Monopolistic Competition Oligopoly Duopoly Monopoly. The further right on the scale, the greater the degree of monopoly power exercised by the firm.

Transcription

1 Oligopoly

2 Monopolistic Competition Oligopoly Duopoly Monopoly The further right on the scale, the greater the degree of monopoly power exercised by the firm.

3 Imperfect competition refers to those market structures that fall between perfect competition and pure monopoly.

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5 Types of Imperfectly Competitive Markets Oligopoly Only a few sellers, each offering a similar or identical product to the others. Monopolistic Competition Many firms selling products that are similar but not identical.

6 Copyright 2004 South-Western Number of Firms? Many firms Type of Products? One firm Few firms Differentiated products Identical products Monopoly (Chapter 15) Oligopoly (Chapter 16) Monopolistic Competition (Chapter 17) Perfect Competition (Chapter 14) Tap water Cable TV Tennis balls Crude oil Novels Movies Wheat Milk

7 Oligopoly is a market structure defined by Natural or legal barriers that prevent entry of new firms A small number of firms compete Oligopolies may be Natural, due to natural barriers to entry Legal, legal barriers to entry

8 The actions of each firm in the market simultaneously influence the nature of the market and the strategy of other firms This introduces a level of strategic interactions, which makes oligopoly complex, and unique

9 Example Car industry Airline industry Cigarettes Cleaning products Electrical appliance

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12 Oligopoly arises, when there is a small number of firms Market concentration is measured via the Herfindalhl-Hirschman Index (HHI) Sum of the square of market share for the top 50 firms

13 Competitive market with 100 firms, each 1% share: Monopolist: Two firms, dividing the market equally: HHI above 1000 is considered oligopoly

14 HHI above 1000 is considered oligopoly Many oligopoly markets are dominated by a few firms (4 shown in red)

15 A natural barrier to entry, defined by the nature of the ATC curve In this case, the market is a natural duopoly, two firms are able to supply the entire market most efficiently

16 Costs and Revenue Average total cost Lowest possible Price=ATC Demand 0 Efficient scale of a single firm Two firms meet the demand Quantity Copyright 2004 South-Western

17 Pricing models Kinked demand curve Dominant firm oligopoly Cournot model Collusion

18 Collusion and strategic decisions

19 A small number of firms makes collusion possible cooperation among firms designed to increase prices and profits When firms cooperate to create a monopoly price they form a cartel

20 Collusion: an agreement among firms in a market about quantities to produce or prices to charge Cartel: a group of firms acting in unison

21 Demand for the cartel s product must be inelastic (good cannot be easily replaced) Oil: YES Carrots: NO Members of cartel must not cheat: if some of the cartel members cheat, the cartel agreement will collapse

22 Is collusion sustainable? Will firms cheat? Game theory lets design a game and look for a Nash equilibrium Prisoner dilemma

23 Competition Q=40 P=$30 Profit=$800 Monopolistic pricing (collusion) Q=30 P=$40 Profits=$900

24 Cingular Verizon Verizon gets $900 profit Verizon gets $1000 profit Cingular gets $900 profit Cingular gets $750 profit 40 Verizon gets $750 profit Verizon gets $800 profit Cingular gets $1000 profit Cingular gets $800 profit Copyright 2003 Southwestern/Thomson Learning

25 Other strategic decisions: Production level Investments Advertising Self-interest makes it difficult for the oligopoly to maintain a cooperative outcome with low production, high prices, and monopoly profits.

