1 MODULE 64: INTRODUCTION TO OLIGOPOLY Schmidty School of Economics
2 Learning Targets I Can Understand why oligopolists have an incentive to act in ways that reduce their combined profit. Explain why oligopolies can benefit from collusion. The purpose of this module is to develop the oligopoly market structure. Many of the high-profile industries in the U.S. are oligopolies and all share a common characteristic: mutual interdependence. Firms often find that it could be mutually beneficial to collude or not compete as vigorously as possible because competition drives down profits for all firms.
3 FOUR MARKET MODELS Perfect Competition Monopolistic Competition Oligopoly Pure Monopoly Characteristics of Oligopolies: A Few Large Producers (Less than 10) Identical or Differentiated Products High Barriers to Entry Control Over Price (Price Maker) Mutual Interdependence Firms use Strategic Pricing Examples: OPEC, Cereal Companies, Car Producers
4 HOW DO OLIGOPOLIES OCCUR? Oligopolies occur when only a few large firms start to control an industry. High barriers to entry keep others from entering. Types of Barriers to Entry 1. Economies of Scale Ex: The car industry is difficult to enter because only large firms can make cars at the lowest cost 2. High Start-up Costs 3. Ownership of Raw Materials
6 Key Economic Concepts Oligopoly was briefly introduced in Module 57. This module presents a more in-depth study of the market structure. A simply duopoly (two firms) is enough to illustrate mutual interdependence. If these firms compete, they will each receive normal profits. If they collude (or cooperate), they can act like a monopoly by restricting output, raising prices, and earning positive economic profits. There is an incentive for each duopolist to cheat on a collusive agreement to earn even more profits. Because of this incentive, collusion can be an unstable, not to mention an illegal, arrangement.
7 Duffka School of Economics Module Format I. Understanding Oligopoly A. A Duopoly Example B. Collusion and Competition C. Competing with Prices versus Competing with Quantities
8 I. Understanding Oligopoly Module 57 describes oligopoly as a market structure with a few large producers. There is no universal definition of how many producers must exist before we call the market an oligopoly, so we use measures like the HHI to quantify the market concentration. An additional key characteristic of oligopoly is that the firms are interdependent and engage in strategic behavior. Interdependence simply means that the actions of one firm (Honda, for example) have an impact on another large firm (Toyota) and vice versa. If Honda would choose to advertise during the Super Bowl, Toyota would be affected and must decide whether to respond or do nothing. These strategies, and mutually interdependent outcomes, make studying oligopoly both interesting and challenging.
9 Game Theory The study of how people behave in strategic situations An understanding of game theory helps firms in an oligopoly maximize profit.
10 A. A Duopoly Example ü Suppose there are only two gas stations in a small rural town of Boonetuckey. ü These gas stations, Margaret s Gas Stop and Pam s Station, are duopolists in the gasoline market and they each sell 50% of all of the gas in town. ü The demand schedule for gasoline in Boonetuckey is given in the table on the nest. We will assume that the marginal cost of selling a gallon of gas is $1.
11 A. A Duopoly Example If these station owners operated in a perfectly competitive world, P=MC=$1. In this case, the firms would split $1400 of total revenue, so each would earn $700.
12 A. A Duopoly Example But two sellers do not need to behave as perfectly competitive firms. They could decide to collude and charge a price of $4 per gallon and each would sell 800/2 = 400 gallons. At this collusive price, each firm would earn $3200/2 = $1600 of total revenue.
13 A. A Duopoly Example But would such an agreement (to not compete) last? Probably not
14 Game theory helps predict human behavior THE ICE CREAM MAN SIMULATION 1. You are an ice cream salesmen at the beach 2. You have identical prices as another salesmen. 3. Beachgoers will purchase from the closest salesmen 4. People are evenly distributed along the beach. 5. Each morning the two firms pick locations on the beach Where is the best location?
15 Where should you put your firm? B A Firm A decides where to goes first. What is the best strategy for choosing a location each day? Can you predict the end result each day? How is this observed in the real-world?
