16
Oligopoly
BETWEEN MONOPOLY AND PERFECT COMPETITION
Imperfect competition refers to those market structures that fall between perfect competition and pure monopoly.
BETWEEN MONOPOLY AND PERFECT COMPETITION
Imperfect competition includes industries in which firms have competitors but do not face so much competition that they are price takers.
BETWEEN MONOPOLY AND PERFECT COMPETITION
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.
Figure 1 The Four Types of Market Structure
Copyright © 2004 South-Western
•
Tap water
•
Cable TV
Monopoly
(Chapter 15)
•
Novels
•
Movies
Monopolistic
Competition
(Chapter 17)
•
Tennis balls
•
Crude oil
Oligopoly
(Chapter 16)
Number of Firms?
Perfect
•
Wheat
•
Milk
Competition
(Chapter 14)
Type of Products?
Identical
products
Differentiated
products
One
firm
Few
firms
Many
firms
MARKETS WITH ONLY A FEW SELLERS
Because of the few sellers, the key feature of oligopoly is the tension between cooperation and self-interest.
MARKETS WITH ONLY A FEW SELLERS
Characteristics of an Oligopoly Market
Few sellers offering similar or identical products
Interdependent firms
Best off cooperating and acting like a monopolist by producing a small quantity of output and charging a price above marginal cost
A Duopoly Example
A duopoly is an oligopoly with only two members. It is the simplest type of oligopoly.
Table 1 The Demand Schedule for Water
Copyright © 2004 South-Western
A Duopoly Example
Price and Quantity Supplied
The price of water in a perfectly competitive market would be driven to where the marginal cost is zero:
P = MC = $0
Q = 120 gallons
The price and quantity in a monopoly market would be where total profit is maximized:
P = $60
Q = 60 gallons
A Duopoly Example
Price and Quantity Supplied
The socially efficient quantity of water is 120 gallons, but a monopolist would produce only 60 gallons of water.
So what outcome then could be expected from duopolists?
Competition, Monopolies, and Cartels
The duopolists may agree on a monopoly outcome.
Collusion
An agreement among firms in a market about quantities to produce or prices to charge.
Cartel
A group of firms acting in unison.
Competition, Monopolies, and Cartels
Although oligopolists would like to form cartels and earn monopoly profits, often that is not possible. Antitrust laws prohibit explicit agreements among oligopolists as a matter of public policy.
The Equilibrium for an Oligopoly
A Nash equilibrium is a situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the others have chosen.
The Equilibrium for an Oligopoly
When firms in an oligopoly individually choose production to maximize profit, they produce quantity of output greater than the level produced by monopoly and less than the level produced by competition.
The Equilibrium for an Oligopoly
The oligopoly price is less than the monopoly price but greater than the competitive price (which equals marginal cost).
Equilibrium for an Oligopoly
Summary
Possible outcome if oligopoly firms pursue their own self-interests:
Joint output is greater than the monopoly quantity but less than the competitive industry quantity.
Market prices are lower than monopoly price but greater than competitive price.
Total profits are less than the monopoly profit.
Table 1 The Demand Schedule for Water
Copyright © 2004 South-Western
How the Size of an Oligopoly Affects the Market Outcome
How increasing the number of sellers affects the price and quantity:
The output effect: Because price is above marginal cost, selling more at the going price raises profits.
The price effect: Raising production will increase the amount sold, which will lower the price and the profit per unit on all units sold.
How the Size of an Oligopoly Affects the Market Outcome
As the number of sellers in an oligopoly grows larger, an oligopolistic market looks more and more like a competitive market.
The price approaches marginal cost, and the quantity produced approaches the socially efficient level.
GAME THEORY AND THE ECONOMICS OF COOPERATION
Game theory is the study of how people behave in strategic situations.
Strategic decisions are those in which each person, in deciding what actions to take, must consider how others might respond to that action.
GAME THEORY AND THE ECONOMICS OF COOPERATION
Because the number of firms in an oligopolistic market is small, each firm must act strategically.
Each firm knows that its profit depends not only on how much it produces but also on how much the other firms produce.
The Prisoners’ Dilemma
The prisoners’ dilemma provides insight into the difficulty in maintaining cooperation.
