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Oligopoly

Oligopoly. Characteristics of oligopoly Small number of firms Interdependence Strategic dependence Whatever you do, I shall do – the zero percent financing. Oligopoly. Strategic Dependence

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Oligopoly

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  1. Oligopoly • Characteristics of oligopoly • Small number of firms • Interdependence • Strategic dependence • Whatever you do, I shall do –the zero percent financing

  2. Oligopoly • Strategic Dependence • A situation in which one firm’s actions with respect to price, quality, advertising, and related changes may be strategically countered by the reactions of one or more other firms in the industry • LIKE PLAYING CHESS

  3. Oligopoly • Why oligopoly occurs • Economies of scale • Barriers to entry • Mergers • Vertical mergers • Horizontal mergers

  4. Oligopoly • Vertical Merger • The joining of a firm with another to which it sells an output or from which it buys an input • Horizontal Merger • The joining of firms that are producing or selling a similar product

  5. Oligopoly • Measuring industry concentration • Concentration Ratio • The percentage of all sales contributed by the leading four or leading eight firms in an industry

  6. 400 88.9% = 450 Four-firm concentration ratio = Computing the Four-Firm Concentration Ratio Annual Sales Firm ($ Millions) 1 150 2 100 3 80 4 70 5 through 25 50 Total number of firms in Industry = 25 Total 450

  7. Computing the Four-Firm Concentration Ratio Percentage of Value of Total Domestic Shipments Accounted Industry For By the Top Four Firms % Domestic motor vehicles 84 Breakfast cereals 85 Soft drinks 69 Tobacco products 93 Primary aluminum 59 Household vacuum cleaners 59 Electronic computers 45 Printing and publishing 23 Source: U.S. Bureau of the Census

  8. Models of Oligopoly • Game Theory • A way of describing the various possible outcomes in any situation involving two or more interacting individuals when those individuals are aware of the interactive nature of their situation and plan accordingly

  9. Game Theory • Cooperative Game • A game in which the players explicitly cooperate to make themselves better off • Noncooperative Game • A game in which the players neither negotiate nor cooperate in any way • Zero-Sum Game • A game in which any gains within the group are exactly offset by equal losses by the end of the game • Negative-Sum Game • A game in which players as a group lose at the end of the game

  10. Strategic Behaviorand Game Theory • Positive-Sum Game • A game in which players as a group are better off at the end of the game

  11. Strategic Behaviorand Game Theory • Strategies in noncooperative games • Strategy • Any rule that is used to make a choice • Any potential choice that can be made by players in a game • Dominant Strategies • Strategies that always yield the highest benefit

  12. Prisoner’s Dilemma • You and your partner rob a bank and get caught.

  13. Prisoner’s Dilemma • You are separated and given these options: • Both confess and get 5 years in jail • Neither confess and get 2 years • One confess and the other does not • Confessor goes free • One who does not confess get 10 years

  14. The Prisoners’ Dilemma Payoff Matrix Figure 25-3

  15. Strategic Behaviorand Game Theory • Applying game theory to pricing strategies • Would you choose a high price or a low price? • Remember • No collusion

  16. Strategic Behaviorand Game Theory Figure 25-4

  17. Strategic Behaviorand Game Theory • Opportunistic Behavior • Actions that ignore the possible long-run benefits of cooperation and focus solely on short-run gains

  18. Strategic Behaviorand Game Theory • Opportunistic behavior • Implies a noncooperative game • Not realistic • We make repeat transactions

  19. Strategic Behaviorand Game Theory • Tit-for-Tat Strategic Behavior • In game theory, cooperation that continues so long as the other players continue to cooperate

  20. International Example:Strategically Relating Subsidies to Nuclear Weapons • Pakistan agreed to certain conditions for an IMF loan • In 1999, the IMF discovered that Pakistan had spent much of this loan on the development of nuclear weapons • Soon, Pakistan had to default on its debt • Why would Pakistan engage in this behavior with the IMF?

  21. Price Rigidity and the Kinked Demand Curve d1 is relatively elastic • if one firm raises its price the others will not and it will lose market share d2 is relatively inelastic • if one firm lowers its price the others lower their price so gain in sales is small Figure 25-5, Panel (a)

  22. Price Rigidity and the Kinked Demand Curve The kinked demand curve indicates the possibility of price rigidity Figure 25-5, Panel (b)

  23. Price Rigidity and theKinked Demand Curve Changes in cost do not impact output and prices as long as MC remains in the vertical portion of MR Figure 25-6

  24. Criticisms of theKinked Demand Curve • Cannot determine P0 • Empirical evidence does not confirm the kinked demand theory d1 P0 MR1 Price and Marginal Revenue per Unit d2 MR2 q0 Quantity per Time Period

  25. Strategic Behavior • Do pet products have nine lives? • H.J. Heinz’s Pet Products Company • Dropped its price of 9-Lives cat food by 22% to meet increased competition from Nestle, Quaker, Grand Metropolitan, and Mars • Heinz then decided to raise prices • Its competition did not and Heinz’s market share dropped from 23 to 15 percent

  26. Strategic Behavior with Implicit Collusion: A Model of Price Leadership • Price Leadership • A practice in many oligopolistic industries in which the largest firm publishes its price list ahead of its competitors, who then match those announced prices

  27. Strategic Behavior with Implicit Collusion: A Model of Price Leadership • Price War • A pricing campaign designed to drive competing firms out of a market by repeatedly cutting prices

  28. Strategic Behavior with Implicit Collusion: A Model of Price Leadership • Markets where price wars are common • Cigarettes • Long-distance telephone companies • Airlines

  29. Strategic Behavior with Implicit Collusion: A Model of Price Leadership • Markets where price wars are common • Diapers • Frozen foods • PC hardware and software

  30. Strategic Behavior with Implicit Collusion: A Model of Price Leadership • Cigarette price wars • Philip Morris cut Marlboro by 40 cents a pack • RJR Nabisco matched the cut for Camel • Marlboro’s market share rose from 22.1% to 27.3% • Profits and stock prices fell

  31. Strategic Behavior with Implicit Collusion: A Model of Price Leadership • Cigarette price wars • Phillip Morris reduced prices by 18% and sales went up by only 12.5% • Profits fell by 25%

  32. Deterring Entry Into an Industry • Entry Deterrence Strategy • Any strategy undertaken by firms in an industry, either individually or together, with the intent or effect of raising the cost of entry into the industry by a new firm

  33. Deterring Entry Into an Industry • Increasing entry cost • Threat of price wars • Government regulations • Environmental regulation • Safety standards

  34. Deterring Entry Into an Industry • Limit-Pricing Strategies • A model that hypothesizes that a group of colluding sellers will set the highest common price that they believe they can charge without new firms seeking to enter that industry in search of relatively high profits

  35. Deterring Entry Into an Industry • Raising customer’s switching cost • Examples • Non-compatible software • Non-transferability of college courses

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