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Monopolistic Competition and Oligopoly

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  • you do not have examples of oligopoly and monopoly.but overall is okey.
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  • As new firms enter a monopolistically competitive industry in search of profits, the demand curves of profit-making existing firms begin to shift to the left, pushing marginal revenue with them as consumers switch to the new close substitutes. This process continues until profits are eliminated, which occurs for a firm when its demand curve is just tangent to its average cost curve.
  • Monopolistic Competition and Oligopoly

    1. 1. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair CHAPTERCHAPTER 1313 Prepared by: Fernando QuijanoPrepared by: Fernando Quijano and Yvonn Quijanoand Yvonn Quijano Monopolistic Competition andMonopolistic Competition and OligopolyOligopoly
    2. 2. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Monopolistic CompetitionMonopolistic Competition • AA monopolistically competitivemonopolistically competitive industryindustry has the followinghas the following characteristics:characteristics: • A large number of firmsA large number of firms • No barriers to entryNo barriers to entry • Product differentiationProduct differentiation
    3. 3. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Monopolistic CompetitionMonopolistic Competition • Monopolistic competitionMonopolistic competition is a commonis a common form of industry (market) structure in theform of industry (market) structure in the United States, characterized by a largeUnited States, characterized by a large number of firms, none of which can influencenumber of firms, none of which can influence market price by virtue of size alone.market price by virtue of size alone. • Some degree of market power is achievedSome degree of market power is achieved by firms producing differentiated products.by firms producing differentiated products. • New firms can enter and established firmsNew firms can enter and established firms can exit such an industry with ease.can exit such an industry with ease.
    4. 4. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Nine Industries with Characteristics ofNine Industries with Characteristics of Monopolistic CompetitionMonopolistic Competition Percentage of Value of Shipments Accounted for by the Largest Firms inPercentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 1992Selected Industries, 1992 SIC NO.SIC NO. INDUSTRYINDUSTRY DESIGNATIONDESIGNATION FOURFOUR LARGESTLARGEST FIRMSFIRMS EIGHTEIGHT LARGESTLARGEST FIRMSFIRMS TWENTYTWENTY LARGESTLARGEST FIRMSFIRMS NUMBERNUMBER OFOF FIRMSFIRMS 37923792 Travel trailers and campersTravel trailers and campers 4141 5757 7272 270270 39423942 DollsDolls 3434 4747 6767 204204 25212521 Wood office furnitureWood office furniture 2626 3434 5151 611611 27312731 Book publishingBook publishing 2323 3838 6262 25042504 23912391 Curtains and draperiesCurtains and draperies 2222 3232 4848 10041004 20922092 Fresh or frozen seafoodFresh or frozen seafood 1919 2828 4747 600600 35643564 Blowers and fansBlowers and fans 1414 2222 4141 518518 23352335 Women’s dressesWomen’s dresses 1111 1717 3030 39433943 30893089 Miscellaneous plastic productsMiscellaneous plastic products 55 88 1313 76057605 Source:Source: U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers,U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing,Concentration Ratios in Manufacturing, Subject SeriesSubject Series MC92-S-2, 1997.MC92-S-2, 1997.
    5. 5. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Product Differentiation, Advertising,Product Differentiation, Advertising, and Social Welfareand Social Welfare Total Advertising Expenditures in 1998Total Advertising Expenditures in 1998 DOLLARSDOLLARS (BILLIONS)(BILLIONS) NewspapersNewspapers 44.244.2 TelevisionTelevision 48.048.0 Direct mailDirect mail 39.539.5 OtherOther 31.731.7 Yellow pagesYellow pages 12.012.0 RadioRadio 14.514.5 MagazinesMagazines 10.410.4 TotalTotal 200.3200.3 Source:Source: McCann Erickson, Inc., Reported in U.S. Bureau of the Census,McCann Erickson, Inc., Reported in U.S. Bureau of the Census, Statistical Abstract of the UnitedStatistical Abstract of the United StatesStates, 1999, Table 947., 1999, Table 947.