Often people (firms) fail to cooperate with one another even when cooperation would make them better off.
The Prisoners’ Dilemma
The prisoners’ dilemma is a particular “game” between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial.
Figure 2 The Prisoners’ Dilemma
Copyright©2003 Southwestern/Thomson Learning
Bonnie’ s Decision
Confess
Confess
Bonnie gets 8 years
Clyde gets 8 years
Bonnie gets 20 years
Clyde goes free
Bonnie goes free
Clyde gets 20 years
gets 1 year
Bonnie
Clyde gets 1 year
Remain Silent
Remain
Silent
Clyde’s
Decision
The Prisoners’ Dilemma
The dominant strategy is the best strategy for a player to follow regardless of the strategies chosen by the other players.
The Prisoners’ Dilemma
Cooperation is difficult to maintain, because cooperation is not in the best interest of the individual player.
Figure 3 An Oligopoly Game
Copyright©2003 Southwestern/Thomson Learning
Iraq
’
s Decision
High
Production
High Production
Iraq gets $40 billion
Iran gets $40 billion
Iraq gets $30 billion
Iran gets $60 billion
Iraq gets $60 billion
Iran gets $30 billion
Iraq gets $50 billion
Iran gets $50 billion
Low Production
Low
Production
Iran
’
s
Decision
Oligopolies as a Prisoners’ Dilemma
Self-interest makes it difficult for the oligopoly to maintain a cooperative outcome with low production, high prices, and monopoly profits.
Figure 4 An Arms-Race Game
Copyright©2003 Southwestern/Thomson Learning
Decision of the United States (.)
Arm
Arm
. at risk
USSR at risk
. at risk and weak
USSR safe and powerful
. safe and powerful
USSR at risk and weak
. safe
USSR safe
Disarm
Disarm
Decision
of the
Soviet Union
(USSR)
Figure 5 An Advertising Game
Copyright©2003 Southwestern/Thomson Learning
Marlboro’ s Decision
Advertise
Advertise
Marlboro gets $3
billion profit
Camel gets $3
billion profit
Camel gets $5
billion profit
Marlboro gets $2
billion profit
Camel gets $2
billion profit
Marlboro gets $5
billion profit
Camel gets $4
billion profit
Marlboro gets $4
billion profit
Don
’
t Advertise
Don
’
t
Advertise
Camel’s
Decision
Figure 6 A Common-Resource Game
Copyright©2003 Southwestern/Thomson Learning
Exxon
’
s Decision
Drill Two
Wells
Drill Two Wells
Exxon gets $4
million profit
Texaco gets $4
million profit
Texaco gets $6
million profit
Exxon gets $3
million profit
Texaco gets $3
million profit
Exxon gets $6
million profit
Texaco gets $5
million profit
Exxon gets $5
million profit
Drill One Well
Drill One
Well
Texaco’s
Decision
Why People Sometimes Cooperate
Firms that care about future profits will cooperate in repeated games rather than cheating in a single game to achieve a one-time gain.
Figure 7 Jack and Jill Oligopoly Game
Copyright©2003 Southwestern/Thomson Learning
Jack’s Decision
Sell 40
Gallons
Sell 40 Gallons
Jack gets
$1,600 profit
Jill gets
$1,600 profit
Jill gets
$2,000 profit
Jack gets
$1,500 profit
Jill gets
$1,500 profit
Jack gets
$2,000 profit
Jill gets
$1,800 profit
Jack gets
$1,800 profit
Sell 30 Gallons
Sell 30
Gallons
Jill’s
Decision
PUBLIC POLICY TOWARD OLIGOPOLIES
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.
Restraint of Trade and the Antitrust Laws
Antitrust laws make it illegal to restrain trade or attempt to monopolize a market.
Sherman Antitrust Act of 1890
Clayton Act of 1914
Controversies over Antitrust Policy
Antitrust policies sometimes may not allow business practices that have potentially positive effects:
Resale price maintenance
Predatory pricing
Tying
Controversies over Antitrust Policy
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
Summary
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.
Summary
The prisoners’ dilemma shows that self-interest 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.
Summary
Policymakers use the antitrust laws to prevent oligopolies from engaging in behavior that reduces competition.
