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Oligopoly: A market in which the actions of individual firms materially affect the industry price level Types of Oligop

Oligopoly: A market in which the actions of individual firms materially affect the industry price level Types of Oligopoly homogeneous product type : oil, aluminium, cement, and other ‘commodity’ products, more or less perfect substitutes heterogeneous types (three),

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Oligopoly: A market in which the actions of individual firms materially affect the industry price level Types of Oligop

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  1. Oligopoly: A market in which the actions of individual firms materially affect the industry price level Types of Oligopoly homogeneous product type: oil, aluminium, cement, and other ‘commodity’ products, more or less perfect substitutes heterogeneous types (three), 1. product differentiation and branding of technically similar products such as colas and soap powders to make them imperfect substitutes. Advertising a competitive weapon. Faculty of Business and Economics

  2. Types of Oligopoly (cont.) • 2. ongoing product development type, where quality and features develop over time, such as autos, civil aircraft and pc’s, and products are imperfect subs. Product development as a competitive weapon. • innovation based oligopolies. competition on the basis of introduction of new products, pharmaceuticals and defence equipment. R&D as a competitive weapon. • **Key point is that competition is about advertising, product development, and R&D as well as price and output, but we cannot go into all of these dimensions in this introduction. Faculty of Business and Economics

  3. BERTRAND BASICS EXPLAINED Two firms producing a homogeneous product (oil, cement) now choose to set their prices (not their outputs) and to let the market decide what level of production can be sold at that price. Each still wants to max. its own profits. And each needs to take account of the possible actions of the other(s)…….. ‘strategic interdependence’---which refers to fact that the result (pay-off) of my decisions (e.g. price, R&D, advertising) now depend on the choices you make or might make and of course vice versa. Faculty of Business and Economics

  4. BERTRAND BASICS EXPLAINED (cont.) Consider the logic of the first firm. It argues that for any given price (p2) set by firm two, its own best (profit max.) price will be just below this level. Because? But the second firm also thinks that its best price is a price just below any price that might be set by firm one. Faculty of Business and Economics

  5. BERTRAND BASICS EXPLAINED (cont.) So the only stable (equilibrium) outcome, where both are doing their best given what the other is doing... is one where price equals the competitive level and above normal profits are squeezed to zero. Because at any other price one firm feels it can do better by reducing its price. It isn’t worried about the industry, only about itself. It is trying to do the best it can do given what the others might be doing. So with just two firms we get a competitive outcome! Faculty of Business and Economics

  6. BERTRAND BASICS EXPLAINED (cont.) So the only stable (equilibrium) outcome, where both are doing their best given what the other is doing... is one where price equals the competitive level and above normal profits are squeezed to zero. Because at any other price one firm feels it can do better by reducing its price. It isn’t worried about the industry, only about itself. It is trying to do the best it can do given what the others might be doing. So with just two firms we get a competitive outcome! Faculty of Business and Economics

  7. GETTING ROUND THE BERTRAND TRAP The importance of differentiating the product. If the enterprises concerned can convincingly differentiate the product this may allow them a way out of the destructive logic of price competition. This is no doubt why firms in industries like oil and soap powder and tobacco and airline travel spend heavily on differentiation activity. With differentiation the logic of the firms changes from mutually destructive price cutting to a situation where higher prices are possible and so above normal profits can prevail. Faculty of Business and Economics

  8. GETTING ROUND THE BERTRAND TRAP (cont.) The logic involved this time is like this (intuitive version). With different products, Sales (firm one) = f (p1, p2) So profits (firm one) will be a function of both prices. Sales will fall as you raise your own price but not to the extent that you lose all customers, assuming consumers are convinced by the differences, Faculty of Business and Economics

  9. GETTING ROUND THE BERTRAND TRAP (cont.) But sales will rise as your rival raises its price because you will gain some sales (and vice versa for your rivals). So if you are doing your best given what the other firm might do, then your profit max. price will now be an increasing function of that of your rivals, and vice versa. This leads to a predicted outcome where prices are above the competitive level and profits are above normal. So differentiation works as long as the costs involved do not soak up the healthier industry profits available. Faculty of Business and Economics

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