1 chapter 12 principles of economics by fred m gottheil chapter 12 price and output determination...
TRANSCRIPT
1
Principles of Economicsby Fred M Gottheil
Chapter 12Chapter 12
Principles of Economicsby Fred M Gottheil
Chapter 12Chapter 12
Price and Output Price and Output Determination Under Determination Under
OligopolyOligopoly
PowerPoint Slides prepared by Ken Long©©1999 South-Western College Publishing
2
What is Oligopoly?What is Oligopoly?
A market structure consisting of only a few firms producing goods that are close substitutes
©©1999 South-Western College Publishing
3
What are some examples of Oligopoly?
What are some examples of Oligopoly?
AutomobilesSteelSoup
Cereals©©1999 South-Western College Publishing
4
What determines if a market is an Oligopoly?
What determines if a market is an Oligopoly?
The concentration ratio can be used as a guide
©©1999 South-Western College Publishing
5
What concentration ratio constitutes an Oligopoly?What concentration ratio constitutes an Oligopoly?
There is no magic number, but if a large percentage of the sales are from the 4 largest firms, it’s an Oligopoly
©©1999 South-Western College Publishing
6
What is an example of a high concentration ratio?What is an example of a high concentration ratio?
Out of 151 firms in the aircraft industry the leading 4 constitutes 79% of total sales
©©1999 South-Western College Publishing
7
For more information on industry concentration
check out these web pages -
For more information on industry concentration
check out these web pages -
• http://www.census.gov• http://www.census.gov/econ/www/manumenu.html
©©1999 South-Western College Publishing
8
What is the Herfindahl-Hirschman Index (HHI)?What is the Herfindahl-
Hirschman Index (HHI)?A measure of industry
concentration, calculated as the sum of the squares of the market shares held by each firm in the industry
©©1999 South-Western College Publishing
9
Calculation of the HHICalculation of the HHI
HHI = s12 + s2
2 + …..sn2
where Si = the ith firms market
share, n= number of firms in industry
10
Problems: For an industry with only 1
firm, (monopoly), what would be the HHI?
Problems: For an industry with only 1
firm, (monopoly), what would be the HHI?
11
Suppose the industry has 10 equal size firms, what
is the HHI?
Suppose the industry has 10 equal size firms, what
is the HHI?What if the industry has
100 equal size firms?
12
Answers:Answers:
Monopoly, HHI = 10,00010 equal size firms, HHI = 1,000100 equal size firms, HHI = 100
13
How Oligopolistic is the U.S. Economy?
How Oligopolistic is the U.S. Economy?
Oligopoly is very much of a fact of life in the U.S.
©©1999 South-Western College Publishing
14
Is the U.S. becoming more Oligopolistic?
Is the U.S. becoming more Oligopolistic?
Answer appears to be NO to this question. While there have been some
periods of time when industries appeared to be getting more
concentrated into fewer firms, there are other periods of history where just
the opposite happened.
15
What is Market Power?What is Market Power?A firm’s ability to select
and control market price and output
©©1999 South-Western College Publishing
16
What is anUnbalanced Oligopoly?
What is anUnbalanced Oligopoly?An oligopoly in which
the sales of the leading firms are distributed unevenly among them
©©1999 South-Western College Publishing
17
What is aBalanced Oligopoly?
What is aBalanced Oligopoly?
An oligopoly in which the sales of the leading firms are distributed fairly evenly among them
©©1999 South-Western College Publishing
18
In which type is market power most concentrated?In which type is market
power most concentrated?Unbalanced Oligopoly
©©1999 South-Western College Publishing
19
Why do Oligopolies exist?Why do Oligopolies exist?MergersEconomies of scaleReputationStrategic barriersGovernment barriers
©©1999 South-Western College Publishing
20
What is aHorizontal Merger?
What is aHorizontal Merger?
A merger between firms producing the same good in the same industry
©©1999 South-Western College Publishing
21
What is aVertical Merger?
What is aVertical Merger?
A merger between firms that have a supplier - purchaser relationship
©©1999 South-Western College Publishing
22
What is aConglomerate Merger?
