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Unit 4: Imperfect Competition Oligopoly

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Page 1: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Unit 4: Imperfect Competition

Oligopoly

Page 2: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

2

PerfectCompetition

PureMonopoly

MonopolisticCompetition Oligopoly

Characteristics of Oligopolies:•A Few Large Producers (Less than 10)• Identical or Differentiated Products•High Barriers to Entry •Control Over Price (Price Maker)•Mutual Interdependence• Firms use Strategic Pricing

Examples: OPEC, Cereal Companies, Car Producers

Page 3: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Oligopolies occur when only a few large firms start to control an industry.

High barriers to entry keep others from entering.

Types of Barriers to Entry 1. Economies of Scale

Ex: The car industry is difficult to enter because only large firms can make cars at the lowest cost

2. High Start-up Costs 3. Ownership of Raw Materials

HOW DO OLIGOPOLIES OCCUR?

Page 4: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Game Theory

An understanding of GAME THEORY helps firms in an

OLIGOPOLY MAXIMIZE PROFIT.

The study of how people behave in strategic situations

Page 5: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Game theory helps predict human behavior

THE ICE CREAM MAN SIMULATION1.You are a ice cream salesmen at the

beach.

2.You have identical prices as another salesmen.

3.Beachgoers will purchase from the closest salesmen.

4.People are evenly distributed along the beach.

5.Each morning the two firms pick locations on the beach.

Where is the best location?

Page 6: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Firm A decides where to goes first. What is the best strategy for choosing

a location each day?Can you predict the end result each

day?How is this observed in the “real-

world”?B

Where should you put your firm?

A

Page 7: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Why learn about game theory?

• Oligopolies are interdependent since they compete with only a few other firms.

• Their pricing and output decisions must be strategic as to avoid economic losses.

• Game theory helps us analyze their strategies.

SIMULATION!

Page 8: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Prisoner’s Dilemma

I am innocent…

Page 9: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

SituationTwo suspects are arrested by the police.

The police have sufficient evidence for a conviction, and have separated both prisoners, visit each of them to offer the same deal.

If one testifies for the prosecution against the other (“betrays”) and the other remains silent (“cooperates”), the betrayer goes free and the silent accomplice receives the full twenty-year sentence.

If both remain silent, both prisoners are sentenced to only five years in jail for a minor charge.

If both betray each other, each receives a nine-year sentence.

Each prisoner must choose to betray or to remain silent.

Each one is assured that the other would not know about the decision before the end of the investigation.

How would you act if you were one of the prisoners?

Page 10: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Directions1. You cannot communicate with your partner

in crime.

2. If the you decide to betray your partner-in-crime, you should place your black card on the table. If you decide to remain silent, you should place red card.

3. When everyone has made a decision, then look at the two cards and add (+) or subtract (-) the requisite number of years on your sheet.

4. The winner is who walks away with more life time left at the 10th round.

Page 11: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Number of Turns

Your Action

Partner’s Action

Amount of Life Left

Start ----- ----- 100 years

1

2

3

4

5

6

7

8

9

10

Page 12: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Confess Remain(Betray) Silent Confess Remain(Betray) Silent

Confess

(Betray)

RemainSilent

Confess

(Betray)

RemainSilent

20 years / Free20 years / Free

9 years / 9 years9 years / 9 years

Prisoner’s

Dilemma

Free / 20 years Free / 20 years

5 years / 5 years 5 years / 5 years

Page 13: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Reflection Questions1.If you only played the game once with your partner

and both of you are trying to minimize your individual jail sentences, what is more rationally beneficial, remaining silent or testifying against your partner? Why?

2.If you and your partner had been able to communicate, would your decision have changed? If so, why?

3.What was your strategy when you repeatedly played games with the same partner? Who ended up spending a shorter amount of time in jail? Why?

4.Would you have chosen a different strategy if you were to repeatedly play against your partner again? If so, which strategy would you adopt? If not, why not?

5.Did your moral or personal values play a part in your strategy? If so, do you think they put you at an advantage or a disadvantage? Why?

Page 14: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few
Page 15: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Raise Price

Remain the

Same

Raise Price Remain the Same

45 52 60 54

50 51 55 64

45 52 60 54

50 51 55 64

54

6450

60

Play Station will follow XBox’s Strategy

Xbox will remain the same price; and PS will raise the price.

Page 16: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Advertise Don’t Advertise

Advertise

Don’t Advertise

15 18 36 32

20 14 34 33

Page 17: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

67 71 85 5468 46 78 45

Raise PriceMaintain Raise

Price

Maintain

12 10 14 1311 9 15 16

Advertise Don’t Advertise

Advertise

Don’t Advertis

e

Page 18: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

2009 FRQB #3Payoff matrix for two competing bus companies

Page 19: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

What did we learn?