16 Where should you put your firm? A B Firm A decides where to goes first. What is the best strategy for choosing a location each day? Can you predict the end result each day? How is this observed in the real-world?
18 B. Collusion and Competition Collusive agreement: Margaret and Pam have agreed to only offer 400 gallons each at a price of $4 per gallon. This earns each gas station $1600 in total revenue. Suppose that Margaret does some quick calculations and sees that she can secretly sell an additional 100 gallons of gas, thus cheating on the agreement with Pam. What happens? There are now 900 gallons being sold, pushing the market price down to $3.50 per gallon. Margaret s Total Revenue = $3.50*500 = $1750 which is $150 more than under the agreement. Pam s Total Revenue = $3.50*400 = $1400 which is $100 less than agreed upon.
19 B. Collusion and Competition Pam is HAPPY and selling more gas. Margaret retaliates and price drops even further. Pretty soon, price has fallen all the way to P=MC=$1 and these firms are back to the competitive (or non-cooperative) outcome. It should be clearly noted that explicitly agreeing to collude on the basis of price and/or output is illegal and people can, and do, get fined and/or imprisoned for doing so.
20 C. Competing with Prices versus Competing with Quantities In the above duopoly example, it didn t matter if Margaret cheated by selling 100 additional gallons, or if she lowered the price of gasoline to $3.50. The outcome would have been the same. However, which choice is most likely to be immediately detected by Pam and punished? The price drop. These strategies between duopolists have been studied by economists for many years. Joseph Bertrand ( ) showed that when firms are selling an identical product, oligopolists will repeatedly lower price to undercut the competition. This process ends at the perfectly competitive outcome where P=MC. Augustin Cournot ( ) focused on quantity competition, rather than price competition. Again assuming a homogenous product, duopoly firms choose output to maximize profit, given the output of the rival firm. There exists an equilibrium level of output that allows each firm to earn profits that are below monopoly-level profits, but are above normal profits.
21 Because firms are interdependent There are 3 types of Oligopolies 1. Price Leadership (no graph) 2. Colluding Oligopoly 3. Non Colluding Oligopoly
22 #1. PRICE LEADERSHIP
23 Example: Small Town Gas Stations To maximize profit what will they do? OPEC does this with OIL
24 Collusion is ILLEGAL. Firms CANNOT set prices. Price Leadership Price leadership is a strategy used by firms to coordinate prices without outright collusion General Process: 1. Dominant firm initiates a price change 2. Other firms follow the leader
25 Price Leadership Breakdowns in Price Leadership Temporary Price Wars may occur if other firms don t follow price increases of dominant firm. Each firm tries to undercut each other. Example: Employee Pricing for Ford
26 #2. COLLUDING OLIGOPOLIES
27 Cartel = Colluding Oligopoly A cartel is a group of producers that create an agreement to fix prices high. 1. Cartels set price and output at an agreed upon level 2. Firms require identical or highly similar demand and costs 3. Cartel must have a way to punish cheaters 4. Together they act as a monopoly
28 Firms in a colluding oligopoly act as a monopoly and share the profit P MC ATC D MR Q
29 #3. NON-COLLUDING OLIGOPOLIES
30 Kinked Demand Curve Model The kinked demand curve model shows how noncollusive firms are interdependent If firms are NOT colluding they are likely to react to competitor s pricing in two ways: 1. Match price-if one firm cuts it s prices, then the other firms follow suit causing inelastic demand 2. Ignore change-if one firm raises prices, others maintain same price causing elastic demand
31 If this firm increases it s price, other firms will ignore it and keep prices the same As the only firm with high prices, Qd for this firm will decrease a lot P P 1 P e Elasti c Q 1 Q e D Q
32 If this firm decreases it s price, other firms will match it and lower their prices Since all firms have lower prices, Qd for this firm will increase only a little P P 1 P e Elasti c P 2 Q 1 Q e Q 2 D Q
33 Where is Marginal Revenue? MR has a vertical gap at the kink. The result is that MC can move and Qe won t change. Price is sticky. P P e MC Q MR D Q
34 Practice Question # 1 1. When firms cooperate to raise their joint profits, they are necessarily a. colluding. b. in a cartel. c. a monopoly. d. in a duopoly. e. in a competitive industry.