    6. 6. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Case for Product DifferentiationThe Case for Product Differentiation and Advertisingand Advertising • The advocates of free and openThe advocates of free and open competition believe that differentiatedcompetition believe that differentiated products and advertising give theproducts and advertising give the market system its vitality and are themarket system its vitality and are the basis of its power.basis of its power. • Product differentiation helps to ensureProduct differentiation helps to ensure high quality and efficient production.high quality and efficient production.
    7. 7. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Case for Product DifferentiationThe Case for Product Differentiation and Advertisingand Advertising • Advertising provides consumers withAdvertising provides consumers with the valuable information on productthe valuable information on product availability, quality, and price thatavailability, quality, and price that they need to make efficient choicesthey need to make efficient choices in the market place.in the market place.
    8. 8. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Case Against ProductThe Case Against Product Differentiation and AdvertisingDifferentiation and Advertising • Critics of product differentiation andCritics of product differentiation and advertising argue that they amount toadvertising argue that they amount to nothing more than waste andnothing more than waste and inefficiency.inefficiency. • Enormous sums are spent to createEnormous sums are spent to create minute, meaningless, and possiblyminute, meaningless, and possibly nonexistent differences amongnonexistent differences among products.products.
    9. 9. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Case Against ProductThe Case Against Product Differentiation and AdvertisingDifferentiation and Advertising • Advertising raises the cost of productsAdvertising raises the cost of products and frequently contains very littleand frequently contains very little information. Often, it is merely aninformation. Often, it is merely an annoyance.annoyance. • People exist to satisfy the needs of thePeople exist to satisfy the needs of the economy, not vice versa.economy, not vice versa. • Advertising can lead to unproductiveAdvertising can lead to unproductive warfare and may serve as a barrier towarfare and may serve as a barrier to entry, thus reducing real competition.entry, thus reducing real competition.
    10. 10. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Product Differentiation Reduces theProduct Differentiation Reduces the Elasticity of Demand Facing a FirmElasticity of Demand Facing a Firm • Based on the availability ofBased on the availability of substitutes, the demandsubstitutes, the demand curve faced by acurve faced by a monopolistic competitor ismonopolistic competitor is likely to belikely to be less elasticless elastic than the demand curvethan the demand curve faced by a perfectlyfaced by a perfectly competitive firm, and likelycompetitive firm, and likely to beto be more elasticmore elastic than thethan the demand curve faced by ademand curve faced by a monopoly.monopoly.
    11. 11. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Monopolistic Competition in the Short RunMonopolistic Competition in the Short Run • In the short-run, a monopolistically competitiveIn the short-run, a monopolistically competitive firm will produce up to the point wherefirm will produce up to the point where MR = MCMR = MC.. • This firm isThis firm is earning positiveearning positive profits in theprofits in the short-run.short-run.
    12. 12. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Monopolistic Competition in the Short-RunMonopolistic Competition in the Short-Run • Profits are not guaranteed. Here, a firm with aProfits are not guaranteed. Here, a firm with a similar cost structure is shown facing a weakersimilar cost structure is shown facing a weaker demand and suffering short-run losses.demand and suffering short-run losses.
    13. 13. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Monopolistic Competition in the Long-RunMonopolistic Competition in the Long-Run • The firm’s demandThe firm’s demand curve must end upcurve must end up tangent to its averagetangent to its average total cost curve fortotal cost curve for profits to equal zero.profits to equal zero. This is the condition forThis is the condition for long-run equilibrium inlong-run equilibrium in a monopolisticallya monopolistically competitive industry.competitive industry.
    14. 14. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Economic EfficiencyEconomic Efficiency and Resource Allocationand Resource Allocation • In the long-run, economic profits are eliminated; thus, weIn the long-run, economic profits are eliminated; thus, we might conclude that monopolistic competition is efficient,might conclude that monopolistic competition is efficient, however:however: • Price is above marginalPrice is above marginal cost.cost. More output couldMore output could be produced at abe produced at a resource cost below theresource cost below the value that consumersvalue that consumers place on the product.place on the product.
