Chapter 13

Oligopoly

Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Oligopoly
Oligopoly
A few large producers
Homogeneous oligopoly
Differentiated oligopoly
Limited control over price
Entry barriers
Mergers
LO

13-2

Oligopoly
A few large producers
Each firm has a large market share
The firms are interdependent
The firms have an incentive to collude
When a small number of firms share a
market, they can increase their profit by
forming a cartel and acting like a monopoly.
A cartel is a group of firms acting together to
limit output, raise price, and increase
economic profit.
13-3

Oligopoly
Barriers to entry
Scale economies may make it unprofitable for
more than a few firms to coexist in the market;
patents or access to a technology may exclude
potential competitors;
the need to spend money for name recognition
and market reputation may discourage entry
by new firms; and
Incumbent firms may take strategic actions to
deter entry.

13-4

Natural Barriers to Entry

Example
A duopoly is a market
with two firms.
1.The lowest possible price
equals minimum ATC.
2.The efficient scale is 30
rides a day.
3.The quantity demanded
(60 rides a day) can be
met by two firms
natural duopoly.

13-5

Oligopoly
Managing an oligopolistic firm is
complicated because pricing, output,
advertising, and investment
decisions involve important strategic
considerations, which can be highly
complex.

13-6

Oligopoly
Interdependence
Profit earned by each firm depends on
the firms own actions and on the
actions of the other firms.
Each firm must consider how the other
firms will react to its decision and
influence its profit.

13-7

Equilibrium in an Oligopolistic
Market
In an oligopolistic market, however, a firm sets
price or output based partly on strategic
considerations regarding the behavior of its
competitors.
With some modification, the underlying principle to
describe an equilibrium when firms make decisions
that explicitly take each others behavior into
account is the same as the equilibrium in
competitive and monopolistic markets:
When a market is in equilibrium, firms are doing the
best they can and have no reason to change their
price or output.
13-8

Oligopolistic Industries
Four-firm concentration ratio
40% or more to be an oligopoly
Shortcomings

LO

Localized markets
Interindustry competition
Import competition
Dominant firms

13-9

High Concentration Industries

4-Firm
Concentrati
on Ratio

(3)
Herfinda
hl
Index

Primary copper

99

ND

Cane sugar
refining

95

(2)
(1)
Industry

4-Firm
Concentrati
on Ratio

(3)
Herfinda
hl
Index

Petrochemicals

80

2,535

ND

Breakfast cereals

80

2,426

79

2,447

(2)
(1)
Industry

Cigarettes

98

ND

Small-arms
ammunition

Household
laundry
equipment

98

ND

Primary aluminum

77

2,250

76

2,015

Household
refrigerators and
freezers

92

ND

Mens slacks and

jeans

Beer

90

ND

Electric light bulbs

75

2,258

Glass containers

87

2,507

Tires

73

1,540

Household vacuum
cleaners

71

1,519

Alcohol distilleries

70

13-10
1,915

Electronic
computers

87

ND

Oligopoly Behavior
Oligopolies display strategic
behavior
Mutual interdependence
Collusion
Incentive to cheat
Game theory
Prisoners dilemma
LO

13-11

Game Theory
Analyzes the choices made by rival
firms, people, and even governments
when they are trying to maximize
their own well-being while anticipating
and reacting to the actions of others
in their environment.
Dominant strategy
In game theory, a strategy that is best no
matter what the opposition does.
13-12

Game Theory
THE PRISONERS DILEMMA
A game in which the players are prevented from
cooperating and in which each has a dominant strategy
that leaves them both worse off than if they could
cooperate.
Equilibrium - Occurs when each player takes the best
possible action given the action of the other player.
Nash equilibrium is an equilibrium in which each
player takes the best possible action given the action of
the other player.
The equilibrium of the prisoners dilemma is not the
best outcome for the players.
players

13-13

2 competitors
2 price
strategies
Each strategy
has a payoff
matrix
Greatest
combined
profit
Independent
actions
stimulate a
response
LO

Uptowns price strategy

Game Theory Overview

RareAirs price strategy
High
A

$12

Low
B

$15

High
$12

C
Low
$15

$6

$6

$8

$8

13-14

Independently
lowered prices
in expectation
of greater
profit leads to
worst
combined
outcome
Eventually low
outcomes
make firms
return to
higher prices.
LO

Uptowns price strategy

Game Theory Overview

RareAirs price strategy
High
A

$12

Low
B

$15

High
$12

C
Low
$15

$6

$6

$8

$8

13-15

Game Theory
Nash
Equilibrium

The Prisoners Dilemma

Both players have a dominant strategy and will confess.
confess
If Rocky does not confess, Ginger will because going free beats a year in jail.
Similarly, if Rocky does confess, Ginger will confess because 5 years in the
slammer is better than 7.
Rocky has the same set of choices.
If Ginger does not confess, Rocky will because going free beats a year in jail.
Similarly, if Ginger does confess, Rocky also will confess because 5 years in the
slammer is better than 7.
13-16
Both will confess regardless of what the other does.