35 Practice Question # 2 2. Which of the following is most important to oligopoly firms? A. Maximizing revenue B. Beating a competitor even if it means lower profits. C. Maximizing profit regardless of other firms profits. D. Loss minimizing E. Eliminating barriers to entry.
36 Duffka School of Economics Practice Question # 3 3. An agreement among several producers to restrict output and increase profit is necessary for a. cooperation. b. collusion. c. monopolization. d. a cartel. e. competition.
37 Practice Question # 4 4. Oligopolists engage in which of the following types of behavior? I. quantity competition II. price competition III. cooperative behavior a. I only b. II only c. III only d. I and II only e. I, II, and III
38 Duffka School of Economics Practice Question # 5 5. Which of the following will make it easier for firms in an industry to maintain positive economic profit? a. a ban on cartels b. a small number of firms in the industry c. a lack of product differentiation d. low start-up costs for new firms e. the assumption by firms that other firms have variable output levels
1 Unit 4: Imperfect Competition FOUR MARKET MODELS Perfect Competition Monopolistic Competition Pure Characteristics of Oligopolies: A Few Large Producers (Less than 10) Identical or Differentiated Products
Chapter 16 Monopolistic Competition and Oligopoly Market Structure Market structure refers to the physical characteristics of the market within which firms interact It is determined by the number of firms
Oligopoly Chapter 16-2 Models of Oligopoly Behavior No single general model of oligopoly behavior exists. Oligopoly An oligopoly is a market structure characterized by: Few firms Either standardized or
CHAPTER 16 OLIGOPOLY FOUR TYPES OF MARKET STRUCTURE Extreme cases PERFECTLY COMPETITION Many firms No barriers to entry Identical products MONOPOLY One firm Huge barriers to entry Unique product In between
Topic 8 Chapter 13 Oligopoly and Monopolistic Competition Econ 203 Topic 8 page 1 Oligopoly: How do firms behave when there are only a few competitors? These firms produce all or most of their industry
Pre-Test Chapter 23 ed17 Multiple Choice Questions 1. The kinked-demand curve model of oligopoly: A. assumes a firm's rivals will ignore a price cut but match a price increase. B. embodies the possibility
WSG10 7/7/03 4:24 PM Page 145 10 Market Structure: Duopoly and Oligopoly OVERVIEW An oligopoly is an industry comprising a few firms. A duopoly, which is a special case of oligopoly, is an industry consisting
Models of Imperfect Competition Monopolistic Competition Oligopoly Models of Imperfect Competition So far, we have discussed two forms of market competition that are difficult to observe in practice Perfect
Chapter 8 Production Technology and Costs 8.1 Economic Costs and Economic Profit 1) Accountants include costs as part of a firm's costs, while economists include costs. A) explicit; no explicit B) implicit;
Name: Date: 1. Most electric, gas, and water companies are examples of: A) unregulated monopolies. B) natural monopolies. C) restricted-input monopolies. D) sunk-cost monopolies. Use the following to answer
Chap 13 Monopolistic Competition and Oligopoly These questions may include topics that were not covered in class and may not be on the exam. MULTIPLE CHOICE. Choose the one alternative that best completes
Week 7 - Game Theory and Industrial Organisation The Cournot and Bertrand models are the two basic templates for models of oligopoly; industry structures with a small number of firms. There are a number
Imperfect Competition Oligopoly Chapter 16 Imperfect competition refers to those market structures that fall between perfect competition and pure monopoly. Copyright 2001 by Harcourt, Inc. All rights reserved.
