OligopolyMacroeconomics FoundationAlaleh Mani2011

Specification One type of oligopoly firms Produce

identical Products but compete on price Another type produce differentiated

product and compete on price, quality and marketing

Barrier to entry natural or legal (economic of scale) Small number of firms compete

Natural Oligopoly

Ten firms can meet the demand five firms can meet the demand

One firms can meet the demand

Small Number of firms Interdependence: ultimately one stay

and the other leave Temptation to cooperate: use conspiracy and collusion then make a

cartel to control the price and quantity of production and share the market

Two models of oligopoly Traditional model :

The kinked demand curve model Dominant firm oligopoly

Game theory model Prisoners dilemma Price fixing game other

Kinked demand curve model Assumption: If one firm raises its price nobody follows but If one firm cuts its price other cut as well Costs change slightly

Result: In between a and b if MC changes price is not sensitive to its slight change

Problem of kinked model: When assumption does not work : costs change enough to change price firms increase their price at the same time

Dominate Oligopoly Model

Total Demand

Price Taker

MonopolyPerfect Competition

Divide equally among rest Monopoly maximize its profit

Oligopoly Game Model Game features:

Rules: any action has its compensation Strategy: all possible action for every player Payoff: table of action Outcome: all results in payoff: Nash equilibrium: every player takes a action

given the action of other player_ the Dilemma: every player has this doubt what to

choose_ A bad outcome: the equilibrium outcome is not

always the best result

Collusion Agreement between producer to form a cartel to

restrict an output and raise the price and make more profit

Two strategy in collusion: Comply Cheat

Payoff in Duopoly:1. Both comply2. Both Cheat Break even happens. No economic profit 3. One cheat and the other comply (vsvs) one has

economic loss the cheater makes bigger profit

How Collusion works Summation of Individual Marginal Cost

=Industry MC Summation of Individual Marginal

revenue=Industry Marginal revenue Social Demand is clear

Duopoly Collusion when both Comply

Take Price

Q/2

MCATC

Econ

omic

Pro

fit

Measure of Concentration 1. the four firm concentration ratio:

Sale of 4 Largest firm in industry *100 =A Total Sale of IndustryIf for only one company A=100 % MonopolyIf A>60% OligopolyIf A<60% Monopolistic CompetitionIf A0 Perfect Competition

Measure of Concentration 2 2.Herfindahl-Hirschman Index=HHI HHI=Σ n² n=Share% in Market n=1 to 50

HHI<1000 competition Market1000<HHI<1800 moderately CompetitiveHHI>1800 uncompetitiveHHI=10000 for one monopoly Co.

Measures Failure 1. Geographical scope of Market:

1. National Market2. Regional Market3. Global MarketExp: Newspaper in City or World

2.Barrier to entry and firm turn over Exp: Restaurant in small city and big city 3.Market and Industry Correspondence

1. Market is narrower than industry Exp: In competitive market of Pharmacy selling exclusively AIDS medicine is monopoly

2. A firm may produce several different product in different industry

3. Firms switch from one Market to another at the same time Exp: Motorola produced TV and now cellular phone