What is aConglomerate Merger?A merger between firms
in unrelated industries
©©1999 South-Western College Publishing
23
For more information on mergers check out these sites:
For more information on mergers check out these sites:
• http://www.stocksmart.com/newsipos.html
• http://www.antitrust.org• http://www.usdoj.gov/atr/index.html
• http://www.usdoj.gov/atr/guidelin.htm• http://www.ftc.gov
©©1999 South-Western College Publishing
24
Firms in Oligopoly are said to be Mutually
Interdependent
Firms in Oligopoly are said to be Mutually
InterdependentFirms realize the large impact that other
firms behavior has on their profitsLeads to many models of oligopoly,
depending on how the firms deal with the mutual interdependence issue
25
One way to deal with the Mutual Interdependence
problem is…..
One way to deal with the Mutual Interdependence
problem is…..LET’S CHEAT!!!!THE COLLUSION
SOLUTION!!!
26
What is Collusion?What is Collusion?The practice of firms to
negotiate price and market decisions that limit competition
©©1999 South-Western College Publishing
27
What is a Cartel?What is a Cartel?A group of firms that
collude to limit competition in a market by negotiating and accepting agreed-upon price and market shares
©©1999 South-Western College Publishing
28
One model of collusion that can be used is the
cartel model
One model of collusion that can be used is the
cartel model• Internationally, some cartels like
OPEC exist• Domestically, these would be
illegal• If the cartel can collude perfectly,
would tend to charge the monopoly price
29
Ingredients for a successful cartelIngredients for a successful cartel
• Control a large share of the market• Inelastic and stable demand for the product• Similar costs among cartel members• Fairly homogenous product• Few number of firms• Ways of preventing cheating on the
agreement
30
Check out the Opec CartelCheck out the Opec Cartel
• http://www.opec.org
31
What is the relationship between market
concentration and price?
What is the relationship between market
concentration and price?A high concentration ratio in
an industry may translate into noncompetitive prices and behavior
©©1999 South-Western College Publishing
32
Kinked demand curve model of oligopoly: assumption, rivals will match all price cuts
but not price increases. Under this assumption, its as if each firm faces a
“kinked” demand curve, with 2 sections to it: more elastic above the existing price, since rivals won’t match a price increase, and less elastic below the existing price, since rivals
quickly match price cuts.
Kinked demand curve model of oligopoly: assumption, rivals will match all price cuts
but not price increases. Under this assumption, its as if each firm faces a
“kinked” demand curve, with 2 sections to it: more elastic above the existing price, since rivals won’t match a price increase, and less elastic below the existing price, since rivals
quickly match price cuts.
33
Kinked Demand CurveKinked Demand Curve
P1
Starting price
33
DMR
MR Gap
Price
QuantityQ1
34
Graph explanation: Let P1 and Q1 be the existing price and quantity for
this oligopoly firm: due to the assumptions of this model, the
demand curve has a kink in it at this price and output. Because of the
strange shape of the demand curve, the MR curve is discontinuous, or
has a gap in it.
Graph explanation: Let P1 and Q1 be the existing price and quantity for
this oligopoly firm: due to the assumptions of this model, the
demand curve has a kink in it at this price and output. Because of the
strange shape of the demand curve, the MR curve is discontinuous, or
has a gap in it.
35
Kinked demand curve model is an attempt to explain rigid prices in
oligopoly: That is, firms might not change price very often. Why? Firm
is reluctant to raise price if its competitors do not, since it could lose sales to them, and little reason is seen to lower price if competitors quickly
match the price cut, since little will be gained.
Kinked demand curve model is an attempt to explain rigid prices in
oligopoly: That is, firms might not change price very often. Why? Firm
is reluctant to raise price if its competitors do not, since it could lose sales to them, and little reason is seen to lower price if competitors quickly
match the price cut, since little will be gained.
36
What does the kinked demand curve illustrate?What does the kinked
demand curve illustrate?There is a great deal of price
stability and nonprice competition is important
©©1999 South-Western College Publishing
37
How do firms in an Oligopoly set price?How do firms in an Oligopoly set price?