Chapter Monopolistic Competition and Oligopoly Review Questions. What are the characteristics of a monopolistically competitive market? What happens to the equilibrium price and quantity in such a market
Chapter 7: Market Structures Section 3 Objectives 1. Describe characteristics and give examples of monopolistic competition. 2. Explain how firms compete without lowering prices. 3. Understand how firms
R.E.Marks 1998 Oligopoly 1 R.E.Marks 1998 Oligopoly Oligopoly and Strategic Pricing In this section we consider how firms compete when there are few sellers an oligopolistic market (from the Greek). Small
Managerial Economics & Business Strategy Chapter 9 Basic Oligopoly Models Overview I. Conditions for Oligopoly? II. Role of Strategic Interdependence III. Profit Maximization in Four Oligopoly Settings
Public ownership Common in European countries government runs telephone, water, electric companies. US: Postal service. Because delivery of mail seems to be natural monopoly. Private ownership incentive
CHAPTER 11: MONOPOLISTIC COMPETITION AND OLIGOPOLY Introduction While perfect competition and monopoly represent the extremes of market structures, most American firms are found in the two market structures
Chapter 13 MONOPOLISTIC COMPETITION AND OLIGOPOLY Key Concepts Monopolistic Competition The market structure of most industries lies between the extremes of perfect competition and monopoly. Monopolistic
Characteristics of Monopolistic Competition large number of firms differentiated products (ie. substitutes) freedom of entry and exit Examples Upholstered furniture: firms; HHI* = 395 Jewelry and Silverware:
S209-S220_Krugman2e_PS_Ch15.qxp 9/16/08 9:23 PM Page S-209 Oligopoly chapter: 15 1. The accompanying table presents market share data for the U.S. breakfast cereal market in 2006. Company a. Use the data
Mikroekonomia B by Mikolaj Czajkowski Test 12 - Oligopoly Name Group MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The market structure in which
Chapter 7 Monopoly, Oligopoly and Strategy After reading Chapter 7, MONOPOLY, OLIGOPOLY AND STRATEGY, you should be able to: Define the characteristics of Monopoly and Oligopoly, and explain why the are
1 Economics 130-Windward Community College Review Sheet for the Final Exam This final exam is comprehensive in nature and in scope. The test will be divided into two parts: a multiple-choice section and
CHAPTER 12 MARKETS WITH MARKET POWER Microeconomics in Context (Goodwin, et al.), 2 nd Edition Chapter Summary Now that you understand the model of a perfectly competitive market, this chapter complicates
ECON101 STUDY GUIDE 7 CHAPTER 14 MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) An oligopoly firm is similar to a monopolistically competitive
Chapter 16 1. In which market structure would you place each of the following products: monopoly, oligopoly, monopolistic competition, or perfect competition? Why? a. Retail market for water and sewerage
1Oligopoly 19 As you move your cart down the grocery isle, stop in front of the canned soups. You see before maybe four or five different brands of soup. If you stop in front of the frozen pizzas you might
Collusion. Industry profit in an oligopoly (sum of all firms profits) < monopoly profit. Price lower and industry output higher than in a monopoly. Firms lose because of non-cooperative behavior : Each
Market Structures This hand-out gives an overview of the main market structures including perfect competition, monopoly, monopolistic competition, and oligopoly. Summary Chart Perfect Competition Monopoly
Oligopoly Oligopoly is a market structure in which the number of sellers is small. Oligopoly requires strategic thinking, unlike perfect competition, monopoly, and monopolistic competition. Under perfect
CHAPTER 18 MARKETS WITH MARKET POWER Principles of Economics in Context (Goodwin et al.) Chapter Summary Now that you understand the model of a perfectly competitive market, this chapter complicates the
LECTURE #15: MICROECONOMICS CHAPTER 17 I. IMPORTANT DEFINITIONS A. Oligopoly: a market structure with a few sellers offering similar or identical products. B. Game Theory: the study of how people behave
Professor Scholz Posted: 11/10/2009 Economics 101, Problem Set #9, brief answers Due: 11/17/2009 Oligopoly and Monopolistic Competition Please SHOW your work and, if you have room, do the assignment on