    15. 15. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Economic EfficiencyEconomic Efficiency and Resource Allocationand Resource Allocation • In the long-run, economic profits are eliminated; thus, weIn the long-run, economic profits are eliminated; thus, we might conclude that monopolistic competition is efficient,might conclude that monopolistic competition is efficient, however:however: • Average total cost is notAverage total cost is not minimized.minimized. The typicalThe typical firm will not realize all thefirm will not realize all the economies of scaleeconomies of scale available. Smaller andavailable. Smaller and smaller market sharesmaller market share results in excess capacity.results in excess capacity.
    16. 16. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair OligopolyOligopoly • AnAn oligopolyoligopoly is a form of industryis a form of industry (market) structure characterized by a(market) structure characterized by a few dominant firms. Products mayfew dominant firms. Products may be homogeneous or differentiated.be homogeneous or differentiated. • The behavior of any one firm in anThe behavior of any one firm in an oligopoly depends to a great extentoligopoly depends to a great extent on the behavior of others.on the behavior of others.
    17. 17. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Ten Highly Concentrated IndustriesTen Highly Concentrated Industries Percentage of Value of Shipments Accounted for by the Largest Firms in High-Percentage of Value of Shipments Accounted for by the Largest Firms in High- Concentration Industries, 1992Concentration Industries, 1992 SIC NO.SIC NO. INDUSTRYINDUSTRY DESIGNATIONDESIGNATION FOURFOUR LARGESTLARGEST FIRMSFIRMS EIGHTEIGHT LARGESTLARGEST FIRMSFIRMS NUMBERNUMBER OFOF FIRMSFIRMS 28232823 Cellulosic man-made fiberCellulosic man-made fiber 9898 100100 55 33313331 Primary copperPrimary copper 9898 9999 1111 36333633 Household laundry equipmentHousehold laundry equipment 9494 9999 1010 21112111 CigarettesCigarettes 9393 100100 88 20822082 Malt beverages (beer)Malt beverages (beer) 9090 9898 160160 36413641 Electric lamp bulbsElectric lamp bulbs 8686 9494 7676 20432043 Cereal breakfast foodsCereal breakfast foods 8585 9898 4242 37113711 Motor vehiclesMotor vehicles 8484 9191 398398 34823482 Small arms ammunitionSmall arms ammunition 8484 9595 5555 36323632 Household refrigerators and freezersHousehold refrigerators and freezers 8282 9898 5252 Source:Source: U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers,U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing,Concentration Ratios in Manufacturing, SubjectSubject Series MC92-S-2, 1997.Series MC92-S-2, 1997.
    18. 18. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Oligopoly ModelsOligopoly Models • All kinds of oligopoly have oneAll kinds of oligopoly have one thing in common:thing in common: • The behavior of any givenThe behavior of any given oligopolistic firm depends on theoligopolistic firm depends on the behavior of the other firms in thebehavior of the other firms in the industry comprising the oligopoly.industry comprising the oligopoly.
    19. 19. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Collusion ModelThe Collusion Model • A group of firms that gets togetherA group of firms that gets together and makes price and outputand makes price and output decisions jointly is called adecisions jointly is called a cartelcartel.. • Collusion occurs when price- andCollusion occurs when price- and quantity-fixing agreements arequantity-fixing agreements are explicit.explicit. • Tacit collusionTacit collusion occurs when firmsoccurs when firms end up fixing price without a specificend up fixing price without a specific agreement, or when agreements areagreement, or when agreements are implicit.implicit.
    20. 20. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Cournot ModelThe Cournot Model • TheThe Cournot modelCournot model is a model of ais a model of a two-firm industry (duopoly) in which atwo-firm industry (duopoly) in which a series of output-adjustmentseries of output-adjustment decisions leads to a final level ofdecisions leads to a final level of output between the output that wouldoutput between the output that would prevail if the market were organizedprevail if the market were organized competitively and the output thatcompetitively and the output that would be set by a monopoly.would be set by a monopoly.
