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Oligopoly. Characteristics of oligopoly Small number of firms Interdependence Strategic dependence Whatever you do, I shall do – the zero percent financing. Oligopoly. Strategic Dependence

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oligopoly
Oligopoly
  • Characteristics of oligopoly
    • Small number of firms
    • Interdependence
      • Strategic dependence
      • Whatever you do, I shall do –the zero percent financing
oligopoly2
Oligopoly
  • Strategic Dependence
    • A situation in which one firm’s actions with respect to price, quality, advertising, and related changes may be strategically countered by the reactions of one or more other firms in the industry
    • LIKE PLAYING CHESS
oligopoly3
Oligopoly
  • Why oligopoly occurs
    • Economies of scale
    • Barriers to entry
    • Mergers
      • Vertical mergers
      • Horizontal mergers
oligopoly4
Oligopoly
  • Vertical Merger
    • The joining of a firm with another to which it sells an output or from which it buys an input
  • Horizontal Merger
    • The joining of firms that are producing or selling a similar product
oligopoly5
Oligopoly
  • Measuring industry concentration
    • Concentration Ratio
      • The percentage of all sales contributed by the leading four or leading eight firms in an industry
computing the four firm concentration ratio

400

88.9%

=

450

Four-firm concentration ratio =

Computing the Four-Firm Concentration Ratio

Annual Sales

Firm ($ Millions)

1 150

2 100

3 80

4 70

5 through 25 50

Total number

of firms in

Industry = 25

Total 450

computing the four firm concentration ratio7
Computing the Four-Firm Concentration Ratio

Percentage of Value of Total

Domestic Shipments Accounted

Industry For By the Top Four Firms %

Domestic motor vehicles 84

Breakfast cereals 85

Soft drinks 69

Tobacco products 93

Primary aluminum 59

Household vacuum cleaners 59

Electronic computers 45

Printing and publishing 23

Source: U.S. Bureau of the Census

models of oligopoly
Models of Oligopoly
  • Game Theory
    • A way of describing the various possible outcomes in any situation involving two or more interacting individuals when those individuals are aware of the interactive nature of their situation and plan accordingly
game theory
Game Theory
  • Cooperative Game
    • A game in which the players explicitly cooperate to make themselves better off
  • Noncooperative Game
    • A game in which the players neither negotiate nor cooperate in any way
  • Zero-Sum Game
    • A game in which any gains within the group are exactly offset by equal losses by the end of the game
  • Negative-Sum Game
    • A game in which players as a group lose at the end of the game
strategic behavior and game theory
Strategic Behaviorand Game Theory
  • Positive-Sum Game
    • A game in which players as a group are better off at the end of the game
strategic behavior and game theory11
Strategic Behaviorand Game Theory
  • Strategies in noncooperative games
    • Strategy
      • Any rule that is used to make a choice
      • Any potential choice that can be made by players in a game
    • Dominant Strategies
      • Strategies that always yield the highest benefit
prisoner s dilemma
Prisoner’s Dilemma
  • You and your partner rob a bank and get caught.
prisoner s dilemma13
Prisoner’s Dilemma
  • You are separated and given these options:
    • Both confess and get 5 years in jail
    • Neither confess and get 2 years
    • One confess and the other does not
      • Confessor goes free
      • One who does not confess get 10 years
strategic behavior and game theory15
Strategic Behaviorand Game Theory
  • Applying game theory to pricing strategies
    • Would you choose a high price or a low price?
      • Remember
        • No collusion
strategic behavior and game theory17
Strategic Behaviorand Game Theory
  • Opportunistic Behavior
    • Actions that ignore the possible long-run benefits of cooperation and focus solely on short-run gains
strategic behavior and game theory18
Strategic Behaviorand Game Theory
  • Opportunistic behavior
    • Implies a noncooperative game
    • Not realistic
      • We make repeat transactions
strategic behavior and game theory19
Strategic Behaviorand Game Theory
  • Tit-for-Tat Strategic Behavior
    • In game theory, cooperation that continues so long as the other players continue to cooperate
international example strategically relating subsidies to nuclear weapons
International Example:Strategically Relating Subsidies to Nuclear Weapons
  • Pakistan agreed to certain conditions for an IMF loan
    • In 1999, the IMF discovered that Pakistan had spent much of this loan on the development of nuclear weapons
    • Soon, Pakistan had to default on its debt
  • Why would Pakistan engage in this behavior with the IMF?
price rigidity and the kinked demand curve
Price Rigidity and the Kinked Demand Curve

