oligopoly market(economics)

7/27/2019 Oligopoly market(economics)

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Imperfect competition


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Imperfect Competition

The spectrum of competition:

Perfect Comp. -------------Monopoly

Monop. Comp.-- Oligopoly Assumptions underlying oligopoly

Few Sellers

Interdependenceeach seller must be aware that their actions

will provoke actions by rival firms Differentiated versus non-differentiated products (cars

or oil

Differentiated products leads to non-price competition throughactivities such as advertising, style changes, quality


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Cartels

Explicit agreements among firms to fix output andpricesand act as a monopolist.

Examples are OPEC, Electrical Conspiracy (Econ USA),Shipping Cartel

Incentive to cooperateearn monopoly profits

Incentive to cheatincrease individual profits if cheatingis not detected or punished.

Sources of instability in cartels: Number of Sellers

Cost differences

Potential competition

Recessions

Cheating


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Cartels and Government

Monopoly power is often granted by governmentvia regulation. Example Ma Bell (Econ USA).

Other examples are shipping and the airlineindustry (pre-deregulation).

Justifications for government regulation includeinfant industry and natural monopoly.

Criticisms include decreased competition,increased costs due to x-inefficiency and lobbying,and regulation outlives its usefulness.


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Links

http://www.sunship.com/mideast/oil.html

http://www.eia.doe.gov/emeu/cabs/chron.ht

ml http://www.naseo.org/energy_sectors/fossil/oil/Supply_Graphs.htm#Prices,%201973-97
http://www.sunship.com/mideast/oil.htmlhttp://www.eia.doe.gov/emeu/cabs/chron.htmlhttp://www.eia.doe.gov/emeu/cabs/chron.htmlhttp://www.eia.doe.gov/emeu/cabs/chron.htmlhttp://www.eia.doe.gov/emeu/cabs/chron.htmlhttp://www.sunship.com/mideast/oil.html


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Measuring Market Power :

Market Concentration One presumption is that as the number of sellers

decreases, market power increases.

Concentration Ratiospercentage of market sharecontrolled by x number of firms, most commonly

a four-firm concentration ratio

Four-firm concentration ratio = (Sales by four

largest firms in an industry/Sales by all firms in

the industry) x 100


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Concentration Ratios

Primary Copper (1992,2002) 98,95

Cigarettes 93,99

Beer 90,90

Breakfast Cereals 85,83

Motor Vehicles 84,83

Greeting Cards 84

Small-arms munitions 84,89

Household Refrigerators and

Freezers

82,82

McConnell and Brue, Economics and US Census


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Problems with Concentration

Ratios Do not take into account foreign

competition

Fail to account for potential competition.

Contestable marketsfirms are able to enter

and exit at low cost. Potential entry acts as a

limit to market power.


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US Auto Industry 2001

GM 27Ford 24

Daimler-Chrysler 16

Toyota 10Honda 7

Nissan 4

Mitsubishi 2Mazda 2

Subaru 1

Suzuki .3

4 US firmsControl

67%

Japanese Firms

Control

26%

WSJ 4/4/2001 and

Carbaugh page 201


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MergersIncreasing

Concentration Vertical Mergermerging with a firm that

supplies inputs

Horizontal Mergermerging with a competitor Conglomerate Mergermerging with firms that

are not related

Successful mergersBoeing and McDonnell-Douglas

Unsuccessful MergersAOL Time Warner


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Game Theory

Game theory is an attempt to model andunderstand behavior given the presence of

interdependence Games have the following characteristics:

Rules

Strategies

Payoffs

Outcome


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The Prisoners Dilemma

Two criminals, Bill and Paul, are caught red-handed stealing a car, and will receive 2 yearsentences; however, they become suspects in a

previous bank robbery. The DAs job is to see ifhe can solve the bank robbery.

Rules:

Each player is held in separate rooms and cannot

communicate. Each is told that he is suspected of the larger crime and

if both confess to the bank robbery, they get 5 year sentences

if one rats on the other and the other does not confess to the bankrobbery, he gets off, and the other gets a 10 year sentence


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Strategies: Each player has two possible actions

Confess to the bank robbery

Do not confess to the bank robbery

Payoffs: Two players with two outcomes four

possible outcomes with the following payoffs

Both confesseach get 5 year sentences

Both denyeach get 2 year sentence

Bill confesses and Paul deniesBill gets off and Paul gets 10years

Paul confesses and Bill deniesPaul gets off and Bill gets 10

years.