Most often they practice price leadership
©©1999 South-Western College Publishing
38
Price leadership in Oligopoly
Price leadership in Oligopoly
One firm, the dominant firm, sets the price, others follow the leader
Often the dominant firm is the low cost producer in the industry
Is this a form of “tacit” collusion?
39
What is an example nonprice competition?What is an example
nonprice competition?Brand multiplication
when there are variations on one good to increase market share
©©1999 South-Western College Publishing
40
Game Theory Approach to Oligopoly
Game Theory Approach to Oligopoly
Is Oligopoly best analyzed as a strategic game like chess?
41
What is Game Theory?What is Game Theory?A theory of strategy
ascribed to a firm’s behavior in oligopoly
©©1999 South-Western College Publishing
42
For more information about Game Theory -
For more information about Game Theory -
• http://www.pitt.edu/~alroth/alroth.html
©©1999 South-Western College Publishing
Prisoner's Dilemma Prisoner's Dilemma
a
Bob’sChoices
Nathan’s Choices
NotConfess
Confess
Confess
Not Confess
Nathan pays $2,000
Bob pays $2,000
Nathan pays $5,000
Bob pays $500
Nathan pays $500
Bob pays $5,000
Nathan pays $3,000
Bob pays $3,000
1 2
3 4
44
If the 2 people could collude, would likely choose to not confess, but self interest may drive each to confess, hoping the other does not, end up both confessing, worse off for both—many similar situations perhaps for firms in oligopoly
Two firm gameTwo firm game
a
Firm B’sChoices
Firm A’s Choices
Hold toAgreement
BreakAgreement
BreakAgreement
Hold toAgreement
A earns $50,000 profits
B earns $50,000 profits
A earns $5,000 profits
B earns $100,000 profits
A earns $100,000 profits
B earns $5,000 profits
A earns $10,000 profits
B earns $10,000 profits
1 2
3 4
46
What is a dominant strategy?
What is a dominant strategy?
A strategy that is best regardless of what the opposition does. For B, dominant strategy is to break the agreement, and also for A. Both firms avoid the worst case scenario in this manner.
47
What is a Nash equilibrium? (named for Mathematician John Nash…did you see the film “A
Beautiful Mind?)
What is a Nash equilibrium? (named for Mathematician John Nash…did you see the film “A
Beautiful Mind?)
A situation where neither firm can improve its payoff, given what the other firm is doing…in this example, breaking the agreement is the Nash equilibrium
48
Is there any way to get to box 1 where both firms are better off
short of outright collusion?
Is there any way to get to box 1 where both firms are better off
short of outright collusion?Possibility of a tit-for-tat
strategy….somehow indicate to the other firm that although you want to hold the agreement, you will switch to match what the other firm does.
49
For a forum that induces the interactive Prisoner’s
Dilemma check out -
For a forum that induces the interactive Prisoner’s
Dilemma check out -• http://
serendip.brynmawr.edu/~ann/pd.html
©©1999 South-Western College Publishing
50
What isPrice Discrimination?
What isPrice Discrimination?
The practice of offering a specific good or service at different prices to different segments of the market
©©1999 South-Western College Publishing
51
Why would a firm want to price discriminate?
Why would a firm want to price discriminate?
Greater profits possible!!
52
Different types of Price Discrimination
Different types of Price Discrimination
“Perfect” price discrimination: Charge each buyer the highest price they are willing to pay
53
More usual type of price discrimination
More usual type of price discrimination
• Separate buyers into groups (based perhaps on age, sex, region of country, etc.
• Groups should have different elasticities of demand
54
Higher price to more inelastic group, lower to more elastic: must also be able to prevent resale
of product
Higher price to more inelastic group, lower to more elastic: must also be able to prevent resale
of product
55
• What is Oligopoly?• What concentration ratio
constitutes an Oligopoly?• What is an Unbalanced Oligopoly?• What is a Balanced Oligopoly?• What is Collusion?• What is a Cartel?
56
• What is the distinguishing feature of Oligopoly?
• How do firms in an Oligopoly set price?
• What is Game Theory?• What is the Prisoner’s Dilemma?• What is Price Discrimination?
57
ENDENDENDEND
©©1999 South-Western College Publishing