Oligopoly: Firms in Less Competitive Markets

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1 Chapter 13 Oligopoly: Firms in Less Competitive Markets Prepared by: Fernando & Yvonn Quijano 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. Competing with Wal-Mart Learning Objectives Show how barriers to entry explain the existence of oligopolies. Use game theory to analyze the strategies of oligopolistic firms. Use sequential games to analyze business strategies. Use the five competitive forces model to analyze competition in an industry. In an oligopoly, a firm s profitability depends on its interactions with other firms Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 2 1

2 OLIGOPOLY The Four Market Structures CHARACTERISTIC Number of firms Type of product Ease of entry Examples of industries PERFECT COMPETITION Many Identical High Wheat Apples MARKET STRUCTURE MONOPOLISTIC COMPETITION Many Differentiated High Selling DVDs Restaurants OLIGOPOLY Few Identical or differentiated Low Manufacturing computers Manufacturing automobiles MONOPOLY One Unique Entry blocked First-class mail delivery Tap water 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 3 Oligopoly: Firms in Less Competitive Markets Oligopoly A market structure in which a small number of interdependent firms compete Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 4 2

3 Learning Objective 13.1 Oligopoly and Barriers to Entry Barriers to Entry Economies of Scale Barrier to entry Anything that keeps new firms from entering an industry in which firms are earning economic profits. Economies of scale The situation when a firm s long-run average costs fall as it increases output Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 5 Learning Objective 13.1 Oligopoly and Barriers to Entry Barriers to Entry Ownership of a Key Input If production of a good requires a particular input, then control of that input can be a barrier to entry. Government-Imposed Barriers Patent The exclusive right to a product for a period of 20 years from the date the product is invented Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 6 3

4 Game theory The study of how people make decisions in situations in which attaining their goals depends on their interactions with others; in economics, the study of the decisions of firms in industries where the profits of each firm depend on its interactions with other firms Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 7 All games share three key characteristics: 1 Rules that determine what actions are allowable 2 Strategies that players employ to attain their objectives in the game 3 Payoffs that are the results of the interaction among the players strategies Business strategy Actions taken by a firm to achieve a goal, such as maximizing profits Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 8 4

5 A Duopoly Game: Price Competition between Two Firms FIGURE 13.2 A Duopoly Game 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 9 A Duopoly Game: Price Competition between Two Firms Payoff matrix A table that shows the payoffs that each firm earns from every combination of strategies by the firms. Collusion An agreement among firms to charge the same price or otherwise not to compete. Dominant strategy A strategy that is the best for a firm, no matter what strategies other firms use. Nash equilibrium A situation in which each firm chooses the best strategy, given the strategies chosen by other firms. Don t Let This Happen to YOU! Don t Misunderstand Why Each Manager Ends Up Charging a Price of $ Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 10 5

6 Firm Behavior and the Prisoners Dilemma Cooperative equilibrium An equilibrium in a game in which players cooperate to increase their mutual payoff. Noncooperative equilibrium An equilibrium in a game in which players do not cooperate but pursue their own self-interest. Prisoners dilemma A game in which pursuing dominant strategies results in noncooperation that leaves everyone worse off Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 11 Solved Problem 13-2 Is Advertising a Prisoners Dilemma for Coca-Cola and Pepsi? 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 12 6

7 Can Firms Escape the Prisoners Dilemma? FIGURE 13.3 Changing the Payoff Matrix in a Repeated Game 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 13 Can Firms Escape the Prisoners Dilemma? Price leadership A form of implicit collusion where one firm in an oligopoly announces a price change, which is matched by the other firms in the industry Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 14 7

8 Cartels: The Case of OPEC Cartel A group of firms that collude by agreeing to restrict output to increase prices and profits. FIGURE 13.4 World Oil Prices, Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 15 Cartels: The Case of OPEC FIGURE 13.5 The OPEC Cartel with Unequal Members 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 16 8

9 Sequential Games and Business Strategy Learning Objective 13.3 Deterring Entry FIGURE 13.6 The Decision Tree for an Entry Game 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 17 Solved Problem 13-3 Is Deterring Entry Always a Good Idea? Learning Objective Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 18 9

10 Learning Objective 13.3 Sequential Games and Business Strategy Bargaining FIGURE 13.7 The Decision Tree for a Bargaining Game 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e

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