Download Taxes and Welfare

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
Of the many different models of oligopoly, we will
examine three:
1) The collusion or cartel model.
2) Imperfect collusion (price leadership, for
example).
3) No collusion (price wars & game theory).
Oligopoly
slide 2
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 3
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 4
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 5
An oil cartel (OPEC) 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
OPEC MARKET
Oligopoly
slide 6
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 7
Game Theory
The study of how people react in strategic situations.
Oligopoly
slide 8
Assumptions for our sample
game
1) There are only two firms.
2) There are two options for each firm.
3) Each firm pursues its self-interest.
Oligopoly
slide 9
Here's a real world problem that can be studied
using game theory.
Pepsi and Coca Cola are deciding whether or not
to advertise.
What should either company's advertising
strategy be?
Oligopoly
slide 10
Dominant strategy
Definition: A strategy that is best for a firm,
regardless of the strategy chosen by the other firm.
The payoffs to different strategies for Pepsi and
Coke are given on the next slide.
Does either company have a dominant strategy?
Oligopoly
slide 11
The payoffs are million dollars of profit per month.
Coke's payoffs are at the top right of each cell.
Coke
Advertise
No advertising
$1
$2
Advertise
Advertise
$2
$4
Pepsi
$4
No advertising
Oligopoly
$1
$3
$3
slide 12
The Dominant Strategy for both firms is to advertise.
But they both could be better off not advertising.
Cooperation (agreeing between themselves not to
advertise) is very difficult because there is an
incentive for each to cheat.
Oligopoly
slide 13
Note that cooperation leads to the most profits, but
the dominant strategy may well be chosen.
Should Pepsi just not advertise and hope for the
best?
What if they are entering a new market with these
payoffs?
Oligopoly
slide 14