chapter 9 market structure: oligopoly
TRANSCRIPT
Economics for Managersby Paul Farnhamy
Chapter 9Market Structure: Oligopoly
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OligopolyOligopoly
A market structure characterized byA market structure characterized by competition among a small
number of large firms that have gmarket power, but that must take
their rivals’ actions into id ti h d l iconsideration when developing
their competitive strategies
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Characteristicsf Oli lof an Oligopoly
Firms have market power derived from barriers to entryyHowever, a small number of firms compete with each othercompete with each otherEach firm doesn’t have to consider the actions of otherconsider the actions of other firms, thus, behavior is interdependent
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interdependent
Noncooperative Oli l M d lOligopoly Models
Assumes that firms pursue profit-maximizing strategies based on g gassumptions about rivals’ behavior and the impact of this behavior on th i fi ’ t t ithe given firm’s strategies 1. Kinked demand curve model2. Game theory models3 Strategic entr deterrence
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3. Strategic entry deterrence
Kinked Demand C M d lCurve Model
Assumes that a firm is faced with two demand curves, assuming
fthat other firms will not match price increases but will match price decreasesprice decreasesIf the firm considers raising the price above P1, its quantity demanded will depend upon the beha ior of ri al firms
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behavior of rival firms
Kinked Demand C M d lCurve Model
Assumes that managers will inflict maximum damage on other firmsgImplies oligopoly prices tend to be “sticky” and not change asbe sticky and not change as they would in other market structuresDoes not explain why price P1exists initially
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exists initially
Kinked Demand CurveKinked Demand Curve
Figure 9.1g
MC
P1 MR2MR2D2 = Rivals don’t follow
Q0 Q
D1 = rivals followMR1
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Q0 Q1
Game Theory ModelsGame Theory Models
Mathematically analyzes situations in which players make various strategic moves and have different outcomes ormoves and have different outcomes or payoffs associated with those movesDominant strategy: results in best o a t st ategy esu ts bestoutcome to a given player
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Nash EquilibriumNash Equilibrium
Strategies for which all players are choosing their best strategy, g gy,given actions of other playersProves useful when there is onlyProves useful when there is only one unique equilibrium in the gamegThere may be multiple Nash equilibrium
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equilibrium
Strategic Entry D tDeterrence
Policies that prevent rivals from entering the marketg
• Limit pricing: charging a price lower than the profit-maximizinglower than the profit maximizing price
• Predatory pricing: lowering pricesPredatory pricing: lowering prices below cost to drive out existing competitors and scare off
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potential entrants
Limit Pricing ModelLimit Pricing ModelFigure 9.2
Potential Entrant
ATC
Established FirmMCATCEN
PM A CPL
ATCMATCL
ATCBPL
0
ATCL
0 Q Q
F
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0Q
0 Q1 Q2
Limit Pricing ModelLimit Pricing Model
Assumes existing firms have lower costsAttracts other firms into the industryindustry Established firms can thwart entry by charging the limit price (or aby charging the limit price (or a lower price) rather than profit-maximization price
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maximization price
Predatory PricingPredatory PricingFigure 9.3
KT L
PUS
LRAC = LRMCT
JL
GR SPC
PJ
MN
DemandPP
MR
Demand
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Q0 QUS QPQPP QC E
Determinates of Successful P d t P i iPredatory Pricing
How far the predatory price is below costPeriod of time in which the predatory price is in effectRate of return used for judging theRate of return used for judging the investment in predatory pricingHow many rivals enter the industryHow many rivals enter the industry after predation endsTime over which recouping of profits
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p g poccurs
Cooperative Oligopoly M d lModels
Focus on cooperative behavior among rivalsgTwo types
C t l• Cartels• Tacit collusion
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CartelsCartels
Firms that get together and agree to coordinate behavior regarding pricing and output decisionsand output decisionsJoint profit maximization: strategy that maximizes profits for a cartel but may a es p o ts o a ca te but aycreate incentives for individual members to cheatH i t l ti f i l tHorizontal summation of marginal cost curve: calculated from marginal cost curve for the cartel
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Allocation Rule for Joint P fit M i i tiProfit Maximization
MC1 = MC2 = MC3
whereMC Fi #1’ i l t
MC2 = Firm #2’s marginal cost
MC1 = Firm #1’s marginal cost
MC2 Firm #2 s marginal cost
MCC = Cartel’s marginal cost
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When a Carteli S f lis Successful
It can raise market price without inducing significant competition f t l bfrom non-cartel membersThe expected punishment from f i th t l i l l tiforming the cartel is low relative to the expected gainsTh t f t bli hi dThe costs of establishing and enforcing agreement are low relative to the gains
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relative to the gains
Tacit CollusionTacit Collusion
Tacit collusion: coordinated behavior that is an achieved without a formal agreementagreementTacit collusion practices:
Uniform prices• Uniform prices• Penalty for price discounts
Advantage notice of price changes• Advantage notice of price changes• Information exchanges
Swaps and exchanges
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• Swaps and exchanges
Managerial Rule of Thumb: di d iCoordinated Actions
Managers must• Coordinate efforts, but withinCoordinate efforts, but within
constraints of antitrust legislation• Recognize incentives for cheating g g
in coordinated behavior• Remember that even coordinated
ff fl i i hefforts are fleeting, given the dynamic and competitive nature of a market environment
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a market environment
Summary of Key TermsSummary of Key Terms
C t lCartelCooperative oligopoly modelsDominant strategyGame theoryGame theoryHorizontal summation of marginal cost curvescost curvesJoint profit maximization
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Kinked demand curve model
Summary of Key TermsSummary of Key Terms
Limit pricingLimit pricingNash equilibriumNoncooperative oligopoly modelsOligopolyg yPredatory pricingStrategic entry deterrenceStrategic entry deterrenceTacit collusion
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