    21. 21. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Kinked Demand Curve ModelThe Kinked Demand Curve Model • TheThe kinked demand modelkinked demand model is ais a model of oligopoly in which themodel of oligopoly in which the demand curve facing each individualdemand curve facing each individual firm has a “kink” in it. The kinkfirm has a “kink” in it. The kink follows from the assumption thatfollows from the assumption that competitive firms will follow if acompetitive firms will follow if a single firm cuts price but will notsingle firm cuts price but will not follow if a single firm raises price.follow if a single firm raises price.
    22. 22. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Kinked Demand Curve ModelThe Kinked Demand Curve Model • Above P*, an increase inAbove P*, an increase in price, which is not followedprice, which is not followed by competitors, results in aby competitors, results in a large decrease in the firm’slarge decrease in the firm’s quantity demandedquantity demanded (demand is elastic).(demand is elastic). • Below P*, price decreasesBelow P*, price decreases are followed byare followed by competitors so the firmcompetitors so the firm does not gain as muchdoes not gain as much quantity demandedquantity demanded (demand is inelastic).(demand is inelastic).
    23. 23. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Price-Leadership ModelThe Price-Leadership Model • Price-leadershipPrice-leadership is a form ofis a form of oligopoly in which one dominant firmoligopoly in which one dominant firm sets prices and all the smaller firmssets prices and all the smaller firms in the industry follow its pricingin the industry follow its pricing policy.policy.
    24. 24. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Price-Leadership ModelThe Price-Leadership Model • Assumptions of the price-leadership model:Assumptions of the price-leadership model: 1.1. The industry is made up of one large firm and aThe industry is made up of one large firm and a number of smaller, competitive firms;number of smaller, competitive firms; 2.2. The dominant firm maximizes profit subject toThe dominant firm maximizes profit subject to the constraint of market demandthe constraint of market demand andand subject tosubject to the behavior of the smaller firms;the behavior of the smaller firms; 3.3. The dominant firm allows the smaller firms toThe dominant firm allows the smaller firms to sell all they want at the price the leader has set.sell all they want at the price the leader has set.
    25. 25. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Price-Leadership ModelThe Price-Leadership Model • Outcome of the price-leadership model:Outcome of the price-leadership model: 1.1. The quantity demanded in the industry is splitThe quantity demanded in the industry is split between the dominant firm and the group ofbetween the dominant firm and the group of smaller firms.smaller firms. 2.2. This division of output is determined by theThis division of output is determined by the amount of market power that the dominant firmamount of market power that the dominant firm has.has. 3.3. The dominant firm has an incentive to pushThe dominant firm has an incentive to push smaller firms out of the industry in order tosmaller firms out of the industry in order to establish a monopoly.establish a monopoly.
    26. 26. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Predatory PricingPredatory Pricing • The practice of a large, powerful firmThe practice of a large, powerful firm driving smaller firms out of thedriving smaller firms out of the market by temporarily selling at anmarket by temporarily selling at an artificially low price is calledartificially low price is called predatory pricingpredatory pricing.. • Such behavior became illegal in theSuch behavior became illegal in the United States with the passage ofUnited States with the passage of antimonopoly legislation around theantimonopoly legislation around the turn of the century.turn of the century.
    27. 27. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Game TheoryGame Theory • Game theoryGame theory analyzes oligopolisticanalyzes oligopolistic behavior as a complex series ofbehavior as a complex series of strategic moves and reactivestrategic moves and reactive countermoves among rival firms.countermoves among rival firms. • In game theory, firms are assumedIn game theory, firms are assumed to anticipate rival reactions.to anticipate rival reactions.
