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Oligopoly

18. Oligopoly. CHECKPOINTS. Checkpoint 18.1. Checkpoint 18.3. Checkpoint 18.4. Problem 1. Problem 1. Problem 1. Problem 2. Problem 2. Clicker version. Problem 2. Problem 3. Problem 3. In the news. Clicker version. In the news. Checkpoint 18.2. Problem 1. Problem 2. Problem 3.

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Oligopoly

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  1. 18 Oligopoly CHECKPOINTS

  2. Checkpoint 18.1 Checkpoint 18.3 Checkpoint 18.4 Problem 1 Problem 1 Problem 1 Problem 2 Problem 2 Clicker version Problem 2 Problem 3 Problem 3 In the news Clicker version In the news Checkpoint 18.2 Problem 1 Problem 2 Problem 3 Clicker version In the news

  3. Practice Problem 1 What are the distinguishing features of oligopoly? CHECKPOINT 18.1

  4. Solution The distinguishing features of oligopoly are a small number of interdependent firms competing behind natural or legal barriers to entry. CHECKPOINT 18.1

  5. Practice Problem 2 Why are breakfast cereals made by firms in oligopoly? Why isn’t there monopolistic competition in that industry? CHECKPOINT 18.1

  6. Solution Breakfast cereals are made by firms in oligopoly because economies of scale and demand limit the number of firms that can make a profit in that market. CHECKPOINT 18.1

  7. Practice Problem 3 Sparks fly for Energizer Energizer is gaining market share against competitor Duracell and its profit is rising despite the sharp rise in the price of zinc, a key battery ingredient. Source: www.businessweek.com, August 2007 In what type of market are batteries sold? Explain your answer. CHECKPOINT 18.1

  8. Solution The market for batteries is an oligopoly, and with two dominant firms, it is a duopoly. The number of firms is small, their actions are interdependent, and economies of scale and the market demand create a natural barrier to entry. CHECKPOINT 18.1

  9. Practice Problem 1 Isolated Island has two natural gas wells, one owned by Tom and the other owned by Jerry. The marginal cost of producing gas is zero. What will be the price of gas and the quantity produced if Tom and Jerry form a cartel and maximize their joint profit? CHECKPOINT 18.2 The demand schedule for gas on this island.

  10. Solution If Tom and Jerry form a cartel and maximize their joint profit, they will charge the monopoly price. This price is the highest price the market will bear when together they produce the quantity at which marginal revenue equals marginal cost. CHECKPOINT 18.2

  11. Marginal cost is zero, so we need to find the price at which marginal revenue is zero. Marginal revenue is zero when total revenue is a maximum, which occurs when output is 6 units a day. The maximum price at which they can sell 6 units a day is $6 a unit. CHECKPOINT 18.2

  12. The maximum price at which they can sell 6 units a day is $6 a unit. CHECKPOINT 18.2

  13. Practice Problem 2 Isolated Island has two natural gas wells, one owned by Tom and the other owned by Jerry. The marginal cost of producing gas is zero. If Tom and Jerry are forced to sell at the perfectly competitive price, what will be the price of gas and the total quantity produced? CHECKPOINT 18.2 The demand schedule for gas on this island.

  14. Solution The perfectly competitive price equals marginal cost, which is zero. In this case, price is zero and the total quantity produced is 12 units a day. CHECKPOINT 18.2

  15. Practice Problem 3 Isolated Island has two natural gas wells, one owned by Tom and the other owned by Jerry. The marginal cost of producing gas is zero. If Tom and Jerry compete as duopolists, what will be the price of gas? CHECKPOINT 18.2 The demand schedule for gas on this island.

  16. Solution If Tom and Jerry compete as duopolists, they will increase production to more than the monopoly level. The price will fall below the monopoly price of $6 a unit, but they will not drive the price down to zero. CHECKPOINT 18.2

  17. Study Plan ProblemIsolated Island has two natural gas wells, one owned by Tom and the other owned by Jerry. The marginal cost of producing gas is zero. If they compete as duopolist, the price of gas will be: CHECKPOINT 18.2 The demand schedule for gas on this island. • $6 a unit • less than $6 a unit but not free • more than $6 a unit • $0 a unit

  18. In the news Asian rice exporters to discuss cartel Thailand, the world's largest rice exporter, proposed that the Asian rice exporters (Thailand, Cambodia, Laos, and Myanmar) form a cartel. The Philippines said it was a bad idea. Source: CNN, May 6, 2008 Explain how an Asian a profit-maximizing cartel would influence the global market for rice and the world price of rice. Is the Philippines correct? CHECKPOINT 18.2

  19. Solution If rice exporters form a cartel and operate as a profit-maximizing monopoly, they will maximize profit by producing the quantity at which marginal revenue equals marginal cost. The profit-maximizing quantity that a monopoly produces is less than the quantity that competitive rice growers currently produce. The supply of rice on the world market will decrease and the world price of rice will rise. If the cartel does not break down, then the Philippines is correct: The price of rice will rise. CHECKPOINT 18.2

