Chapter 16
Oligopoly
Objectives
1. Recognize market structures that are
between competition and monopoly
2. Know the equilibrium characteristics
of oligopoly.
3. Understand the concept of prisoners’
dilemma and how it applies to oligopoly.
4. Learn how anti-trust laws can increase
competition in oligopoly markets
The Spectrum of Market Structure
The Spectrum of Market Structure
Pure
Competition
Chapter 14
The Spectrum of Market Structure
Pure
Competition
Pure
Monopoly
Chapter 14
Chapter 15
The Spectrum of Market Structure
Pure
Competition
Pure
Monopoly
Chapter 14
Chapter 15
The Spectrum of Market Structure
Pure
Competition
Pure
Monopoly
Chapter 14
Chapter 15
Imperfect
Competition
Chapters 16 & 17
Imperfect Competition is...
…market structures that fall between
perfect competition and pure
monopoly.
Characteristic
–
of:
Industries in which the firms have
competitors but. . . do not face so much
competition that the firm is a price taker.
Imperfect Competition
Two types of imperfectly competitive
markets:
Monopolistic Competition
Many firms selling products that are similar
but not identical (e.g. movies.)
Oligopoly
Only a few sellers, each offering a similar
or identical product to the others (e.g.
tennis balls.)
The Four Types of Market Structure
Number of Firms?
Many
firms
One
firm
Few
firms
Type of Products?
Differentiated
products
Monopolistic
Competition
Identical
products
Perfect
Competition
Monopoly
Oligopoly
• Tap water
• Tennis balls
• Novels
• Wheat
• Cable TV
• Crude oil
• Movies
• Milk
Markets with only a Few Sellers:
Oligopoly
Because of the few sellers, the
actions of any one seller in the market
can have a large impact on the profits
of all the other sellers.
Markets with only a Few Sellers:
Oligopoly
Characteristics
of an Oligopoly Market:
Few sellers offering similar product
– Interdependent on other firms in industry
– Best off by cooperating and acting like a
monopolist by producing a small quantity
of output and charging a price above
marginal cost
–
Duopoly
Example. . .
OLIGOPOLY

1.
2.
3.
4.
Oligopoly is a market structure
characterized by
A few sellers
With a homogeneous or
differentiated product
Much control overprice (pricemaker)
Difficulty in entering and exiting the
market.
Lessons From Duopoly Example
A duopoly (and oligopoly) market
structure may result in:
Collusion: The two firms (industry)
agreeing on the quantity to produce and
the market price to charge.
Cartel:
The two firms (industry) joining
together and acting in unison.
In effect, the actions may result in the
market being served by a monopoly.
A duopoly (and oligopoly) market
structure may result in: (cont..)
Oligopolies pursuing their own selfinterest .
Production is greater than the monopoly
quantity but less than the competitive
industry quantity.
° Market prices are lower than monopoly
but greater than competitive price
(marginal cost.)
± Total profits are less than the monopoly
profit.
How the Size of an Oligopoly Affects the Market
Outcome
 How
increasing the number of sellers
affects the price and quantity:
 The
output effect: Because price is above
marginal cost, selling more at the going
price raises profits.
 The price effect: Raising production
lowers the price and the profit per unit on
all units sold.
The Equilibrium for an Oligopoly
Nash
Equilibrium:
n ÷ (n + 1)
–
–
where n is the
number of firms in
the industry.
If n = 3, then the
joint output would
be 3/4 or 75% of the
competitive market
Nash
–
Equilibrium:
the joint output of
the oligopoly
firms (industry)
would be less
than the output of
the competitive
market.
Oligopoly Size and Market Outcome
As
the size of an oligopoly increases,
production will increase (i.e. the output
effect) maintaining price above marginal
cost.
As the number of sellers in an
oligopoly grows larger, the market is
more similar to a competitive market.
–
Price approaches marginal cost and
output is more socially efficient.
The Demand Schedule for Water
Table 16-1
Quantity
(in gallons)
Price
0
10
20
30
40
50
60
70
80
90
100
110
120
$120
110
100
90
80
70
60
50
40
30
20
10
0
Total Revenue
(and Total Profit)
$
0
1100
2000
2700
3200
3500
3600
3500
3200
2700
2000
1100
0
A Duopoly Example: Price and
Quantity Supplied
The price of water in a perfectly
competitive market would be driven to
where the marginal cost is zero:
P = MC = $0
Q = 120 gallons
The price and quantity in a monopoly
market would be where total profit is
maximized:
P = $60
Q = 60 gallons
Quick Quiz!
 If
the members of an
oligopoly could agree
on a total quantity to
produce, what quantity
would they choose?
 If oligopolies do not act
together, do they
produce a total quantity
more or less than the
previous question?
Game Theory & The Economics of
Cooperation
Game
Theory: the study of how people
behave in strategic situations.