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BILL

P

AU

L

ConfessDeny

Confess

Deny

5 years 10 years

5 years Off

Off 2 years

10 years 2 years

Bill

Paul

Paulif Bill confesses I should too (5 vs 10), if Bill denies, I should

still confess (off vs 2)Billif Paul confesses I should too (5 vs 10); if Paul doesnt. I should

still confess (off vs 2)


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Kinked Demand Curve Model

Show a situation where the best situation for players is to

maintain current prices and that prices remain stable in

spite of firms with different cost structures.

Asymmetry in price movements:

If firm raises price, no one follows, therefore quantity demanded is

elastic

If firm lowers price, all follow suit so the quantity demanded is

quite inelastic Marginal revenue curve is discontinuous and allows for

various marginal cost curves.


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Kinked Demand Curve

If the firm raises its

price above P, it facesan elastic demand curve,

payoff low

If the firm lowers itsprice below P, it faces

an inelastic demandcurve, payoff low


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Kinked Demand Curve Different firms can have

different MCs. As long as

they fall with in the

discontinuous MR, P will

remain stable.

Output Effect < Price

Effect for price

movements with the

discontinuous MR curve.

IfMC increases enough,

all firms raise their prices

and the kink vanishes.


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Dominant Firm Price Leadership

A large dominant firm with lower costs that itcompetitors becomes the price maker.

A competitive fringe with many firms that areprice takers or followers.

The dominant firms demand curve is the totalmarket demand minus the supply of the

competitive fringe. The dominant firm sets price and its quantity

based upon residual demand and this determinesthe price for competitive firms and their supply.

(Examples OPEC).


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Dominant Firm The large firm can set the price and receives a marginal

revenue that is less than price along the curve MR.

Residual

Demand

Dominant Firms

Demand Curve


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Dominant Firm As long as the dominant firm has lower costs, it can act like

a monopolist over the residual demand.


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Other Price Leadership Models

Barometric price leadership - firms come to tacit

agreement to allow one firm to set the price

according to cost consideration. If cost move isjustified, others will follow and validate the price .

If not, or if some firm decides to defect, the price

change will not be validated.

Rotating price leadershipfirms come to tacitagreement to allow the price leading firm to rotate

among key players in the industry.


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Oligopoly and Efficiency

The question whether oligopoly affects economic

welfare depends on whether or not they exercise

market power over prices and production In competition, the level of output produced is

where P=MC or MB=MC. Hence, net benefits to

society are maximized. Market prices as low as

possible and respond to changes in market forces.This allows prices to help direct resource

allocation.


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In monopoly, the level of output produced is

where P>MC or MB>MC. Hence, net benefits tosociety are NOT maximized. Market prices arehigher and respond to changes in market forces.This allows prices to help direct resource

allocation. In oligopoly, the level of output is somewherebetween the competitive and the monopolisticoutcome. As the oligopolist produces closer to the

competitive solution, the net benefits to societymove closer to being maximized. The opposite istrue if the outcome moves closer to the monopolyoutcomes, such as occurs with a perfect carte.


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Non-price competition, such as advertising andproduct differentiation, can negatively affectresource allocation, but it can also contribute to

efficiency. People have different preferences forproducts and advertising can help informconsumers about the price and nature of a product.

If prices are sticky, they can also causeinefficiency by failing to act as signals forresource allocation.

The extent of these inefficiencies are the subject ofdebate among economists and non-economists.


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Market Structures: Monopolistic

Competition


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Imperfect Competition

The spectrum of competition:

Perfect Comp. -------------Monopoly

Monop. Comp.-- Oligopoly

Assumptions underlying MonopolisticCompetition

Differentiated products

Differentiated products leads to some market power over price

or a downward slping demand curve Many buyers and sellers

Free entry and exit

Perfect knowledge


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Short-run Vs. Long-run Supply

Decisions In the short-run, the firm is able to set prices like a

monopolistic. P>MR so MR=MC implies thatP>MC. A firm can make profits, breakeven or

make losses.

In the long-run, free entry and exit will eliminateeconomic profits or losses.

In either case, the monopolistically competitivefirm produces a level of output where LRAC aregreater than LRAC minimum or the efficient scaleand sets price above MC.


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Monopoly Competition and

Economic Welfare Compared to competitive markets, monopolistic

competition results in an output level where thereis

Excess capacityLRAC >LRAC min

P>MC - or MB>MC

So, Deadweight Welfare Loss exists

Welfare loss is due to product differentiation

If differentiation is real, the welfare is small

If differentiation is the result of advertising which doesnot contribute anything to consumer satisfaction, itrepresents welfare loss


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Advertising

Advertising is costly, the question is - does it add

anything of value to the consumer?

informative advertising which contributes tocompetition

Advertising aimed at creating perceived differences or

brand loyalty

Breakfast cereals and kids versus supermarket ads Advertising and the prisoners dilemma self-

canceling ads.

oligopoly market(economics)

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