26 Copyright 2003 Southwestern/Thomson Learning Iraq s Decision High Production Iraq gets $40 billion Low Production Iraq gets $30 billion Iran s Decision High Production Low Production Iran gets $40 billion Iraq gets $60 billion Iran gets $30 billion Iran gets $60 billion Iraq gets $50 billion Iran gets $50 billion

27 Copyright 2003 Southwestern/Thomson Learning Marlboro s Decision Camel s Decision Advertise Don t Advertise Advertise Camel gets $3 billion profit Camel gets $2 billion profit Marlboro gets $3 billion profit Marlboro gets $5 billion profit Don t Advertise Camel gets $5 billion profit Camel gets $4 billion profit Marlboro gets $2 billion profit Marlboro gets $4 billion profit

28 Exxon s Decision Drill Two Wells Drill One Well Texaco s Decision Drill Two Wells Drill One Well Texaco gets $4 million profit Texaco gets $3 million profit Exxon gets $4 million profit Exxon gets $6 million profit Texaco gets $6 million profit Texaco gets $5 million profit Exxon gets $3 million profit Exxon gets $5 million profit Copyright 2003 Southwestern/Thomson Learning

29 Suppose, there are two farmers, whose caws graze the same field. They need to choose the size of the herd: 100 or 200 caws. Cost of a caw: 100 Production of milk per caw: 60 if there are 200 caws on a field 50 if there are 300 caws on a field 35 if there are 400 caws on a field Value of meat: 80 What should the farmers do?

30 Firms that care about future profits will cooperate in repeated games rather than cheating in a single game to achieve a onetime gain.

31 Lufthansa British Airways $ 400 $ 600 $ 400 British Airways $0.8 million profit British Airlines $1.6 million profit Lufthansa gets $0.8 million profit Lufthansa $0 million profit $ 600 British Airways $0 million profit British Airlines $1.2 million profit Lufthansa gets $1.6 million profit Lufthansa $1.2 million profit Copyright 2003 Southwestern/Thomson Learning

32 Suppose, the airlines play the same game a number of times Suppose, after some time, Lufthansa increases the price to $600 Lufthansa executives may signal that both firms will be better off charging $600 British Airlines should follow the suit This type repeated game is called tit for tat strategy

33 An agent using this strategy will first cooperate, then subsequently replicate an opponent's previous action. If the opponent previously was cooperative, the agent is cooperative. If not, the agent is not. A one-time, single-bit error in either player's interpretation of events can lead to an unending "death spiral When the opponent defects, the player will occasionally cooperate on the next move anyway

34 Kinked demand curve

35 From the perspective of one firm in an oligopoly If the firm charges more then the other firms, they will not follow the firm strategy If it charges less, other firm will follow the firm strategy From the perspective of the manager, the demand curve is not continuous, it breaks at the competitor price

36 Constant share demand curve: All firms in the market set the same price Market share doesn t depend on my price The demand for the firm s goods depends only on the total demand Variable share demand curve Other firms don t change their prices Market share depends on my price Demand curve is more elastic than before

37 Price Kinked demand curve Variable demand Constant share demand 0 Quantity

38 The MR curve associated with a kinkeddemand curve contains three distinct segments One is associated with the upper more elastic segment. One is connected to the lower less elastic segment. And one that arises from the kink that joins the two.

39 Copyright 2004 South-Western Costs and Revenue P Marginal cost Kinked demand curve 0 Q Marginal revenue Quantity

40 The firm perceives a break at the current market price (competitors price) keep in mind, the demand curve displayed here is the curve the firm faces The vertical segment is the key feature of this marginal revenue curve.

41 Copyright 2004 South-Western Costs and Revenue P MC2 MC1 Kinked demand curve Marginal revenue 0 Q Quantity

42 MC curve can increase or decrease without inducing a profit-maximizing oligopoly to change price or quantity This vertical segment is what helps to explain rigid prices for oligopoly

43 Dominant firm oligopoly

44 The kinked demand curve model occurs when a small number of firms have similar cost structures However, this is not always the case. Imagine, instead, that market concentration is high because it is dominated by a large firm, with many firms supplying small portions of the market Consider, Gas stations Electricity suppliers

45 The dominant firm acts almost like a monopolist If the dominant firm charges a single price, it faces a marginal revenue curve similar to a monopolist Other firms in the market are unable to price higher than the dominant firm The dominant firm will produce the quantity demanded net the amount supplied by smaller firms The output under the price leadership is between the production level under the monopoly and a perfect competition