  20. Practice Problem 1 Bud and Wise are trying to figure out how much of this new beer to produce. They know that if: Each produces 10,000 gallons a day, they will make the maximum profit of $100,000 each. Bud produces 20,000 gallons while Wise produces 10,000 a day, Bud will make an economic profit of $150,000 and Wise will incur an economic loss of $50,000 (or vice verse). Each produces 20,000 gallons a day, they’ll make zero profit. Construct the payoff matrix. CHECKPOINT 18.3

  21. Solution CHECKPOINT 18.3

  22. Practice Problem 2 Bud and Wise are the two producers of a new beer. Given the payoffs in the payoff matrix, what is the Nash equilibrium of the game they play? CHECKPOINT 18.3

  23. Solution The Nash equilibrium is for both to produce 20,000 gallons. To see why, notice that regardless of the quantity that Bud produces, Wise makes more profit by producing 20,000 gallons a day. The same is true for Bud. So Bud and Wise each produce 20,000 gallons a day. CHECKPOINT 18.3

  24. Study Plan ProblemBud and Wise are the two producers of a new beer. Given the payoffs in the payoff matrix, in the Nash equilibrium Bud produces ______ and Wise produces ____. CHECKPOINT 18.3 • 10,000 gallons; 20,000 gallons • 20,000 gallons; 10,000 gallons • 20,000 gallons; 20,000 gallons • 10,000 gallons; 10,000 gallons

  25. Practice Problem 3 Bud and Wise are the two producers of a new beer. Given the payoffs in the payoff matrix, what is the outcome of the game if it is played repeatedly? CHECKPOINT 18.3

  26. Solution If Bud and Wise play this game repeatedly, each produces 10,000 gallons a day and makes maximum economic profit. They can achieve this outcome by playing a tit-for-tat strategy. CHECKPOINT 18.3

  27. In the news Microsoft Internet Explorer is faster than Mozilla Firefox Promotions of the new Internet Explorer IE8 say it is faster, more reliable, and more secure than rival browsers. One reviewer noted that IE8 is slower than Firefox, but if you’re a light-duty user and attracted to the new IE’s strong suite of fresh features, you might prefer it to Firefox. Another says the point isn’t which browser is hundredths of a second faster, but other features. Source: USA Today, March 23, 2009 What is the game that Microsoft and Mozilla have played in the past few years? How do you think the game will change in the coming years? CHECKPOINT 18.3

  28. Solution The game that Microsoft and Mozilla have played is product development: improving speed or adding features. The outcome has been that both have allocated development to increasing speed and as the reviewers imply their speeds are only hundredths of a second apart (basically the same). In the coming years, the development game will probably move away from speed and to additional features to maintain or expand market share. CHECKPOINT 18.3

  29. Study Plan ProblemBud and Wise are the two producers of a new beer. Given the payoffs in the payoff matrix, if they play repeatedly, Bud produces ____ and Wise produces ___. CHECKPOINT 18.3 • 10,000 gallons; 20,000 gallons • 20,000 gallons; 10,000 gallons • 20,000 gallons; 20,000 gallons • 10,000 gallons; 10,000 gallons

  30. Practice Problem 1 Explain each of the following terms: Attempt to monopolize Price fixing Predatory pricing Tying arrangements CHECKPOINT 18.4

  31. Solution An attempt to monopolize is an attempt by a company to drive out its competitors so it can operate as a monopoly. Price fixing is making an agreement with competitors to set a specified price and not to vary it. Predatory pricing is the attempt to drive out competitors by charging a price that is too low for anyone to earn a profit. Tying arrangements exist when a company does not offer a buyer the opportunity to buy one item without buying another item at the same time. CHECKPOINT 18.4

  32. Practice Problem 2 Since 1987, hundreds of hospital mergers have taken place in the United States. Rarely has the U.S. Federal Trade Commission challenged a hospital merger. What can you infer about the structure of the market in hospital services? CHECKPOINT 18.4

  33. Solution The U.S. Federal Trade Commission will not challenge a merger if it will not substantially lessen competition. Such a situation arises if(1) the merger would not increase the likelihood of market power either because strong competitors exist or because the merging hospitals were sufficiently differentiated; (2) the merger would allow the hospitals to reduce cost; or (3) the merger would eliminate a hospital that otherwise would probably have failed and left the market. CHECKPOINT 18.4

  34. In the news Intel will find refuge in the courts The European Union recently fined Intel $1.45 billion because it gave “loyalty discounts” to repeat customers, presumably increasing Intel’s dominance in the microprocessor business—called predatory pricing in the United States. Source: Wall Street Journal, June 2, 2009 Did Intel practice predatory pricing? If every morning you pick up a coffee at Starbucks and it offers you a loyalty discount, is that predatory pricing? CHECKPOINT 18.4

  35. Solution Predatory pricing is the setting of a low price with the aim of driving competitors out of business and then setting the monopoly price when the competitors are gone. If the loyalty discount was intended to drive out AMD, Intel’s competitor, then Intel’s practice was predatory pricing. A loyalty discount at Starbucks isn’t predatory pricing because the market for coffee is competitive. Driving out one coffee outlet will not create monopoly. CHECKPOINT 18.4

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