Game Theory: Advertising

Both players have a dominant strategy.

If B does not advertise, A will because $75,000 beats $50,000.
If B does advertise, A will also advertise because a profit of $10,000
beats a loss of $25,000.
A will advertise regardless of what B does. Similarly, B will advertise
regardless of what A does.
If A does not advertise, B will because $75,000 beats $50,000.
If A does advertise, B will too because a $10,000 profit beats a loss of
$25,000.

13-17

Game Theory

In the original game (a), C does not have a dominant

strategy.
If D plays left, C plays top;
if D plays right, C plays bottom.
D, on the other hand, does have a dominant strategy:
D will play right regardless of what C does.
If C believes that D is rational, C will predict that D will
play right.
If C concludes that D will play right, C will play bottom.
The result is a Nash equilibrium because each player is
doing the best that it can given what the other is doing.
13-18

Game Theory

Payoff Matrixes for Left/RightTop/Bottom Strategies

In the new game (b), C had better be very sure that D will play
right because if D plays left and C plays bottom, C is in big trouble,
losing $10,000.
C will probably play top to minimize the potential loss if the
probability of Ds choosing left is at all significant.

13-19

Three Oligopoly Models

LO

Kinked-demand curve
Collusive pricing
Price leadership
Reasons for 3 models
Diversity of oligopolies
Complications of interdependence

13-20

Kinked-Demand Theory
Noncollusive oligopoly
Uncertainty about rivals reactions
Rivals match any price change
Rivals ignore any price change
Assume combined strategy
Match price reductions
Ignore price increases
LO

13-21

Kinked-Demand Curve

Rivals ignore
price increase
P0

P0

D2
MR2

Rivals match g
price decrease
Q0

LO

D2

D1
MR1

MR2

e
f

MC1

MC2

g
D1
Q0

MR1

13-22

Kinked-Demand Curve
Criticisms
Explains inflexibility, not price
Prices are not that rigid
Price war

LO

13-23

Cartels and Other Collusion

MC

ATC

P0
A0
Economic
profit

MR=MC
MR

Q0

LO

13-24

Overt Collusion
A cartel is a group of firms or
nations that collude
Formally agreeing to the price
Sets output levels for members
Collusion is illegal in the United
States
OPEC
LO

13-25

Obstacles to Collusion

LO

Demand and cost differences

Number of firms
Cheating
Recession
New entrants
Legal obstacles

13-26

Price Leadership Model

Price leadership
Dominant firm initiates price
changes
Other firms follow the leader
Use limit pricing to block entry of
new firms
Possible price war
LO

13-27

Oligopoly and Advertising

Oligopolies commonly compete
though product development and
advertising
Less easily duplicated than a price
change
Financially able to advertise

LO

13-28

Positive Effects of Advertising

Low-cost way of providing
information to consumers
Enhances competition
Speeds up technological progress
Can help firms obtain economies of
scale

LO

13-29

Oligopoly and Advertising

The Largest U.S. Advertisers,
2011
Company
Proctor & Gamble

LO

Advertising Spending
Millions of $
$4,971.5

General Motors

3,055.7

Verizon

2,523.0

Comcast

2,465.4

AT&T

2,359.0

JP Morgan Chase

2,351.8

Ford Motor

2,141.3

American Express

2,125.3

LOral

2,124.6

13-30

Negative Effects of Advertising

Can be manipulative
Contain misleading claims that
confuse consumers
Consumers may pay high prices for a
good while forgoing a better, lower
priced, unadvertised version of the
product

LO

13-31

Oligopoly and Efficiency

Oligopolies are inefficient
Productively inefficient because P >
min ATC
Allocatively inefficient because P > MC
Qualifications
Increased foreign competition
Limit pricing
Technological advance
LO

13-32

Internet Oligopolies
The Internet became accessible to the
average person in the mid 1990s
Today it is dominated by a few very large
firms
Google, Facebook, Amazon, Microsoft, Apple
Not satisfied with just revenues generated
in their respective sectors
Compete for advertising $s
Compete with their own electronic devices
13-33