Download Unit-5b oligopoly notes

Oligopoly
0.
Characteristics:
i. A few large producers: competition among the few

each firm has a large share of the market
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4-firm concentration ratio: 4 largest firms = more than 40% of market. Half
of US manufacturing industries!!!
ii. Either homogenous [oil, steel, standardized products] or differentiated [cars,
tires, cereals, cigarettes]
iii. significant barriers to entry: start up costs, economies of scale, or intimidation
factor of playing with the big boys
iv. Mutual interdependence: actions of one firm have a large impact on other firms
in the market
1.

Strategic behavior: each firm takes into account the possible actions by rival
firms -- how a firm “expects” other firms to react to its business decisions
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“game theory” attempts to model interdependent behavior of players. “Nash
Equilibrium” John Nash in A Beautiful Mind… We’ll look at this next class.

The resulting dilemma is whether to complete or collude
Secret Collusion and Price Leadership
i. a “non-collusive” agreement
ii. firms do not officially set prices together, but they follow each other’s lead:
“strategic behavior”
iii. Airlines are a classic example
iv. Leads to Relative Stability in Price

prices tend to be stable
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kinked demand curve at market price
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if one firm raises price, other firms might not follow and the firm will lose
revenue: elastic demand
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if one firm lowers price, other firms compelled to follow, so there ends up
being no additional revenue to lowering price: inelastic demand
v. Unless price wars begin: extreme price-cutting

in order to stay in the market, firms will operate at a loss
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they may keep output high, even if costs rise
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they won’t pass on costs to customers
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goal is to ride out the price war until someone drops out; others pick up the
market share

who will survive? Larger firms, more capital, diversified
vi. Since price competition is dangerous, these firms instead use non-price
competition
2.
Explicit Collusion and Cartels

an agreement between firms to set price and/or quantity
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it is illegal because it creates a monopoly market
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if it is a formal, public agreement, we call it a cartel
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OPEC classic example
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Tends to be successful if:
o
the goods are homogenous
o
there are relatively few firms
o
effective communication and monitoring systems to identify cheating;

3.
o
stable supply and demand make quotas easy to allocate;
o
similar production costs so they make similar profits
incentive to secretly cheat
Game theory



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Used to explain the strategic behavior of oligopolistic firms.
Model of the interdependent behavior of these firms.
Similar to a card game: strategy depends on their hand in conjunction
with the cards and plays of other participants.
Three different strategies:
1.
Dominant strategy: the one that is best for one player
regardless of any strategy other players follow
2.
Nash Equilibrium: the result when each player follows the
dominant strategy. It does not always provide the best result
for society. It is a non-cooperative equilibrium.
3.
Cooperative outcome: the one you choose if cooperating
(dominated by agreement, threat, cartel)
Prisoner’s Dilemma: Nash Equilibrium in “A Beautiful Mind”
https://www.youtube.com/watch?v=2d_dtTZQyUM
Prisoner’s Dilemma: Dominant Strategy
https://www.youtube.com/watch?v=YGyZX0VoRpI
Golden Balls Video, https://www.youtube.com/watch?v=p3Uos2fzIJ0
https://www.youtube.com/watch?v=S0qjK3TWZE8
Play the Prisoner’s Dilemma: select the first one
http://www.gametheory.net/applets/prisoners.html
OPEC cartel cheating:
http://www.nytimes.com/2016/02/17/business/energy-environment/opec-oil-production.html
http://www.cnbc.com/2016/02/16/oil-prices-spike-on-reports-of-saudi-russia-output-cut-talks.html
http://www.wsj.com/articles/saudi-oil-minister-production-wont-be-cut-to-reduce-global-supply-glut1456246011