46 Costs and Revenue Marginal cost P XD D MR 0 Q Quantity

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48 The dominant firm has an incentive to push smaller firms out of the market: Merges: the dominant firm could just merge with the smaller firm Aggressive price setting: cut prices artificially low in order to drive smaller firms out of business. It can recoup its own losses by charging higher prices latter on (predatory pricing)

49 Cournot model

50 Suppose There are two firms (A and B) in the market and none of them is dominant. They produce identical products and know each other cost curves. Firms can not collude (agree on the price this possibility will be discussed later)

51 Costs and Revenue Marginal cost P1 P2 Demand Marginal revenue Quantity

52 What is the Firm A optimal output if Firm B doesn t produce anything Firm A becomes a monopolist and produces 2000 units What is the Firm A optimal output if Firm B produces 4000 units (the perfectly competitive outcome) Firm A will not produce anything

53 The best response function shows the firm s optimal, profit maximizing output given the other firm production level The quantity, which the firm A will choose, depends on the quantity produced by the firm B. The decision of the firm A is based on XD (like in the dominant firm case) - the total demand minus the quantity supplied by the Firm B.

54 Quantity: B Best response A Best response B Quantity: A

55 The best response equilibrium: the point of intersection of the best response functions Both Firm A and Firm B will do best to produce units The duopoly total is (more than the monopoly outcome but less than the perfectly competitive production level) Will the market reach the best response equilibrium?

56 Small town has 90 residents The good cell phone service with unlimited anytime minutes and free phone Smalltown demand schedule Two firms: Cingular and Verizon Each firm s costs: FC=$0, MC=$3 P Q

57 P Q Revenue MR MC Monopoly outcome: P=$6 Q=40 Competitive outcome: P=MC=$3 Q=70

58 P Q Verizon Revenue MR MC Best response: Q=30 P=5

59 P Q $ QC 8 20-QC 7 30-QC 6 40-QC 5 50-QC 4 60-QC 3 70-QC 2 80-QC 1 90-QC

60 P QV Revenue MR MC $ QC 9 (10-QC) 7+0.1*QC QC 8 (20-QC) 5+0.1*QC QC 7 (30-QC) 3+0.1*QC QC 6 (40-QC) 1+0.1*QC QC 5 (50-QC) *QC QC 4 (60-QC) *QC QC 3 (70-QC) *QC QC 2 (80-QC) *QC QC 1 (90-QC) *QC 3

61 Verison will choose the quantity QV, which will maximize its profit MR=MC=3 The best response function is QC QV

62 Cingular faces analogous decision process. It maximized the profit, hence equalize MC=MR=3 Its best response function is QV QC

63 Verison Cingular QC QV QV QC If Cingular chooses 20, then Verison chooses 30. If Verison chooses 20, then Cingular chooses 30.

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67 Anti trust law

68 In the decision process, firms need to take into account decisions of their competitors. 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.

69 Pricing models: Kinked curve Cournot model Decision on the quantity produced. Equilibrium: intersection of best response functions. Quantity: higher than under monopoly and lower than under the competition. Price: lower than under monopoly and higher than under competition.

70 Cooperation among oligopolists is undesirable from the standpoint of society as a whole because it leads to production that is too low and prices that are too high. Antitrust laws make it illegal to restrain trade or attempt to monopolize a market.

71 Antitrust policies sometimes may not allow business practices that have potentially positive effects: Resale price maintenance Predatory pricing Tying

72 Resale Price Maintenance (or fair trade) occurs when suppliers (like wholesalers) require retailers to charge a specific amount 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 when a firm offers two (or more) of its products together at a single price, rather than separately

73 The prisoners dilemma shows that selfinterest can prevent people from maintaining cooperation, even when cooperation is in their mutual self-interest. The logic of the prisoners dilemma applies in many situations, including oligopolies.

74 Policymakers use the antitrust laws to prevent oligopolies from engaging in behavior that reduces competition.