Oligopoly: Competition has aface and a name.Small number of firms that makeoutput and price decisions taking intoconsidera...
Characteristics   Few firms each large enough to   influence market price   Products may be differentiated or   homogeneou...
Examples of Oligopolies  Tennis Balls: Wilson, Penn, Dunlop and  Spalding.  Cars: GM, Ford, DaimlerChrysler  Cereal: Quake...
OPECThe Organization of Petroleum Exporting Countries:•Africa (Algeria, Libya and Nigeria)•Asia (Indonesia)•Middle East (I...
It is the “fewness” thatdistinguishes OligopolyBut how many firms is “a few firms”?         © 2000, 20001Claudia Garcia-Sz...
Measures of Concentration   Four Firm Concentration Ratio     Sum of market shares of the four largest     firms in the in...
The weight assigned                                                       Firm        Market                              ...
Herfindahl-Hirschman Index (HHI)   The largest index for a monopoly:                                                      ...
The More Concentrated theIndustry,The larger the Herfindahl-HirschmanIndex (HHI)         © 2000, 20001Claudia Garcia-Szekely
Percentage of 1992        Value of Shipments      Industry                      Largest 4             HHIMedicinal        ...
Profit Maximization underOligopoly  Much is uncertain: there is NO Single model  for Profit Maximization…  An oligopolys p...
Oligopoly Decision MakingLook for the “winning strategy”:A set of steps to take, contingent onthe competitor’s behavior.  ...
Two Alternative Oligopoly Models The Collusion Model (Cartel)   The group behaves as ONE monopoly The Kinked Demand Model ...
The Collusion Model: “Let’s Agreeto Behave like a Monopolist” Firms act together like a monopolist Restrict output to maxi...
Illegal but done nonetheless… Explicit Price Collusion   OPEC Implicit Price Collusion: Firms just happen to charge the sa...
The Collusion Model Suppose there are only two firms Producing identical products Face identical demand Have identical cos...
The Sum of the Firms’ Demand =Market Demand Each Firm’s Demand                             One= Half Market               ...
The Sum of the Firms’ Demand =Market Demand      Sum of demand lines for both firms = Market Demand                 The Su...
Collusion: Agree to behave asOne Monopolist             Together these two firms will sell Qo                   each firm ...
Oligopoly Collusion Solution isInefficient     The efficient solution is the perfectly                                 com...
When firms coordinate theiractivities they form a CartelEnforcement of Cartel agreements is   difficult for two reasons:1....
The Incentive to Cheat the Aggreement  MC = 10 Profit Maximizing OutputEach firm at: MC = MR                              ...
Each firm should produce 30unitsTotal sold = 60 unitsPrice =$60Firm’s Total Revenue = $3600/2 =1,800         © 2000, 20001...
If each firm sellsTo maximize Profit, both firms will    If one firm sells 30       and the other                         ...
Both firms will bring 40 unitsfor saleTotal Sold = 80 unitsPrice = $40Firm’s Total Revenue =$3200/2=1,600         © 2000, ...
Decision Making in Oligopoly Each firm must take into account the other firm’s actions and reactions. There is uncertainty...
To set up the oligopoly decision as agame you need to:  Specify the number of players     firms  Strategies available to e...
Setting Up the PreviousExample as a Game.We must first build a “payoff matrix”:a table that contains the outcomesunder all...
Payoff Matrix                                             Firm A’s Strategies                                   Produce 30...
Most Likely Outcome: Both Cheat                                    A’s Strategies                               Produce 30...
The Kinked Demand Model     Developed to explain why prices in     oligopoly markets tended to be     inflexible.        C...
The Kinked Demand Model ofOligopoly We assume that firms follow the following  strategy:                                  ...
The Kinked Demand Model                                                    Quantity                                       ...
Above P0 demand looks like this                            Above P0 MR looks like this                            Below P0...
The Kinked                                                                  Demand is more elasticDemand Model For prices ...
Why are prices                                                             MC2sticky under                                ...
