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Copyright2004 South-Western

1616Oligopoly

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Copyright 2004 South-Western

BETWEEN MONOPOLY ANDPERFECT COMPETITION

Imperfect competition includes industries in

which firms have competitors but do not face so

much competition that they are price takers.

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BETWEEN MONOPOLY ANDPERFECT COMPETITION

Types of Imperfectly Competitive Markets

Oligopoly

Only afew sellers, each offering a similar or identical

product to the others. Monopolistic Competition

Many firmsselling products that are similar but not

identical.

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Figure 1 The Four Types of Marke !ru"ure


# Tap $aer# Ca%&e T'

Mo(opo&y)Chaper 1*+

# No,e&s# Mo,ies

Mo(opo&isi"

Co-peiio()Chaper 1.+

# Te((is %a&&s# Cru/e oi&

O&igopo&y)Chaper 10+

Number of Firms?

Perfe"

# Whea# Mi&k

Co-peiio()Chaper 1+

ype of !ro"u#ts?

I/e(i"a&pro/u"s

Differe(iae/pro/u"s

O(efir-

Fe$fir-s

Ma(yfir-s

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MAR2ET! WIT3 ONLY A FEW!ELLER!

ecause of the few sellers, the key feature of

oligopoly is the tension between cooperation

and self!interest.

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MAR2ET! WIT3 ONLY A FEW!ELLER!

Characteristics of an Oligopoly Market

"ew sellers offering similar or identical products

Interdependent firms

est off cooperating and acting like a monopolist by

producing a small #uantity of output and charging a

price above marginal cost

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A Duopo&y E4a-p&e

$ duopoly is an oligopoly with only two

members. It is the simplest type of oligopoly.

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Ta%&e 1 The De-a(/ !"he/u&e for Waer


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A Duopo&y E4a-p&e

%rice and &uantity 'upplied

The price of water in a perfectly competitive market

would be driven to where the marginal cost is (ero)

P = MC = *+ Q = -+ gallons

The price and #uantity in a monopoly market would

be where total profit is maimi(ed)

P = */+

Q = /+ gallons

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A Duopo&y E4a-p&e

%rice and &uantity 'upplied

The socially efficient #uantity of water is -+

gallons, but a monopolist would produce only /+

gallons of water. 'o what outcome then could be epected from

duopolists0

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Co-peiio(5 Mo(opo&ies5 a(/ Care&s

The duopolists may agree on a monopoly

outcome.

Collusion

$n agreement among firms in a market about #uantitiesto produce or prices to charge.

Cartel

$ group of firms acting in unison.

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Co-peiio(5 Mo(opo&ies5 a(/ Care&s

$lthough oligopolists would like to form cartelsand earn monopoly profits, often that is not

possible. $ntitrust laws prohibit eplicit

agreements among oligopolists as a matter ofpublic policy.

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The E6ui&i%riu- for a( O&igopo&y

$Nash equilibrium is a situation in whicheconomic actors interacting with one another

each choose their best strategy given the

strategies that all the others have chosen.

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1hen firms in an oligopoly individually chooseproduction to maimi(e profit, they produce

#uantity of output greater than the level

produced by monopoly and less than the levelproduced by competition.

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The oligopoly price is less than the monopolyprice but greater than the competitive price

2which e#uals marginal cost3.

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E6ui&i%riu- for a( O&igopo&y

'ummary

%ossible outcome if oligopoly firms pursue their

own self!interests)

4oint output is greater than the monopoly #uantity but lessthan the competitive industry #uantity.

Market prices are lower than monopoly price but greater

than competitive price.

Total profits are less than the monopoly profit.

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Ta%&e 1 The De-a(/ !"he/u&e for Waer


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3o$ he !i7e of a( O&igopo&y Affe"s heMarke Ou"o-e

5ow increasing the number of sellers affectsthe price and #uantity)

The output effect) ecause price is above marginal

cost, selling more at the going price raises profits. The price effect) 6aising production will increase

the amount sold, which will lower the price and the

profit per unit on all units sold.

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3o$ he !i7e of a( O&igopo&y Affe"s heMarke Ou"o-e

$s the number of sellers in an oligopoly growslarger, an oligopolistic market looks more and

more like a competitive market.

The price approaches marginal cost, and the#uantity produced approaches the socially

efficient level.

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8AME T3EORY AND T3EECONOMIC! OF COOPERATION

Game theory is the study of how people behavein strategic situations.

'trategic decisions are those in which each

person, in deciding what actions to take, mustconsider how others might respond to that

action.

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8AME T3EORY AND T3EECONOMIC! OF COOPERATION

ecause the number of firms in an oligopolisticmarket is small, each firm must act

strategically.

7ach firm knows that its profit depends notonly on how much it produces but also on how

much the other firms produce.

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The Priso(ers9 Di&e--a

Theprisoners dilemmaprovides insight intothe difficulty in maintaining cooperation.

Often people (firms) fail to cooperate with

one another even when cooperation wouldmake them better off.