1. Oligopolies must use strategic pricing (they have to worry about the other guy)

2. Oligopolies have a tendency to collude to gain profit.

Collusion is the act of cooperating with rivals in order to “rig” a situation.

3. Collusion results in the incentive to cheat.

4. Firms make informed decisions based on their dominant strategies

Page 20: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

OligopolyBecause firms are interdependent

There are 3 types of

Oligopolies

1. Price Leadership

2. Colluding Oligopoly

3. Non-Colluding Oligopoly

Page 21: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Example: Small Town Gas StationsTo maximize profit what will they

do?

OPEC does this with OIL

#1. Price Leadership

Page 22: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Collusion is ILLEGAL. Firms CANNOT set prices. Price leadership is a strategy

used by firms to coordinate prices without outright collusion

General Process: 1.“Dominant firm” initiates a price change

2.Other firms follow the leader

#1. Price Leadership

Page 23: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Breakdowns in Price Leadership Temporary Price Wars may

occur if other firms don’t follow price increases of dominant firm.

Each firm tries to undercut each other.

Example: Employee Pricing for Ford

#1. Price Leadership

Page 24: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

#2. Colluding Oligopolies#2. Colluding OligopoliesCartel = Colluding Oligopoly

Definition: A cartel is a group of producers that create an agreement to fix prices high.

1.Cartels set price and output at an agreed upon level

2.Firms require identical or highly similar demand and costs

3.Cartel must have a way to punish cheaters

4.Together they act as a monopoly

Page 25: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Firms in a colluding oligopoly act as a monopoly and share the profit

D

MC ATC

Q

P

MR

#2. Colluding Oligopolies#2. Colluding Oligopolies

Page 26: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

#3. Non-Colluding Oligopolies#3. Non-Colluding Oligopolies

Kinked Demand Curve ModelThe kinked demand curve model shows

how non-collusive firms are interdependent

If firms are NOT colluding they are likely to react to competitor’s pricing in two ways:1.MATCH PRICE-If one firm cuts it’s

prices, then the other firms follow suit causing inelastic demand

2.IGNORE CHANGE-If one firm raises prices, others maintain same price causing elastic demand

Not on AP Test

anymore ,

So don’t worry

about it.

Page 27: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Elastic

Inelastic

P1

Q1

P2

Q2

DQ

If this firm increases it’s price, other firms will ignore it &

keep prices the same

P

As the only firm with high prices,

Qd for this firm will fall a lot

Pe

Qe

If this firm decreases it’s price, other firms will match it &

lower their prices

Since all firms have lower prices,

Qd for this firm will increase only a little

Not on AP Test

anymore ,

So don’t worry

about it.

Page 28: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

D

Q

Where is Marginal Revenue?

P

Pe

Q

MR has a vertical gap at the kink. The result is that MC can move and Qe won’t

change.Price is sticky.

MC

MR

Not on AP Test

anymore ,

So don’t worry

about it.

Page 29: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Market Structures Venn Diagram

Perfect Competition

Monopolistic Competition

Oligopoly

Monopoly

No Similaritie

s

Page 30: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Name the market structure(s) that it is associated with each concept

1. Price Maker

(Demand>MR)

2. Collusion/Cartels

3. Identical Products

4. Price Taker

(Demand=MR)

5. Excess Capacity

6. Low Barriers to Entry

7. Game Theory

8. Differentiated Products

9. Long-run Profits

10.Efficiency

11.Normal Profit

12.Dead Weight Loss

13.High Barriers to Entry

14.Firm = Industry

15. MR=MC Rule

Page 31: Unit 4: Imperfect Competition Oligopoly. 2 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Characteristics of Oligopolies: A Few

Perfect Competitio

n

Monopolistic

Competition

OligopolyMonopoly

No Similarities

MR = MCShut-Down PointCost CurvesMotivation for Profit

Excess CapacityExcess AdvertisingDifferentiated Products

More Elastic demand than Monopoly100s

Low barriers to entryNo Long-Run ProfitPrice = ATC

Price Maker (D>MR)

Some Non-Price Competition Inefficient

CollusionStrategic Pricing

(Interdependence)Game Theory10 or less

Unique GoodPrice Discrimination1

Price Maker (D>MR) High Barriers Ability to Make LR Profit Inefficient

Avoca

dos

T.J. H

amm

ocks Retail Stores

CarsAppliances

Local

Utiliti

e

s

Identical Products

No advantageD=MR=AR=PBoth efficiencies

Price-Taker1000s