INTRODUCTION Questions examined in this chapter include: What determines how much market power a firm has? How do firms in an oligopoly set prices and output? What problems does an oligopoly have in maintaining
Cooleconomics.com Monopolistic Competition and Oligopoly Contents: Monopolistic Competition Attributes Short Run performance Long run performance Excess capacity Importance of Advertising Socialist Critique
Market Structure: Oligopoly (Imperfect Competition) I. Characteristics of Imperfectly Competitive Industries A. Monopolistic Competition large number of potential buyers and sellers differentiated product
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
Chapter 14. Oligopoly Instructor: JINKOOK LEE Department of Economics / Texas A&M University ECON 202 504 Principles of Microeconomics Oligopoly Market Oligopoly: A market structure in which a small number
Chapter 13 Oligopoly 1 4. Oligopoly A market structure with a small number of firms (usually big) Oligopolists know each other: Strategic interaction: actions of one firm will trigger re-actions of others
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The four-firm concentration ratio equals the percentage of the value of accounted for by the four
Economics Instructor Miller Oligopoly Practice Problems 1. An oligopolistic industry is characterized by all of the following except A) existence of entry barriers. B) the possibility of reaping long run
Chapter 11: Price-Searcher Markets with High Entry Barriers I. Why are entry barriers sometimes high? A. Economies of Scale in some markets average total costs fall over the full range of output. Therefore
Oligopoly PowerPoint Slides prepared by: Andreea CHIRITESCU Eastern Illinois University 1 Oligopoly Only a few sellers Oligopoly Offer similar or identical products Interdependent Game theory How people
Equilibrium of a firm under perfect competition in the short-run. A firm is under equilibrium at that point where it maximizes its profits. Profit depends upon two factors Revenue Structure Cost Structure
ECON 202: Principles of Microeconomics Chapter 13 Oligopoly Oligopoly 1. Oligopoly and Barriers to Entry. 2. Using Game Theory to Analyze Oligopoly. 3. Sequential Games and Business Strategy. 4. The Five
UNIVERSITY OF CALICUT SCHOOL OF DISTANCE EDUCATION BA ECONOMICS III SEMESTER CORE COURSE (2011 Admission onwards) MICRO ECONOMICS - II QUESTION BANK 1. Which of the following industry is most closely approximates
ECON 312: Oligopolisitic Competition 1 Industrial Organization Oligopolistic Competition Both the monopoly and the perfectly competitive market structure has in common is that neither has to concern itself
Learning Objectives After reading Chapter 13 and working the problems for Chapter 13 in the textbook and in this Workbook, you should be able to do the following things For simultaneous decisions: Explain
ECON 1620 Basic Economics Principles 2010 2011 2 nd Semester Mid term test (1) : 40 multiple choice questions Time allowed : 60 minutes 1. When demand is inelastic the price elasticity of demand is (A)
Name: Class: Date: ID: A Economics Chapter 7 Review Matching a. perfect competition e. imperfect competition b. efficiency f. price and output c. start-up costs g. technological barrier d. commodity h.
Chapter 05 Perfect Competition, Monopoly, and Economic Multiple Choice Questions Use Figure 5.1 to answer questions 1-2: Figure 5.1 1. In Figure 5.1 above, what output would a perfect competitor produce?
T28 OLIGOPOLY 3/1/15 1. Oligopoly is a market structure in which there are a small number of firms that engage in strategic interactions. If there are only two firms then we refer to the situation as a
Oligopoly and Strategic Behavior MULTIPLE-CHOICE QUESTIONS Like a pure monopoly, an oligopoly is characterized by: a. free entry and exit in the long run. b. free entry and exit in the short run. c. significant
Eco 340 Industrial Economics Market Structures: Cartels / Cooperative Oligopoly Prof Dr. Murat Yulek Oligopolistic Markets and the Cartel Competitive market: firms operate independently In other markets,
Lesson 13. Duopoly 1 Lesson 13 Duopoly c 2010, 2011 Roberto Serrano and Allan M. Feldman All rights reserved Version C 1. Introduction In this lesson, we study market structures that lie between perfect
Market is a network of dealings between buyers and sellers. Market is the characteristic phenomenon of economic life and the constitution of markets and market prices is the central problem of Economics.