“Strategic” decisions means that each
person (firm) in deciding what actions to
take, must consider how others (firms)
might respond to that action.
– In an oligopolistic market the number of
firms are small, hence each firm acts
strategically.
–
Game Theory & The Economics of
Cooperation
Prisoners’
Dilemma: illustrates the
difficulty in maintaining cooperation.
–
Often people (firms) fail to cooperate with
one another even when cooperation
would make them better off.
The
–
Prisoners’ Dilemma Story:
Bonnie and Clyde Example (Table 16-2)
The Prisoners’ Dilemma
Choice # 1
Choice # 2 Choice # 1
Person # 2 Decision
Person #1 Decision
Choice # 2
Payoff
1,1
Payoff
1,2
Payoff
2,1
Payoff
2,2
The Prisoners’ Dilemma
Figure 16-2
Bonnie’s Decision
Confess
Confess
• 8 years for each
Remain Silent
• Bonnie gets 20 yrs
• Clyde goes free
Clyde’s
Decision
Remain • Bonnie goes free
Silent • Clyde gets 20 yrs
• 1 year for each
The Prisoners’ Dilemma
Dominant
Strategy: The best strategy
for a player to follow regardless of the
strategies pursued by other players.
Cooperation is difficult to maintain,
because cooperation is not in the best
interest of the individual.
– Self interest makes it difficult for the
oligopoly to maintain the cooperative
outcome with low production, high prices
and monopoly profits.
–
Oligopolies and Prisoners’ Dilemma
Self
interest makes it difficult for the
oligopoly to maintain the cooperative
outcome with low production, high
prices and monopoly profits.
May lead to cartel cheating.
Examples:
–
–
–
Iran and Iraq (Table 16-3)
International arms race (Table 16-4)
Cigarette Advertising (Table 16-5)
An Oligopoly Game
Figure 16-2
Iraq’s Decision
High
Production
Low
Production
• $40 billion for each
• Iraq gets $30 billion
• Iran gets $60 billion
Low
• Iraq gets $60 billion
Production • Iran gets $30 billion
• $50 billion for each
High
Production
Iran’s
Decision
An Advertising Game
Figure 16-5
Marlboro’s Decision
Advertise
Advertise
Camel’s
Decision
Don’t
Advertise
Don’t
Advertise
• $3 billion profit for each
• Marlboro gets $2 billion
profit
• Camel gets $5 billion
profit
• Marlboro gets $5 billion
profit
• Camel gets $2 billion
profit
• $4 billion profit for each
Public Policy Toward Oligopolies
 Firms
in oligopolies have a strong incentive
to collude in order to:
– reduce production
– raise prices
– increase profits
“People in the same trade seldom meet
together... but the conversation ends in a
conspiracy against the public, or in some
[diversion] to raise prices.”
(Adam Smith, 1776)
Why People Sometimes
Cooperate
Firms that care about future
profits will cooperate in
repeated games rather than
cheating in a single game to
achieve a one-time gain.
Public Policy Toward Oligopolies
From the standpoint
of society,
cooperation among
oligopolists is
undesirable because
it leads to production
that is too low
prices that are too high
–
–
Public Policy Toward Oligopolies
Antitrust
Laws:
– Sherman Antitrust Act
of 1890
– Clayton Act of 1914
Make it illegal to restrain
trade or attempt to
monopolize a market.
Controversies over Antitrust Policy
Sometimes
the Antitrust Policies may
not allow business practices that have
potentially positive effects:
– Resale Price Maintenance
– Predatory pricing
– Tying
Examples…
– Toys “R” Us
– The Movie Industry
Resale Price Maintenance
Resale price maintenance (or fair
trade) occurs when suppliers (like
wholesalers) require the retailers
that they sell to, to charge
customers a specific amount.
Predatory Pricing
Predatory pricing occurs when a
large firm begins to cut the price
of its product(s) with the intent
of driving its competitor(s) out of
the market.
Tying
Tying refers to when a firm
offers two (or more) of its
products together at a single
price, rather than separately.
Quick Quiz!
What
kind of
agreement is illegal
for businesses to
make?
Why are the
antitrust laws
controversial?
Summary
An
oligopoly may end up looking more
like a monopoly or a competitive
market, depending on how many firms
there are.
Oligopolies can attempt to cooperate
with each other but are limited by laws.
Antitrust laws are used to regulate the
behavior of oligopolies.
Summary
 Oligopolists
maximize their total
profits by forming a cartel and acting
like a monopolist.
 If oligopolists make decisions about
production levels individually, the
result is a greater quantity and a
lower price than under the monopoly
outcome.
Summary
 The
prisoners’ dilemma shows that
self-interest can prevent people from
maintaining cooperation, even when
cooperation is in their mutual selfinterest.
 The logic of the prisoners’ dilemma
applies in many situations, including
oligopolies.
Summary
Policymakers
use the antitrust
laws to prevent oligopolies from
engaging in behavior that reduces
competition.