    28. 28. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Payoff Matrix for Advertising GamePayoff Matrix for Advertising Game B’s STRATEGYB’s STRATEGY A’s STRATEGYA’s STRATEGY Do not advertiseDo not advertise AdvertiseAdvertise Do not advertiseDo not advertise A’s profit = $50,000A’s profit = $50,000 B’s profit = $50,000B’s profit = $50,000 A’s loss = $25,000A’s loss = $25,000 B’s profit = $75,000B’s profit = $75,000 AdvertiseAdvertise A’s profit = $75,000A’s profit = $75,000 B’s loss = $25,000B’s loss = $25,000 A’s profit = $10,000A’s profit = $10,000 B’s profit = $10,000B’s profit = $10,000 • The strategy that firm A will actually choose depends on the information available concerning B’s likely strategy.
    29. 29. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Payoff Matrix for Advertising GamePayoff Matrix for Advertising Game B’s STRATEGYB’s STRATEGY A’s STRATEGYA’s STRATEGY Do not advertiseDo not advertise AdvertiseAdvertise Do not advertiseDo not advertise A’s profit = $50,000A’s profit = $50,000 B’s profit = $50,000B’s profit = $50,000 A’s loss = $25,000A’s loss = $25,000 B’s profit = $75,000B’s profit = $75,000 AdvertiseAdvertise A’s profit = $75,000A’s profit = $75,000 B’s loss = $25,000B’s loss = $25,000 A’s profit = $10,000A’s profit = $10,000 B’s profit = $10,000B’s profit = $10,000 • Regardless of what B does, it pays A to advertise. This is the dominant strategy, or the strategy that is best no matter what the opposition does.
    30. 30. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Prisoners’ DilemmaThe Prisoners’ Dilemma ROCKYROCKY GINGERGINGER Do not confessDo not confess ConfessConfess Do not confessDo not confess Ginger: 1 yearGinger: 1 year Rocky: 1 yearRocky: 1 year Ginger: 7 yearsGinger: 7 years Rocky: freeRocky: free ConfessConfess Ginger: freeGinger: free Rocky: 7 yearsRocky: 7 years Ginger: 5 yearsGinger: 5 years Rocky: 5 yearsRocky: 5 years • Both Ginger and Rocky have dominant strategies: to confess. Both will confess, even though they would be better off if they both kept their mouths shut.
    31. 31. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Payoff Matrix forPayoff Matrix for Left/Right-Top/Bottom StrategiesLeft/Right-Top/Bottom Strategies Original GameOriginal Game D’s STRATEGYD’s STRATEGY C’sC’s STRATEGYSTRATEGY LeftLeft RightRight TopTop C wins $100C wins $100 D wins no $D wins no $ C wins $100C wins $100 D wins $100D wins $100 BottomBottom C loses $100C loses $100 D wins no $D wins no $ C wins $200C wins $200 D wins $100D wins $100 • Because D’s behavior is predictable (he will play the right-hand strategy), C will play bottom. • When all players are playing their best strategy given what their competitors are doing, the result is called Nash equilibrium.
    32. 32. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Payoff Matrix forPayoff Matrix for Left/Right-Top/Bottom StrategiesLeft/Right-Top/Bottom Strategies • C is likely to play top and guarantee herself a $100 profit instead of losing $10,000 to win $200, even if there is just a small chance of D’s choosing left. • When uncertainty and risk are introduced, the game changes. A maximin strategy is a strategy chosen to maximize the minimum gain that can be earned. New GameNew Game D’s STRATEGYD’s STRATEGY C’sC’s STRATEGYSTRATEGY LeftLeft RightRight TopTop C wins $100C wins $100 D wins no $D wins no $ C wins $100C wins $100 D wins $100D wins $100 BottomBottom C losesC loses $10,000$10,000 D wins no $D wins no $ C wins $200C wins $200 D wins $100D wins $100
    33. 33. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Contestable MarketsContestable Markets • A market isA market is perfectly contestableperfectly contestable ifif entry to itentry to it andand exit from it areexit from it are costless.costless. • In contestable markets, even largeIn contestable markets, even large oligopolistic firms end up behavingoligopolistic firms end up behaving like perfectly competitive firms.like perfectly competitive firms. Prices are pushed to long-runPrices are pushed to long-run average cost by competition, andaverage cost by competition, and positive profits do not persist.positive profits do not persist.
