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Oligopoly
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Oligopoly
Market Structure – A classification system for the key traits of a
market, including
• the number of firms,
• the similarity of the products they sell, and
• the ease of entry and exit
Oligopoly
only a few firms (firms have market power, can change price)
offer identical (homogeneous) or similar (differentiated)
products
difficult to enter or exit the industry
Interdependent unlike participants in perfect competition where firms
don’t need to consider actions of other producers in the short run, in
oligopoly actions of each firm will impact other firms in the market
copyright © michael .roberson@eStudy.us 2010, All rights reserved
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Market Structure
Economists who study industrial organization divide markets into
four types: monopoly, oligopoly, monopolistic competition, and
perfect competition.
Many
Firms
Number of Firms
One
Firm
Product Type
Few
Firms
Differentiated
Monopoly
Tap Water
Sewer Services
Oligopoly
½ ton trucks
Wireless phones
Identical
Monopolistic
Competition
Perfect
Competition
Novels
Movies
Wheat
Corn
Imperfect Competition
copyright © michael .roberson@eStudy.us 2010, All rights reserved
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Oligopoly
Imperfect competition – between perfect competition and
monopoly
• Oligopoly
• Monopolistic competition
• Produce a quantity where price is greater then marginal cost
• Price will be higher than Perfect Competition
• Quantity produced will be less can Perfect Competition
copyright © michael .roberson@eStudy.us 2010, All rights reserved
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Oligopoly Definition
• Homogeneous Oligopoly
– Steel (U.S. Steel, Arcelor Mittal, Nuco)
– Copper (Phelps Dodge, Arasco, Freeport-McMoRan, Southwire)
GE or GM both needing Steel and Copper will write specification and no
matter which producer wins the business GE and GM will get an identical
product.
• Differentiated Oligopoly
– ½ Ton Truck Market (Ford, GM, Chrysler, Toyota)
– Commercial Airline Market (America, United, Southwest,
Delta, _________, ___________
Even if you don’t know a thing about ½ ton trucks you can identify every
truck producer. How? Trucks are different and each one has the brand
name on the vehicle.
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Markets with Few Sellers
Two types of Oligopoly
• Collusive – market participants work together to
greater a better profit outcome
• Non-collusive – act as competitors in the market place
A small group of sellers
– Tension between cooperation and self-interest
– Best to cooperate with other firms to create monopoly profit
– However, each firm cares only about its own profit which
creates a powerful incentive not to cooperate
Duopoly – Oligopoly with only two members
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Non-collusive
Oligopoly firms participate in non-price completion
– Unique product features (iPhone, iPad)
– Increase transaction cost of switching
• Contracts (Wireless phones, insurance, etc…)
• Lock-in (FirstName.LastName@yahoo.com)
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Non-collusive
• Non-collusion results in:
– Higher quantity
– lower price
– lower profit
• Equilibrium Theory
– Game Theory: how people or firms behave in strategic situations
• Choose among alternative courses of action
• Must consider how others might respond to the action they take
– Nash equilibrium: economic actors interacting with one another each
choose their best strategy given the strategies that all the other actors
have chosen
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Non-collusive
The prisoners’ dilemma
– Particular “game” between two captured prisoners
– Illustrates why cooperation is difficult to maintain
even when it is mutually beneficial
Dominant strategy
– A strategy that is best for a player in a game
regardless of the strategies chosen by the other
players
Pay-off Table quantifies the value of each outcome in
game theory based on participant choices
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Prisoners’ dilemma
Bonnie’s decision
Confess
Bonnie gets 8 years
Remain silent
Bonnie gets 20 years
Confess
Clyde gets 8 years
Clyde’s
Decision
Bonnie goes free
Clyde goes free
Bonnie gets 1 year
Remain
silent
Clyde gets 20 years
Clyde gets 1 year
In this game between two criminals suspected of committing a crime, the dominate
strategy for each is to confess. Why because no matter what the other does
confession is the best choice.
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Prisoners’ dilemma
Oligopolies as a prisoners’ dilemma
– In trying to reach the monopoly outcome
– Firms have self-interest
• and do not cooperate even though cooperation would
increase profits
• each firm has incentive to cheat to maximize profit
Example Ford and GM (1/2 ton pick-up trucks)
– Differentiated oligopoly
– Ford is low cost producer
– Discounting vs. Free Features
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Prisoners’ dilemma
GM Decision
Free Options
GM earns $4
million profit
Rebate
GM earns $3
million profit
Ford gets $6
million profit
Ford gets $4
million profit
Ford
Decision
No Free Options
GM earns $6
million profit
No
Rebate
Ford gets $3
million profit
GM earns $5
million profit
Ford gets $5
million profit
In the ½ ton truck market, using the above payoff table, Ford will choice to Rebate
and GM to offer free options. While each could earn more by cooperating,
cooperation is not a sustainable equilibrium in the ½ ton truck market.