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Oligopoly

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  • The 4- firm concentration ratio gives the largest company twice the weight of the next size firm. Whereas with the HHI the dominant firm’s weight is almost 4 times that of the next largest firm. The HHI gives greater weight to the firms with relatively high market power than does the 4-firm concentration ratio. The la
  • Oligopoly

    1. 1. Oligopoly: Competition has aface and a name.Small number of firms that makeoutput and price decisions taking intoconsideration the competitor’sreactions. © 2000, 20001Claudia Garcia-Szekely
    2. 2. Characteristics Few firms each large enough to influence market price Products may be differentiated or homogeneous The behavior of each firm depends on the behavior of the others Entry barriers exit © 2000, 20001 Claudia Garcia-Szekely
    3. 3. Examples of Oligopolies Tennis Balls: Wilson, Penn, Dunlop and Spalding. Cars: GM, Ford, DaimlerChrysler Cereal: Quaker, Ralston Food, Kellogg, Post and General Mills. Airlines: American and Delta with US Airways, Northwest and TWA struggling along. Aircraft: Boeing (+McDonnell Douglas) and Lockheed Martin © 2000, 20001 Claudia Garcia-Szekely
    4. 4. OPECThe Organization of Petroleum Exporting Countries:•Africa (Algeria, Libya and Nigeria)•Asia (Indonesia)•Middle East (Iran, Iraq, Kuwait, Qatar, Saudi Arabia and the UnitedArab Emirates)•Latin America (Venezuela). 20001 Claudia Garcia-Szekely © 2000,
    5. 5. It is the “fewness” thatdistinguishes OligopolyBut how many firms is “a few firms”? © 2000, 20001Claudia Garcia-Szekely
    6. 6. Measures of Concentration Four Firm Concentration Ratio Sum of market shares of the four largest firms in the industry. The Herfindahl-Hirschman Index (HHI) The Sum of the squares of the market shares of all the firms in the industry. © 2000, 20001 Claudia Garcia-Szekely
    7. 7. The weight assigned Firm Market to the largest firm isAn Example Share twice that of the next largest firm 50% A Four Firm Concentration B 25% Ratio: 84. C 5% 50 + 25 + 5 + 4 = The weight HHI :3,230 D assigned to the 4% largest firm is four 2 2 2 2 50 + 25 + 5 + 5(4 ) = Etimes that 4%the of next largest firm 2,500 + 625 + 25 + 5(16) F 4% The HHI index reflects more G 4% accurately the true distribution of H 4% power in the industry. © 2000, 20001 Claudia Garcia-Szekely
    8. 8. Herfindahl-Hirschman Index (HHI) The largest index for a monopoly: 2 Market share = 100% 100 = 10,000 For an industry with 2 firms: 2 Market share = 50% /each 2(50 )=5,000 For a competitive industry with 10,000 firms: Market share = 1/10,000 = 0.01% 2 10,000(0.01 )= 1 © 2000, 20001 Claudia Garcia-Szekely
    9. 9. The More Concentrated theIndustry,The larger the Herfindahl-HirschmanIndex (HHI) © 2000, 20001Claudia Garcia-Szekely
    10. 10. Percentage of 1992 Value of Shipments Industry Largest 4 HHIMedicinal 76 % 3,000ChemicalsCars 84 % 2,676 The Larger the HHI Index The larger market share concentrated in a fewBreakfast Cereal 85 % 2,253Cigarettes 93 % ? firmsMen/Boy Shirts 28 % 315Ice Cream 24 % 293 © 2000, 20001 Claudia Garcia-Szekely
    11. 11. Profit Maximization underOligopoly Much is uncertain: there is NO Single model for Profit Maximization… An oligopolys plan is a contingency or strategic plan: As in chess: I plan my strategy based on what I believe my opponent will do in response to my moves. Strategic interactions have a variety of potential outcomes rather than a single outcome. © 2000, 20001 Claudia Garcia-Szekely
    12. 12. Oligopoly Decision MakingLook for the “winning strategy”:A set of steps to take, contingent onthe competitor’s behavior. © 2000, 20001Claudia Garcia-Szekely
    13. 13. Two Alternative Oligopoly Models The Collusion Model (Cartel) The group behaves as ONE monopoly The Kinked Demand Model © 2000, 20001 Claudia Garcia-Szekely
