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OLIGOPOLY

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  1. 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

  2. Of the many different models of oligopoly, we will examine three: • The collusion or cartel model. • Imperfect collusion (price leadership, for example). • 3) No collusion (price wars & game theory). Oligopoly

  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

  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

  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

  6. 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 This is the sum of the MC curves of the members. P* D Q Q* MR OPEC MARKET Oligopoly

  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

  8. Game Theory • The study of how people react in strategic situations. Oligopoly

  9. Assumptions for our sample game • There are only two firms. • There are two options for each firm. • Each firm pursues its self-interest. Oligopoly

  10. 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

  11. 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

  12. Coke • The payoffs are million dollars of profit per month. Coke's payoffs are at the top right of each cell. Advertise No advertising Advertise $1 $2 Advertise Advertise $2 $4 Pepsi $4 $3 No advertising $3 $1 Oligopoly

  13. 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

  14. 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