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Lecture eight
© copyright ： qinwang 2013Qinwang@mail.shufe.edu.cn
SHUFE school of international business
Oligopolistic Markets
Color film in US （ 1999 ）KodakFUJI FILM
6520
Auto in US （ 2001 ）GMFortChryslerToyotaHonda
28251697
Soft drink （ 1999 ）CocacolaPepsi
4531
sport shoes （ 1998 ）NikeReebokAdidas
47167
Beer in US （ 1998 ）Anheuser-buschSABMillerAdolph Coors
452310
The trend of market structure
P311
P313
Firm decision in oligopoly
Cournot duopoly model Kinked demand curve model Price leadership model Cartel
Cournot duopoly model (1938)
Hypothesis ：(1) Two firms with same product
(2)Each firm chooses it’s production to achieve profit maximum on the base of other firm’s production
Reaction curve
q1
q2
a-c
(a-c)/2
firm1
firm2
kinked demand curve model: Sweezy model
When the firm falls its price, other firms is following
When the firm rises its price, other firms is not following
P
Q
P3
Q3
d
D
P1
P2
Q1 Q2
A
K
D
0Q
0P
P
0 Q
A
BMR
1MC
2MC
3MC
AMR
BMR
BA MRMCMR
Price is stick in oligopoly market,
the firm’s MR:
Then the price is stick at P0.
Price leadership model
Barometric price leadership:one firm in the industry initiates a price change and the others may or may follow.
Dominant price-leadership model: there is one dominant firm in the industry that sets the price and then all the other firms in the industry behave like perfectly competitive price-taking firms.
Cartel
People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.
---Adam smithAn Inquiry into the Nature and Causes of
the Wealth of Nations
Cartel model
A cartel is a formal (explicit) agreement among competing firms. It is a formal organization of producers and manufacturers that agree to fix prices, marketing, and production.
Cartels usually occur in an oligopolistic industry, where there is a small number of sellers and usually involve homogeneous products.
The aim of collusion (also called the cartel agreement) is to increase individual members' profits by reducing competition.
Types of cartel
Price cartel: basic cartel model; the purpose: high monopoly price, fixed price or low price to squeeze non-cartel member.
Industry output cartel: control supply to raise the price.
After sale service cartel: agreement on after-sales service & support, such as rebate, Payment,etc.
Technology cartel: technology alliance Syndicat: all members with the same
channel of sale and procedure.
Founding condition of cartel
Cartel has the ability to rise industrial price.
Cartel member may not be punished by anti-trust law.
The organizing cost and governing cost of cartel is low ： 1.small number of firms;2.highly centralizaed industry;3.homegenous products; 4. industry association
Decision in cartel C ，P
Q
MC MC1 MC2
MR
D
q
C
q
C
P0
Q0 q1 q2
cartel Member 1 Member 2
Cartel is trustable?
Number and size distribution of sellers Product heterogeneity Cost structure Size and frequency of orders Threat of retaliation Percentage of external output
New entrants Motivation to cheat other members Anti-trust law
Sherman antitrust act in USAnti-trust law in China
Case: Cocacola and Huiyuan
Strategic behavior
The competition based on game theory
For all firms in an oligopoly to be predicting correctly each others’
decisions
Game theory were set up by Von. Neumann (mathematician) and Morgenstern (economist) in1944, now it is applied to economy, military, politics, biology, etc.
Nobel economic prize winner
1994 ， J.Nash(<Beauty mind> ， 2002 ) 、 J.Harsanyi and Reinharn Selten, for their contribution in game theory and economic application.
1996, James A. Mirrlees and William Vickrey for mechanism design under asymmetric information
2001,George A. Akerlof, Joseph E.Stiglitz, A. Michael Spence, information economics;
2005,Robert John Aumann, Thomas C. Schelling; 2007,Leonid Hurwicz, Eric S. Maskin, Roger B.
Myerson, mechanism design.
John.F.J.Nash Born in 1928 1950, graduated
from Princeton, PhD in mathematics
Professor in MIT ， now in Princeton
Books and papers ： Equilibrium points in n-
person games. 1950 Non-cooperation game,
1951
Game model
Components of a game ： players ； actions ；information sets; payoffs; playing sequence; strategies; equilibrium strategy.
Types ： Cooperative Game and non-Cooperative Game One-time game and repeated game ； Two-person game and n-person game ； Zero-sum game and non-zero-sum game Sequential move and simultaneous move game
1. Prisoners’ Dilemma
Prisoners’ Dilemma
All rivals have dominant strategies Always provide best outcome no matter
what decisions rivals make When one exists, the rational decision
maker always follows its dominant strategy
In dominant strategy equilibrium, all are worse off than if they had cooperated in making their decisions
Nash Equilibrium
what I would do is the best one given what you would do; what you would do is the best one given what I would do.
