Oligopoly is derived
from the Greek work
“olig” meaning “few” or
“a small number.”
Oligopoly is a market structure
featuring a small number of sellers that
together account for a large fraction of
market sales.
Features of oligopoly
•Fewness of sellers
•Seller interdependence
•Feasibility of coordinated action among
ostensibly independent firms
Measures of seller
concentration
The concentration ratio is the
percentage of total market sales
accounted for by an absolute number of
the largest firms in the market.
The four-firm concentration ratio (CR4)
measures the percent of total market
sales accounted for by the top four firms
in the market.
The eight-firm concentration ratio (CR4)
measures the percent of total market
sales accounted for by the top eight firms
in the market.
Concentration Ratios: Very Concentrated Industries
Industry or Product
Refrigerators
Motor vehicles
Soft drinks
Long distance telephone
Laundry machines
Breakfast foods
Vaccuum cleaners
Running shoes
Beer
Aircraft engines
Domestic air flights
Tires
Aluminum
Soap
Pet food
CR4
CR8
94
94
94
92
91
88
80
79
77
72
68
66
64
60
52
98
98
97
97
NA
93
96
97
94
83
82
86
88
73
71
Source: U.S. Bureau of the Census, Census of Manufacturers
Concentration Ratios: Less Concentrated Industries
Industry or Product
Fast food
Personal computers
Office furniture
Toys
Bread
Lawn equipment
Machine tools
Paint
Newspapers
Furniture
Boat building
Concrete
Women's dresses
CR4
CR8
44
45
45
41
34
40
30
24
22
17
14
8
6
57
63
59
58
47
57
44
36
34
25
22
12
10
Source: U.S. Bureau of the Census, Census of Manufacturers
Seller interdependence
•If Kroger offers deep discounts on soft drinks,
will Wal-Mart follow suit?
•Northwest Airlines “perks” miles do not
expire—how did United, Delta, et al react?
•AT&T’s “where’s the savings?” ad campaign
prompted an effective retaliatory ad strategy by
MCI.
•Some ISP’s now pledge not to sell information
to database companies—will this affect AOL?
•Alcoa’s decision to add production capacity is
conditioned upon the investment plans of rival
aluminum producers.
Game Theory and
Seller Interdependence
Selecting a course of
action in a situation in
which rival players
are selecting strategies
that suit their interests
is the basic problem
of game theory.
1. Players and
their actions
A situation of competitive rivalry must involve two or
more players whose choice of actions affect each
other.
•A “player” can be a firm, an interest group or coalition,
a military leader, government official.
•Games generally consider only one kind of action—
e.g., number of daily departures, fares, in-flight services,
schedules, advertising, choice of hubs, ordering planes,
expanding terminals, use of computerized reservations
systems, mergers and acquisitions, and human resource
decisions.
2. Outcomes and Payoffs
The firm’s action, together with the actions of
its rivals, determine its payoff
•In the standard “business” game, the payoff can
be in the form of profit, market share, ratings
points,
•In war games, the payoff might be measured in
enemy killed or territory seized.
•In political games, payoffs may be measured in
votes or campaign contributions.
3. Underlying “rules”
The rules of the game define the range of
possible outcomes and payoffs
•For example, collusion to fix prices or a merger
among direct rivals in a concentrated market
structure may be against the rules.
•Another set a rules specifies whether players move
sequentially or simultaneously, who moves first, and
what does each player know about the other players’
preference and prior to actions?
Prisoner’s dilemma
Ralph and Gertie have been charged with
bank robbery. But lacking a confession,
the DA can only get a “reckless
endangerment” charge to stick. So the
police play one suspect off against the other.
Let’s make a deal
OK, Ralph. Confess,
rat on Gertie, and you get a
reduced sentence of one
year in prison.
What will
Gertie do?
The payoff matrix
Gertie
Ralph
Stay
Mum
Confess
Stay
Mum
2 years,
2 years
8 years,
1 year
Confess
1 year,
8 years
5 years,
5 years
Dominant strategy
A dominant strategy yields the best possible
payoff for any strategy selected by the other
player(s).
Confess is the dominant
strategy in this case,
since it gives the shortest sentence
irrespective of whether the other prisoner
selects the “confess” or “stay mum”
strategy
Price wars in a duopoly
The preceding is what we call a
“non-cooperative” game.
Cooperation among duopolists is
a strategy that maximizes joint
profits. So why do price wars
break out?
The payoff matrix for a
running shoe duopoly
NIKE
REEBOK
High
Price
Low
Price
High
Price
$10 million,
$10 million
$5 million,
$12 million
Low
Price
$12 million,
$5 million
$7 million,
$7 million
Notice that “low price” is the
dominant strategy
Advertising rivalry
 Pizza Planet and Luigi’s are rivals in the
market for home-delivered pizza. Each rival
seeks to gain an advantage through advertising
(product differentiation).
 Advertising is presumed NOT to affect market
demand--only market share.
Market share depends on the intensity of
advertising relative to one’s rival.
Let
 P = $15
Q = 100 pizzas (market quantity-demanded)
AC (w/o advertising expense) = $5.
Hence:
/Pizza = (TR - TC)/Q = ($1500 - $500)/100 = $10
If neither seller advertises, each will
sell 50 pizzas and earn a profit of
$500. However, advertising could
potentially increase sales to 75 pizzas.
The payoff matrix for
a pizza duopoly
PIZZA PLANET
LUIGI’S
Low
Advertising
High
Advertising
Low
Advertising
High
Advertising
$400,
$400
$550,
$150
$150,
$550
$300,
$300
Notice that “high advertising” is the
dominant strategy
Nash Equilibrium
A list of strategies, one for each player, is a Nash
equilibrium if each player’s strategy maximizes his
(or her) payoff given the strategies selected by the
other players and if this condition holds for all
players simultaneously.
You have Russell
Crowe—er, I
mean John Nash,
to thank for this
concept
Nash Equilibrium and the Shoe,
Pizza Duopoly Games
•A Nash equilibrium is given by the “lowlow” strategy in the running shoe duopoly
game
•A Nash equilibrium is given by the “highhigh strategy” in the pizza duopoly game.