price of
oil in the mid-1970s and early
1980s. Sustaining high prices has
been difficult over the long run,
however, because members often
exceed their output quotas.
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Using Game Theory to
Analyze Oligopoly
13.2 LEARNING OBJECTIVE
Use game theory to analyze the
strategies of oligopolistic firms.
Cartels: The Case of OPEC
FIGURE 13-5
Chapter 12:Oligopoly: Firms in Less Competitive Markets
The OPEC Cartel with
Unequal Members
Because Saudi Arabia can
produce much more oil than
Nigeria, its output decisions have
a much larger effect on the price
of oil.
In the figure, Low Output
corresponds to cooperating with
the OPEC-assigned output quota,
and High Output corresponds to
producing at maximum capacity.
Saudi Arabia has a dominant
strategy to cooperate and produce
a low output.
Nigeria, however, has a dominant
strategy not to cooperate and
instead produce a high output.
Therefore, the equilibrium of this
game will occur with Saudi Arabia
producing a low output and
Nigeria producing a high output.
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Sequential Games and
Business Strategy
13.3 LEARNING OBJECTIVE
Use sequential games to analyze
business strategies.
Deterring Entry
FIGURE 13-6
Chapter 12:Oligopoly: Firms in Less Competitive Markets
The Decision Tree for an
Entry Game
HP earns its highest return if it
charges $600 for its netbook and
Apple does not enter the market.
But at that price, Apple will enter
the market, and HP will earn only
16 percent.
If HP charges $275, Apple will
not enter because Apple will
suffer an economic loss by
receiving only a 5 percent return
on its investment.
Therefore, HP’s best decision is
to deter Apple’s entry by
charging $275.
HP will earn an economic profit
by receiving a 20 percent return
on its investment.
Note that the dashes indicate the
situation where Apple does not
enter the market, and so makes
no investment and receives no
return.
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13.3 LEARNING OBJECTIVE
Solved Problem
13-3
Use sequential games to analyze
business strategies.
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Is Deterring Entry Always a Good Idea?
Deterrence is worth pursuing only if the payoff is higher than for other
strategies. In this case, expanding the market for netbooks by charging a
lower price has a higher payoff, even given that Apple will enter the market.
YOUR TURN: For more practice, do related problem 3.3 at the end of this
chapter.
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Sequential Games and
Business Strategy
13.3 LEARNING OBJECTIVE
Use sequential games to analyze
business strategies.
Bargaining
FIGURE 13-7
Chapter 12:Oligopoly: Firms in Less Competitive Markets
The Decision Tree for
a Bargaining Game
Dell earns the highest profit
if it offers a contract price of
$20 per copy and TruImage
accepts the contract.
TruImage earns the highest
profit if Dell offers it a
contract of $30 per copy
and it accepts the contract.
TruImage may attempt to
bargain by threatening to
reject a $20-per-copy
contract. But Dell knows
this threat is not credible
because once Dell has
offered a $20-per-copy
contract, TruImage’s profits
are higher if it accepts the
contract than if it rejects it.
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13.4 LEARNING OBJECTIVE
The Five Competitive Forces Model
Use the five competitive forces
model to analyze competition in an
industry.
FIGURE 13-8
Chapter 12:Oligopoly: Firms in Less Competitive Markets
The Five Competitive
Forces Model
Michael Porter’s model
identifies five forces that
determine the level of
competition in an industry:
(1) competition from
existing firms,
(2) the threat from new
entrants,
(3) competition from
substitute goods or
services,
(4) the bargaining power of
buyers, and
(5) the bargaining power of
suppliers.
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13.4 LEARNING OBJECTIVE
The Five Competitive Forces Model
Use the five competitive forces
model to analyze competition in an
industry.
Competition from Existing Firms
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Competition among firms in an industry can lower
prices and profits.
Competition in the form of advertising, better
customer service, or longer warranties can also
reduce profits by raising costs.
The Threat from Potential Entrants
Firms face competition from companies that
currently are not in the market but might enter. We
have already seen how actions taken to deter entry
can reduce profits.
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13.4 LEARNING OBJECTIVE
The Five Competitive Forces Model
Use the five competitive forces
model to analyze competition in an
industry.
Competition from Substitute Goods or Services
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Firms are always vulnerable to competitors
introducing a new product that fills a consumer
need better than their current product does.
The Bargaining Power of Buyers
If buyers have enough bargaining power, they can
insist on lower prices, higher-quality products, or
additional services.
The Bargaining Power of Suppliers
If many firms can supply an input and the input is
not specialized, the suppliers are unlikely to have
the bargaining power to limit a firm’s profits.
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13.4 LEARNING OBJECTIVE
Making
the
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Connection
Can We Predict Which Firms
Will Continue to Be Successful?
Use the five competitive forces
model to analyze competition in an
industry.
Is it possible to draw general
conclusions about which business
strategies are likely to be
successful in the future?
Unfortunately, Circuit City’s
excellence as a company
didn’t last.
YOUR TURN: Test your understanding by doing related problem 4.5 at the end of
this chapter.
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AN INSIDE
LOOK
>> Hewlett-Packard Uses New Technology to
Chapter 12:Oligopoly: Firms in Less Competitive Markets
Boost Sales of Personal Computers
Dell decides whether to sell touch-sensitive personal computers.
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Chapter 12:Oligopoly: Firms in Less Competitive Markets
KEY TERMS
Barrier to entry
Business strategy
Cartel
Collusion
Cooperative equilibrium
Dominant strategy
Economies of scale
Game theory
Nash equilibrium
Noncooperative equilibrium
Oligopoly
Patent
Payoff matrix
Price leadership
Prisoner’s dilemma
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