我所做的是给定你所做的我所能做的最好的 ; 你所做的是给定我所做的你所能做的最好的
Set of actions or decisions for which all managers are choosing their best actions given the actions they expect their rivals to choose
Applications
Public goods ： public green area;
Military competition ： unclear deterrent;
institutions （ WTO, Traffic Rules ） M&A ： Pac-man defense Price war
2. Pigs’ payoff
Applications
Innovation of big firm and small firm Shareholder(large share and
small share)`s governance motivation in public company
WTO negotiation: US and China OPEC member`s production
decision
3.Games of battle of sex
Simultaneous-move game With multiple Nash equilibrium, no way to
predict the likely outcome
Sequential game One firm makes its decision first, then a rival
firm, knowing the action of the first firm, makes its decision
Game Tree: Shows firms decisions as nodes with branches extending from the nodes
2 1
Panel A – Game treeRoll-back solution
boy 1
Football2
2Ballet
girl
girl
Football
Football
Ballet
Ballet0 0
0 0
1 2
First-Mover & Second-Mover Advantages
First-mover advantage If letting rivals know what you are doing by
going first in a sequential decision increases your payoff
Second-mover advantage If reacting to a decision already made by a
rival increases your payoff Determine whether the order of decision making
can be confer an advantage Apply roll-back method to game trees for each
possible sequence of decisions
Motorola’s technology
Analog Digital
Sony’s technolo
gy
Analog
A $10, $13.75
B $8, $9
Digital
C $9.50, $11
D $11.875, $11.25
First-Mover Advantage in Technology Choice
Panel A – Simultaneous technology decision
S
S
M
M
Panel B – Motorola secures a first-mover advantage
First-Mover Advantage in Technology Choice
Example: product choice
Strategic Moves & Commitments Actions used to put rivals at a disadvantage Three types
Commitments Threats Promises
Only credible strategic moves matter Managers announce or demonstrate to rivals that
they will bind themselves to take a particular action or make a specific decision No matter what action is taken by rivals
Example ： commitments
Automobile firm
light-duty vehicle
oversize vehicle
Enginefirm
Small engine 3000 ， 6000 3000， 0
Big engine 1000 ， 1000 8000 ， 3000
Engine firm’s decision
Automobile firm
light-duty vehicle
oversize vehicle
Engine firm
Small engine 0 ， 0 0 ， 0
Big engine 1000 ， 1000 8000 ， 3000
Entry game
New enter
EnterDon’t enter
Incumbent
High price (accept)
5 ， 1 10， 0
Low price(price war)
3 ， -1 4 ， 0
New enter
EnterDon’t enter
Incumbent
High price(accept)
2 ， 1 7 ， 0
Low price(price war)
3 ， -1 4 ， 0
Threats & Promises
Conditional statements Threats
Explicit or tacit “If you take action A, I will take action B,
which is undesirable or costly to you.” Promises
“If you take action A, I will take action B, which is desirable or rewarding to you.”
Strategic behavior
The firm tries to effect other firms’ expectation on it and then makes the other firms change their decisions. (Schelling,1960)
The firm limits its behavior to limit other firms’ behavior.
Firm behavior in non-cooperative game
Limit pricing Predatory Pricing Spatial preemption Product line expansion Product information notice Capacity expansion Consumer lock-in
Limit Pricing Established firm(s) commits to
setting price below profit-maximizing level to prevent entry Under certain circumstances, an
oligopolist (or monopolist), may make a credible commitment to charge a lower price forever
Predatory pricing
The hypothetical practice of selling a product or service at a very low price, intending to drive competitors out of the market.
If competitors cannot sustain equal or lower prices without losing money, they go out of business or choose not to enter the business.
The predatory merchant then has fewer competitors or is even a de facto monopoly, and hypothetically could then raise prices above what the market would otherwise bear.
Q0
P
SACSMC
D
0Q
0P
Qe
Pe A
Qi =Q0 - Qe
B
Predator`s loss ： A+B
plundered firm’s loss ： A
Spatial preemption
Schmalensee (1978): an incumbent firm would preempt entry by brand proliferation, that is enter barrier to other competitors.
Product line expansion
Incumbent expands its product line and supply a lot of product portfolio.
Example: Shampoo of P&G
Product information notice
When the time of firm A`s product to market is slower than competitors’, firm A may announce its product information earlier to effect consumer choice
Example: Borland’s Quattro Pro and Microsoft’s excel
Capacity Expansion
Established firm(s) can make the threat of a price cut credible by irreversibly increasing plant capacity
When increasing capacity results in lower marginal costs of production, the established firm’s best response to entry of a new firm may be to increase its own level of production Requires established firm to cut its price to
sell extra output
Increasing competitors’ cost
Increasing salary or input price ； incompatibility ； Increasing switching cost ； ……..
Consumer lock-in ： increasing switching cost
Switching cost: The costs incurred when a customer changes from one supplier or marketplace to another.
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