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Collusive Oligopoly
• Collusion is an agreement among firms in a
market
• Cartel – a group of firms acting in unison
• Cartels act as a monopoly to maximize profit
– Produce monopoly quantity
– Charge monopoly price
– Same impacts to society
• Collusion for self-interest unlikely to work
– Difficult to reach & enforce an agreement
– Antitrust laws
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Economics of Cooperation
Why firms sometimes cooperate
• Game of repeated prisoners’ dilemma
–Repeat the game
–Agree on penalties if one cheats
–Both need an incentive to cooperate
Encouraging cooperation
• Penalty for not cooperating
• Return to cooperative outcome after a
period of noncooperation
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Collision Example
Organization of Petroleum Exporting Countries (OPEC)
– Formed in 1960: Iran, Iraq, Kuwait, Saudi Arabia, Venezuela
– By 1973: Qatar, Indonesia, Libya, the United Arab Emirates,
Algeria, Nigeria, Ecuador, Gabon
– Control about three-fourths of the world’s oil reserves
– Tries to raise the price of its product
Via a coordinated reduction in quantity produced
Cheating Problem: Each member of the cartel
– Tempted to increase its production
– Get a larger share of the total profit
– Cheat on agreement
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Collision Example
• OPEC was successful at maintaining cooperation
and high prices from 1973 to 1985: increase in
price
• Mid-1980s - member countries began arguing
about production levels
– OPEC became ineffective at maintaining cooperation
– Decrease in price
• 2007 to 2008 – significant increase in price
primarily caused by increased world demand
Booming World economy
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Public Policy
Restraint of trade and the antitrust laws
– The Sherman Antitrust Act, 1890
Elevated agreements among oligopolists from an
unenforceable contract to a criminal conspiracy
– The Clayton Act, 1914
Further strengthened the antitrust laws
– The Federal Trade Commission Act, 1914
• Created the Federal Trade Commission (FTC)
• Can prevent mergers that impede competition
• Can prevent oligopolists from colluding
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Public Policy
An illegal phone call – Collusion Example
Robert Crandall – president of American Airlines
Howard Putnam – president of Braniff Airways
• CRANDALL: I think it’s dumb as hell . . . to sit here and pound the @#$% out
of each other and neither one of us making a #$%& dime.
• PUTNAM: Do you have a suggestion for me?
• CRANDALL: Yes, I have a suggestion for you. Raise your $%*& fares 20
percent. I’ll raise mine the next morning.
• PUTNAM: Robert, we . . .
• CRANDALL: You’ll make more money, and I will, too.
• PUTNAM: We can’t talk about pricing!
• CRANDALL: Oh @#$%, Howard. We can talk about any &*#@ thing we want
to talk about.
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Public Policy
Resale price maintenance (fair trade)
• Require retailers to charge customers a given
price
• Might seem anticompetitive
– Prevents the retailers from competing on price
• Defenders:
– Not aimed at reducing competition
– Legitimate goal
• Some retailers offer service
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Public Policy
Predatory pricing
• Charge prices that are too low
– Anticompetitive because price cuts are
intended to drive other firms out of the
market
• Skeptics
– Predatory pricing (not a profitable strategy)
– Price war (to drive out a rival)
– Pricing below cost
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Public Policy
Tying
• Offer two goods together at a single price
– Expands market power
• Skeptics
– Cannot increase market power by binding
two goods together
• Form of price discrimination
– Tying may increase profit
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Public Policy Example
U.S. government case against Microsoft
• Central issue: tying
Should Microsoft be allowed to integrate its Internet browser
into its Windows operating system
• The government’s claim:
– Microsoft was bundling to expand market power into the
market of Internet browsers
– Would deter other software companies from entering the
market and offering new products
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Microsoft Case
Microsoft responded
– New features into old products - natural part of
technological progress
• Cars - include CD players, air conditioners
• Cameras - built-in flashes
• Operating systems - added many features to Windows
– Previously stand-alone products
– Computers - more reliable and easier to use
– Integration of Internet technology,
• The next natural next step
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Microsoft Case
Disagreement about the extent of Microsoft’s
market power
• The government
– More than 80% of new personal computers
• Use a Microsoft operating system
• Substantial monopoly power
• Microsoft
– Software market is always changing
– Competitors: Apple Mac & Linux operating systems
– Low price illustrates limited market power
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Microsoft Case
• November 1999 ruling
Microsoft illegally abused market power
• June 2000
Ruling to break Microsoft into two companies
Operating system & Applications software
• 2001 appeal
Overturned the breakup order
• September 2001
Justice Department - wanted to settle the case quickly
• November 2002 settlement
Microsoft accepted some restrictions and the browser
remains part of the Windows operating system