    34. 34. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Oligopoly is Consistent withOligopoly is Consistent with a Variety of Behaviorsa Variety of Behaviors • The only necessary condition of oligopoly isThe only necessary condition of oligopoly is that firms are large enough to have somethat firms are large enough to have some control over price.control over price. • Oligopolies are concentrated industries. AtOligopolies are concentrated industries. At one extreme is the cartel, in essence,one extreme is the cartel, in essence, acting as a monopolist. At the otheracting as a monopolist. At the other extreme, firms compete for smallextreme, firms compete for small contestable markets in response tocontestable markets in response to observed profits. In between are a numberobserved profits. In between are a number of alternative models, all of which stressof alternative models, all of which stress the interdependence of oligopolistic firms.the interdependence of oligopolistic firms.
    35. 35. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Oligopoly and Economic PerformanceOligopoly and Economic Performance • Oligopolies, or concentrated industries, areOligopolies, or concentrated industries, are likely to be inefficient for the following reasons:likely to be inefficient for the following reasons: • They are likely to price above marginal cost. ThisThey are likely to price above marginal cost. This means that there would be underproduction frommeans that there would be underproduction from society’s point of view.society’s point of view. • Strategic behavior can force firms into deadlocksStrategic behavior can force firms into deadlocks that waste resources.that waste resources. • Product differentiation and advertising may pose aProduct differentiation and advertising may pose a real danger of waste and inefficiency.real danger of waste and inefficiency.
    36. 36. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Role of GovernmentThe Role of Government • TheThe Celler-Kefauver Act of 1950Celler-Kefauver Act of 1950 extended the government’s authorityextended the government’s authority to ban vertical and conglomerateto ban vertical and conglomerate mergers.mergers. • TheThe Herfindahl-Hirschman IndexHerfindahl-Hirschman Index (HHI)(HHI) is a mathematical calculationis a mathematical calculation that uses market share figures tothat uses market share figures to determine whether or not a proposeddetermine whether or not a proposed merger will be challenged by themerger will be challenged by the government.government.
    37. 37. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Regulation of MergersRegulation of Mergers Calculation of a Simple Herfindahl-Hirschman Index for Four HypotheticalCalculation of a Simple Herfindahl-Hirschman Index for Four Hypothetical Industries, Each With No More Than Four FirmsIndustries, Each With No More Than Four Firms PERCENTAGE SHARE OF:PERCENTAGE SHARE OF: HERFINDAHL-HERFINDAHL- HIRSCHMANHIRSCHMAN INDEXINDEXFIRM 1FIRM 1 FIRM 2FIRM 2 FIRM 3FIRM 3 FIRM 4FIRM 4 Industry AIndustry A 5050 5050 −− −− 505022 + 50+ 5022 = 5,000= 5,000 Industry BIndustry B 8080 1010 1010 −− 808022 + 10+ 1022 + 10+ 1022 = 6,600= 6,600 Industry CIndustry C 2525 2525 2525 2525 252522 + 25+ 2522 + 25+ 2522 + 25+ 2522 = 2,500= 2,500 Industry DIndustry D 4040 2020 2020 2020 404022 + 20+ 2022 + 20+ 2022 + 20+ 2022 = 2,800= 2,800
    38. 38. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Department of Justice MergerDepartment of Justice Merger Guidelines (revised 1984)Guidelines (revised 1984) ANTITRUST DIVISION ACTIONANTITRUST DIVISION ACTION HHIHHI 1,8001,800 1,0001,000 00 ConcentratedConcentrated Challenge if Index isChallenge if Index is raised by more than 50raised by more than 50 points by the mergerpoints by the merger ModerateModerate ConcentrationConcentration Challenge if Index isChallenge if Index is raised by more than 100raised by more than 100 points by the mergerpoints by the merger UnconcentratedUnconcentrated No challengeNo challenge
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