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The prisoners8 dilemma is a particular 9game:between two captured prisoners that illustrates

why cooperation is difficult to maintain even

when it is mutually beneficial.

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Figure : The Priso(ers9 Di&e--a

Copyright200$ South%estern&homson 'e(rning

)onnie* s +e#ision

Confess

Confess

Bo((ie ges ; years

C&y/e ges ; years

Bo((ie ges :< years

C&y/e goes free

Bo((ie goes free

C&y/e ges :< years

ges 1 yearBo((ie

C&y/e ges 1 year

,em(in Silent

,em(inSilent

Cly"e*s

+e#ision

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The dominant strategy is the best strategy for aplayer to follow regardless of the strategies

chosen by the other players.

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Cooperation is difficult to maintain, becausecooperation is not in the best interest of the

individual player.

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Figure = A( O&igopo&y 8a-e


r(.*s +e#ision

/igh!ro"u#tion

/igh !ro"u#tion

Ira6 ges >< %i&&io(

Ira( ges >< %i&&io(

Ira6 ges >=< %i&&io(

Ira( ges >0< %i&&io(

Ira6 ges >0< %i&&io(

Ira( ges >=< %i&&io(

Ira6 ges >*< %i&&io(

Ira( ges >*< %i&&io(

'o% !ro"u#tion

'o%!ro"u#tion

r(n*s

+e#ision

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O&igopo&ies as a Priso(ers9 Di&e--a

'elf!interest makes it difficult for the oligopolyto maintain a cooperative outcome with low

production, high prices, and monopoly profits.

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Figure A( Ar-s?Ra"e 8a-e


+e#ision of the nite" St(tes S3

rm

rm

@! a risk

@!!R a risk

@! a risk a(/ $eak

@!!R safe a(/ po$erfu&

@! safe a(/ po$erfu&

@!!R a risk a(/ $eak

@! safe

@!!R safe

+is(rm

+is(rm

+e#ision

of the

So5iet nion

SS,3

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Figure * A( A/,erisi(g 8a-e


(rlboro* s +e#ision

"5ertise

"5ertise

Mar&%oro ges >=%i&&io( profi

Ca-e& ges >=%i&&io( profi

Ca-e& ges >*%i&&io( profi

Mar&%oro ges >:%i&&io( profi

Ca-e& ges >:

%i&&io( profi

Mar&%oro ges >*%i&&io( profi

Ca-e& ges >

%i&&io( profi

Mar&%oro ges >%i&&io( profi

+on*t "5ertise

+on*t"5ertise

C(mel*s

+e#ision

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Figure 0 A Co--o(?Resour"e 8a-e


788on*s +e#ision

+rill %o

Wells

+rill %o Wells

E44o( ges >

-i&&io( profi

Te4a"o ges >-i&&io( profi

Te4a"o ges >0-i&&io( profi

E44o( ges >=

-i&&io( profi

Te4a"o ges >=

-i&&io( profi

E44o( ges >0

-i&&io( profi

Te4a"o ges >*

-i&&io( profi

E44o( ges >*

-i&&io( profi

+rill One Well

+rill One

Well

e8(#o*s

+e#ision

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Why Peop&e !o-ei-es Cooperae

"irms that care about future profits willcooperate in repeated games rather than

cheating in a single game to achieve a one!time

gain.

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Figure . a"k a(/ i&& O&igopo&y 8a-e


9(#:*s +e#ision

Sell 40;(llons

Sell 40 ;(llons

a"k ges

>150150:5:5

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P@BLIC POLICY TOWARDOLI8OPOLIE!

Cooperation among oligopolists is undesirablefrom the standpoint of society as a whole

because it leads toproduction that is too low

andprices that are too high.

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Resrai( of Tra/e a(/ he A(irus La$s

$ntitrust laws make it illegal to restrain trade orattempt to monopoli(e a market.

'herman $ntitrust $ct of ;

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Co(ro,ersies o,er A(irus Po&i"y

$ntitrust policies sometimes may not allowbusiness practices that have potentially positive

effects)

6esale price maintenance %redatory pricing

Tying

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Co(ro,ersies o,er A(irus Po&i"y

6esale %rice Maintenance 2or fair trade3 occurs when suppliers 2like wholesalers3 re#uire

retailers to charge a specific amount

%redatory %ricing occurs when a large firm begins to cut the price of

its product2s3 with the intent of driving its

competitor2s3 out of the market Tying

when a firm offers two 2or more3 of its products

together at a single price, rather than separately

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!u--ary

Oligopolists maimi(e their total profits byforming a cartel and acting like a monopolist.

If oligopolists make decisions about production

levels individually, the result is a greater#uantity and a lower price than under the

monopoly outcome.

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!u--ary

The prisoners8 dilemma shows that self!interestcan prevent people from maintaining

cooperation, even when cooperation is in their

mutual self!interest. The logic of the prisoners8 dilemma applies in

many situations, including oligopolies.

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!u--ary

%olicymakers use the antitrust laws to preventoligopolies from engaging in behavior that

reduces competition.

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oligopoly