R. Larry Reynolds Firms With "Market Power" Pure competition results in an optimal allocation or resources given the objective of an economic system to allocate resources to their highest valued uses or
Microeconomics Topic 7: Contrast market outcomes under monopoly and competition. Reference: N. Gregory Mankiw s rinciples of Microeconomics, 2 nd edition, Chapter 14 (p. 291-314) and Chapter 15 (p. 315-347).
Econ 101: Principles of Microeconomics Chapter 15 - Oligopoly Fall 2010 Herriges (ISU) Ch. 15 Oligopoly Fall 2010 1 / 25 Outline 1 Understanding Oligopolies 2 Game Theory Overcoming the Prisoner s Dilemma
Lecture 28 Economics 181 International Trade I. Introduction to Strategic Trade Policy If much of world trade is in differentiated products (ie manufactures) characterized by increasing returns to scale,
Chapter 25 Oligopoly We have thus far covered two extreme market structures perfect competition where a large number of small firms produce identical products, and monopoly where a single firm is isolated
Economics Chapter 7 Market Structures Perfect competition is a in which a large number of all produce. There are Four Conditions for Perfect Competition: 1. 2. 3. 4. Barriers to Entry Factors that make
CHAPTER 6 MARKET STRUCTURE CHAPTER SUMMARY This chapter presents an economic analysis of market structure. It starts with perfect competition as a benchmark. Potential barriers to entry, that might limit
Economies of scale and international trade In the models discussed so far, differences in prices across countries (the source of gains from trade) were attributed to differences in resources/technology.
Business Ethics Concepts & Cases Manuel G. Velasquez Chapter Four Ethics in the Marketplace Definition of Market A forum in which people come together to exchange ownership of goods; a place where goods
A2 Micro Business Economics Diagrams Advice on drawing diagrams in the exam The right size for a diagram is ½ of a side of A4 don t make them too small if needed, move onto a new side of paper rather than
Class: Date: ID: A Principles Fall 2013 Midterm 3 Multiple Choice Identify the choice that best completes the statement or answers the question. 1. Trevor s Tire Company produced and sold 500 tires. The
Chapter 7: Market Structures Section 1 Key Terms perfect competition: a market structure in which a large number of firms all produce the same product and no single seller controls supply or prices commodity:
Chapter Monopolistic Competition and Objectives You may wish to call students attention to the objectives in the Section Preview. The objectives are reflected in the main headings of the section. Bellringer
Write down the names of three companies: 1. Company with very little competition. 2. Company with two to three major competitors. 3. Company with many competitors. Which situation do you think describes
MBA 640 Survey of Microeconomics Fall 2006, Quiz 6 Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) A monopoly is best defined as a firm that
1 Monopoly Why Monopolies Arise? Monopoly is a rm that is the sole seller of a product without close substitutes. The fundamental cause of monopoly is barriers to entry: A monopoly remains the only seller
Imperfect Market Structure Models (11/10/09) Today: and Monopsony/Oligopsony Thursday: Market Structure, Conduct and erformance Model Exam III 24 th Characteristics Comparisons of Industry Market Structures
Chapter 13 Market Structure and Competition Solutions to Review Questions 1. Explain why, at a Cournot equilibrium with two firms, neither firm would have any regret about its output choice after it observes
Masaryk University - Brno Department of Economics Faculty of Economics and Administration BPE_MIC1 Microeconomics 1 Fall Semester 2011 Final Exam - 05.12.2011, 9:00-10:30 a.m. Test A Guidelines and Rules:
Market Structure There are a variety of differing market structures which are separated by the levels of competition that exist within each market and the market conditions in which the businesses operate.
WELCOME TO THE REAL WORLD OF MONOPOLISTIC COMPETITION AND OLIGOPOLY Perfect Competition Monopolistic Competition Oligopoly Monopoly THE MAJORITY OF CANADIAN INDUSTRIES DO NOT QUALIFY AS "PERFECTLY COMPETITIVE"