    14. 14. The Collusion Model: “Let’s Agreeto Behave like a Monopolist” Firms act together like a monopolist Restrict output to maximize profit Assign output quotas to member firms All firms agree to charge one price. © 2000, 20001 Claudia Garcia-Szekely
    15. 15. Illegal but done nonetheless… Explicit Price Collusion OPEC Implicit Price Collusion: Firms just happen to charge the same price but did not meet to discuss it. Airlines, Steel. © 2000, 20001 Claudia Garcia-Szekely
    16. 16. The Collusion Model Suppose there are only two firms Producing identical products Face identical demand Have identical cost structures © 2000, 20001 Claudia Garcia-Szekely
    17. 17. The Sum of the Firms’ Demand =Market Demand Each Firm’s Demand One= Half Market Firm’s DemandDemand P0 Market Demand 1000 2000 © 2000, 20001 Claudia Garcia-Szekely
    18. 18. The Sum of the Firms’ Demand =Market Demand Sum of demand lines for both firms = Market Demand The Sum of the MR lines for both firms = deach firm dA+ dB = Market Market Demand Demand deach firm = MRA+B deach firm mreach firm © 2000, 20001 Claudia Garcia-Szekely
    19. 19. Collusion: Agree to behave asOne Monopolist Together these two firms will sell Qo each firm selling half. Po MC D MR Qo © 2000, 20001 Claudia Garcia-Szekely
    20. 20. Oligopoly Collusion Solution isInefficient The efficient solution is the perfectly competitive Price and Output combination (Ppc, Qpc) MC Po Oligopolies restrict Ppc output and charge higher prices (Po, Q o) D MR Qo Qpc © 2000, 20001 Claudia Garcia-Szekely
    21. 21. When firms coordinate theiractivities they form a CartelEnforcement of Cartel agreements is difficult for two reasons:1. Antitrust Laws make collusive agreements illegal2. There is a strong incentive to cheat.© 2000, 20001Claudia Garcia-Szekely
    22. 22. The Incentive to Cheat the Aggreement MC = 10 Profit Maximizing OutputEach firm at: MC = MR for Cartel Q P TR sellstr units MR 30 0 120 0 0 10 110 1100 and charges 110 550 20 100 2000 Price = $60 90 1000 30 90 2700 1350 70 40 80 3200 1600 50 50 70 3500 1750 30 60 60 3600 1800 10 70 50 3500 1750 -10 80 40 3200 1600 -30 90 30 2700 1350 -50 100 20 2000 1000 -70 110 10 1100 550 -90 120 0 0 0 -110 © 2000, 20001 Claudia Garcia-Szekely
    23. 23. Each firm should produce 30unitsTotal sold = 60 unitsPrice =$60Firm’s Total Revenue = $3600/2 =1,800 © 2000, 20001Claudia Garcia-Szekely
    24. 24. If each firm sellsTo maximize Profit, both firms will If one firm sells 30 and the other 30 units, revenue Total revenues for for each firm =cheat.the cheating firm “cheats” selling 40, for Total revenues total units for sale = the cheated firm 1800 would be 50 x 30 = Q P Firm A Firm B can sell TR for Firm B 70 and the price will = would be 50 x 40 1,500 0 120 2,000 30 be $50 10 110 30 20 100 30 30 90 30 40 80 30 10 800 50 70 30 20 1400 60 60 30 30 1800 70 50 30 40 2000 80 40 30 50 2000 90 firm 30 Each can 30 60 1800 increase profits by 100 20 30 70 1400 producing more than 110 10 30 80 800 120 agreed. 0 30 90 0 © 2000, 20001 Claudia Garcia-Szekely
    25. 25. Both firms will bring 40 unitsfor saleTotal Sold = 80 unitsPrice = $40Firm’s Total Revenue =$3200/2=1,600 © 2000, 20001Claudia Garcia-Szekely
    26. 26. Decision Making in Oligopoly Each firm must take into account the other firm’s actions and reactions. There is uncertainty about what the competitor will do. Strategic Decisions Under Uncertainty Game Theory: a tool developed to analyze strategic decisions under uncertainty © 2000, 20001 Claudia Garcia-Szekely
    27. 27. To set up the oligopoly decision as agame you need to: Specify the number of players firms Strategies available to each player Abide by the quota agreement or Cheat the agreement Payoffs to each player for each choice made Revenues = 1,800 for both firms if they cooperate Revenue Cheating Firm = 2,000 Revenue Cheated 20001 Claudia= 1,800 © 2000, Firm Garcia-Szekely
