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OLIGOPOLY
Market in which there are few firms, so individual firms
can affect market price.
Interdependence of firms is an important characteristic.
The demand curves for the individual firms are
dependent on the pricing and marketing decisions of
competitors.
Strategy becomes important to firms in oligopoly.
Oligopoly
slide 1
Barriers to entry are an especially important part of
oligopoly behavior:
1) Xerox and patents
2) Aluminum and control of bauxite deposits
3) Breakfast cereals ,beer, and economies of scale in
advertising
4) Daily newspapers
Oligopoly
slide 2
Of the many different models of oligopoly, we will
examine only two in class:
1) The collusion or cartel model.
2) Cooperation games based on the Prisoners'
Dilemma.
Oligopoly
slide 3
CARTELS
Cartels are usually illegal in the U.S. because of
antitrust laws, but some industries and kinds of
firms are exempt. In addition, some instances of
cartel-like behavior may simply not have been
prosecuted.
Cartel is a form of collusion in which the member
firms in an industry try to agree on all aspects of
pricing and output for the individual firms.
Oligopoly
slide 4
EXAMPLES OF CARTELS OR
COLLUSIVE BEHAVIOR
OPEC
DeBeers
Some professional sports, including the NCAA.
Labor unions (legal in the U.S.).
Agricultural cooperatives (legal in the U.S.).
Oligopoly
slide 5
A cartel that wants to maximize the collective profits
of the members should operate just like a
monopolist with more than one plant.
Marginal cost (for each cartel member) must equal
marginal revenue in the market.
Oligopoly
slide 6
A coffee cartel would set price and quantity
at P* and Q*. Quotas would be ideally
allocated to the members by having them
produce at the same level of marginal cost.
$/Q
 MC
P*
This is the sum
of the MC
curves of the
members.
D
Q
Q*
MR
COFFEE MARKET
Oligopoly
slide 7
Cartels are not without their problems. The most
important problem is keeping members from
striking out on their own, that is, cheating on the
cartel agreement.
Examples:
Oligopoly
slide 8
Prisoners' Dilemma
A crime is committed, and two suspects are arrested.
The police separate the suspects, John and Alice, into
separate interrogation rooms.
The cops give John and Alice the following "deal":
Oligopoly
slide 9
"If you both remain silent, we can only get you on
the lesser charge of trespassing, and you get 3
months in jail each."
"If you remain silent, and your partner confesses and
implicates you, you'll get 5 years in jail. Your
partner will go free."
”If you both confess, you'll each get 2 years in jail."
Oligopoly
slide 10
Here's a summary of the outcomes:
John
Confess
Don't confess
5 years
2 years
Confess
2 years
go free
Alice
go free
3 months
Don't confess
5 years
Oligopoly
3 months
slide 11
The Dominant Strategy for both people is to confess.
But they both could be better off not confessing.
Cooperation (agreeing between themselves not to
confess) is very difficult because there is an
incentive for each to cheat.
Oligopoly
slide 12
Here's a real world pricing problem that can be
studied using the Prisoners' Dilemma.
P&G and Unilever are pricing a uniform product
(like bleach).
The "payoff matrix" is given on the next slide.
What should P&G's pricing policy be?
Oligopoly
slide 13
The payoffs are dollars of profit per month.
Unilever's payoffs are at the top right of each
cell.
Unilever
P=$1.40
P=$1.50
11,000
12,000
P=$1.40
12,000
29,000
P&G
20,000
21,000
P=$1.50
3,000
Oligopoly
20,000
slide 14
Note that cooperation leads to the most profits, but
the dominant strategy may well be chosen.
Should P&G just charge $1.50 and hope for the best?
What if they are entering a new market with these
payoffs?
Oligopoly
slide 15