d1 is relatively elastic

• if one firm raises its

price the others will not

and it will lose market

share

d2 is relatively inelastic

• if one firm lowers its

price the others lower

their price so gain in sales

is small

Figure 25-5, Panel (a)

price rigidity and the kinked demand curve22
Price Rigidity and the Kinked Demand Curve

The kinked demand curve indicates the possibility of price rigidity

Figure 25-5, Panel (b)

price rigidity and the kinked demand curve23
Price Rigidity and theKinked Demand Curve

Changes in cost do

not impact output

and prices as long as

MC remains in the

vertical portion of MR

Figure 25-6

criticisms of the kinked demand curve
Criticisms of theKinked Demand Curve

• Cannot determine P0

• Empirical evidence does not confirm the kinked demand theory

d1

P0

MR1

Price and Marginal Revenue per Unit

d2

MR2

q0

Quantity per Time Period

strategic behavior
Strategic Behavior
  • Do pet products have nine lives?
    • H.J. Heinz’s Pet Products Company
      • Dropped its price of 9-Lives cat food by 22% to meet increased competition from Nestle, Quaker, Grand Metropolitan, and Mars
      • Heinz then decided to raise prices
      • Its competition did not and Heinz’s market share dropped from 23 to 15 percent
strategic behavior with implicit collusion a model of price leadership
Strategic Behavior with Implicit Collusion: A Model of Price Leadership
  • Price Leadership
    • A practice in many oligopolistic industries in which the largest firm publishes its price list ahead of its competitors, who then match those announced prices
strategic behavior with implicit collusion a model of price leadership27
Strategic Behavior with Implicit Collusion: A Model of Price Leadership
  • Price War
    • A pricing campaign designed to drive competing firms out of a market by repeatedly cutting prices
strategic behavior with implicit collusion a model of price leadership28
Strategic Behavior with Implicit Collusion: A Model of Price Leadership
  • Markets where price wars are common
    • Cigarettes
    • Long-distance telephone companies
    • Airlines
strategic behavior with implicit collusion a model of price leadership29
Strategic Behavior with Implicit Collusion: A Model of Price Leadership
  • Markets where price wars are common
    • Diapers
    • Frozen foods
    • PC hardware and software
strategic behavior with implicit collusion a model of price leadership30
Strategic Behavior with Implicit Collusion: A Model of Price Leadership
  • Cigarette price wars
    • Philip Morris cut Marlboro by 40 cents a pack
    • RJR Nabisco matched the cut for Camel
    • Marlboro’s market share rose from 22.1% to 27.3%
    • Profits and stock prices fell
strategic behavior with implicit collusion a model of price leadership31
Strategic Behavior with Implicit Collusion: A Model of Price Leadership
  • Cigarette price wars
    • Phillip Morris reduced prices by 18% and sales went up by only 12.5%
      • Profits fell by 25%
deterring entry into an industry
Deterring Entry Into an Industry
  • Entry Deterrence Strategy
    • Any strategy undertaken by firms in an industry, either individually or together, with the intent or effect of raising the cost of entry into the industry by a new firm
deterring entry into an industry33
Deterring Entry Into an Industry
  • Increasing entry cost
    • Threat of price wars
    • Government regulations
      • Environmental regulation
      • Safety standards
deterring entry into an industry34
Deterring Entry Into an Industry
  • Limit-Pricing Strategies
    • A model that hypothesizes that a group of colluding sellers will set the highest common price that they believe they can charge without new firms seeking to enter that industry in search of relatively high profits
deterring entry into an industry35
Deterring Entry Into an Industry
  • Raising customer’s switching cost
    • Examples
      • Non-compatible software
      • Non-transferability of college courses