    28. 28. Setting Up the PreviousExample as a Game.We must first build a “payoff matrix”:a table that contains the outcomesunder all possible scenarios. © 2000, 20001Claudia Garcia-Szekely
    29. 29. Payoff Matrix Firm A’s Strategies Produce 30 units Cheat (40 units) 40 P = 50 P = 60 50 Firm B’s Strategies Produce A’s Profit = 1,800 30 A’s A sells = 2,000 B If both firms sell If Profit 40, and 30 units (30 x $60 =Quantity = (40 x $50 = 2,000) units, total 1,800) sells 30, total B’s Profitprice = $60 B’s Profit = 1,500 60 and = 1,800 Quantity = 70 and price = $50 (30 x $50 = 1,500) Cheat (40 A’s Profit =30, and B A’sboth firms sell 40 If A sells 1,500 If Profit = 1,600 units) (30 x 40, total Quantity (40 x $40 = 1,600) sells $50 = 1,500) units, total Quantity = 70 and price = $50 = 80 and price = $40 B’s Profit = 2,000 B’s Profit = 1,600 (40 x $50 = 2,000) © 2000, 20001 Claudia Garcia-Szekely
    30. 30. Most Likely Outcome: Both Cheat A’s Strategies Produce 30 units Cheat Best strategy If A Sells 30 Units as Produce If A Cheats1,800 A’s Profit = and sells A’s Profit = 2,000 agreed… B’s Strategies 30 units If B Cheats and sells 40 units…. 40 units, B’s Profit = 1,800 B’s Profit strategy is B’s best = 1,500 A’s best strategy is the one that the B’s best strategy is brings the largest payoff. the one that brings one that brings the the largest payoff. Cheat A’s Profit =payoff. largest 1,500 A’s Profit = 1,600 If B Sells 30 Units as agreed… B’s Profit = 2,000 B’s Profit = 1,600 A’s best strategy is the one that brings the largest payoff. Best strategy Following their best self interest, both choose to cheat Following their best self interest, both choose to cheat © 2000, 20001 Claudia Garcia-Szekely
    31. 31. The Kinked Demand Model Developed to explain why prices in oligopoly markets tended to be inflexible. Changes in costs were only rarely met by changes in prices When price changes did occur they were large in magnitude.This model explains why prices under monopoly tend to be “sticky” © 2000, 20001 Claudia Garcia-Szekely
    32. 32. The Kinked Demand Model ofOligopoly We assume that firms follow the following strategy: My competition will not increase If I increase my price their price and I would lose sales. My competition will also decrease If I decrease my price their price and I would gain very few if any additional sales. © 2000, 20001 Claudia Garcia-Szekely
    33. 33. The Kinked Demand Model Quantity P1 demanded If I increase my price drops by 20% say by 10%, no one follows and I lose P0 sales D0 Demand is more elastic above P0 Q1 Q0 If I decrease my price by 10%, everyone Quantity P0 follows and I gain demanded little or nothing at all! increases 5% P1 D0 Demand is less elastic below P0 © 2000, 20001 Claudia Garcia-Szekely Q0 Q1
    34. 34. Above P0 demand looks like this Above P0 MR looks like this Below P0 demand looks like this Below P0 MR looks like this P0 Ignore the lower part of D0 and MR Ignore the upper part of D0 Note: this Kink in demand, translates and MRinto a gap in the MR line D0 D0 Q0 MR MR
    35. 35. The Kinked Demand is more elasticDemand Model For prices above the P0 current price Marginal Revenue is MR flatter D Demand is less elastic For prices below the current price Marginal Revenue is steeper Q0 © 2000, 20001 Claudia Garcia-Szekely MR
    36. 36. Why are prices MC2sticky under MC1 P2 MC0oligopoly? P 1= P0Price changes onlyMR = MCwhen MC shifts out MR = MC1 D of the MR gap MR = MC0 If Costs increasewithin the MR gap… Price does not change Q1 Q0 © 2000, 20001 Claudia Garcia-Szekely MR

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