Transcript Oligopoly
OLIGOPOLY Chapter 26 What determines how much market power a firm has? How do firms in an oligopoly set prices and output? What problems does an oligopoly have in maintaining price and profit? What does market power really mean? Market power is the key to control. Monopoly is a type of power that all firms dream of, yet pure monopoly is not permitted in our economy. The next best thing is to PUSH the power base to the very edge of government acceptance. Gaining market share is a common term we hear from businesses and Wall Street. MARKET POWER Tom Thumb wants to gain market share from Albertsons. Wal-Mart wants market share from Kmart… boy did they get it! Central Market wants market share from Whole Foods Oligopoly An important market structure that we have yet to discuss involves a situation in which a few large firms comprise an entire industry. They are not perfectly competitive, nor even monopolistically competitive, and because there are several of them a pure monopoly doesn’t exist. Oligopoly (cont'd) Oligopoly A market situation in which there are very few sellers. Each seller knows that the other sellers will react to its changes in prices and quantities. Oligopolist The oligopolist is a price searcher. It produces the quantity of output at which MR = MC. Characteristics of Oligopoly 1. 2. 3. 4. 5. Few firms control the market High barriers to entry Produce either differentiated or homogeneous products Lack of available substitutes Name some examples! Oligopoly (cont'd) Why oligopoly occurs Economies of scale Barriers to entry Mergers Vertical mergers Horizontal mergers Characteristics of Market Structures Market Structure Characteristics Perfect Competition Monopolistic Competition Oligopoly Number of firms Very large number Many Few Barriers to entry None Low High Market power (control over price None Some Substantial Type of product Standardized Differentiated Standardized or differentiated More Examples Market Structure Characteristics Perfect Competition Duopoly Monopoly Number of firms Very large number Two One Barriers to entry None High High Market power (control over price None Substantial Substantial Type of product Standardized Standardized Unique or differentiated Why are certain industries composed of only a few firms? Because cost economies and other barriers to entry keep the numbers small (plus mergers keep out the smaller guys) (enter the political key on who decides if mergers are not eliminating competition) Where economies of scale are substantial, reasonably efficient production will be possible only with a small number of producers… efficiency requires that the productive capacity of each firm be large relative to the total market. Continued Technological progress has made more and more economies of scale attainable over time. Other barriers such as the development or persistence of some oligopolies through patents, control of strategic raw materials, in some cases prodigious advertising (Budweiser) outlays which add a financial barrier to entry for other firms. Examples of Oligopolies 1. automobile 2. beer 3. petroleum 4. steel 5. tire 6. gypsum 7. aluminum 8. airline 9. cell phone industry What do we see in the 21St Century? Many big corporations seeking more market share have been following a simple rule. “Don’t build what you can buy.” WSJ, February13,2006 Part of this zeal to purchase is to fill some of the empty production space created in the building boon of late 90’s…. This will allow for movement to capacity production which is more efficient. Oligopoly (cont'd) 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 Oligopoly (cont'd) Measuring industry concentration Concentration Ratio The percentage of all sales contributed by the leading four or leading eight firms in an industry Sometimes called the industry concentration ratio Table 26-1 Computing the FourFirm Concentration Ratio Table 26-2 Four-Firm Domestic Concentration Ratios for Selected U.S. Industries Example: The Four-Firm Concentration Ratio in the U.S. Auto Industry In a recent year, the bulk of U.S. auto sales were accounted for by these seven firms: General Motors (19.1 percent) Ford (16.5 percent) Toyota (15.3 percent) Honda (10.6 percent) Chrysler (9.3 percent) Nissan (7.9 percent) Hyundai (7.7 percent) The four-firm concentration ratio for the U.S. auto industry was therefore 61.5 percent. Oligopoly (cont'd) The more U.S. firms face competition from the rest of the world, the less any current oligopoly will be able to exercise market power Strategic Behavior and Game Theory Explaining the pricing and output behavior of oligopoly markets Reaction Function The manner in which one oligopolist reacts to a change in price, output, or quality made by another oligopolist in the industry Strategic Behavior and Game Theory (cont'd) 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 The plans made by these individuals are known as game strategies Market Power So, where does government enter in this equation? The Anti-trust division of the Justice Department and the applicable IRC has to decide if a gain of X% of the market share is destroying competition or not when a merger is suggested. HP/Compaq (will this destroy the competitive edge for Dell?) 1. 2. In 1992 the Justice Dept decided to use other parameters in determining anti-trust and destructive competition---barrier to entry. If low, then highly concentrated industry might be compelled to behave more competitively. (hence, contestability and structure were now added to the merger equation.) Game Theory Each oligopolist has to consider the potential responses of rivals when formulating price or output strategies. The payoff to an oligopolist’s price cut depends on how its rivals respond. Game theory is the study of decision making in situations where strategic interaction (moves and countermoves) between rivals occurs. Allocation of Market Shares One way to distribute output is a cartel agreement. A cartel is a group of firms with an explicit agreement to fix prices and output shares in a particular market. Cartels are illegal in the United States… OPEC (Organization of Petroleum Exporting Countries) is the most famous now.(11 countries) http://www.opec.org Price and Output . To maximize industry profit, the firms in an oligopoly must agree on a monopoly price and agree to maintain it by limiting production and allocating market shares.===Illegal in U.S. – OPEC is example of how this works (Cartel) Drug Cartel in Mexico PRICE FIXING IS ILLEGAL The examples are plentiful. The Ivy League schools in 2001 were caught by Justice Dept for fixing prices in biding for students who qualified for financial aid… which they had been doing for over 30 years. Price Leadership or Fixing? Leadership is acceptable.. Fixing is not. Sometimes they send up smoke signals to alert their rivals about a price increase in hopes the rivals will follow. Whenever oligopolist successfully raises prices, unit sales will decline. What happens if AA lowers airline fares? Price or Cost (dollars per unit) Maximizing Oligopoly Profits Industry marginal cost Profitmaximizing price Industry average cost Market demand Profits Average cost at profitmaximizing output J Industry marginal revenue Profit-maximizing output 0 Quantity (units per period) Reality of this Coordination Problems There is an inherent conflict in the joint and individual interests of oligopolists. Each oligopolist wants industry profits to be maximized. Each oligopolist wants to maximize it’s own market share. To avoid self-destructive behavior, each oligopolist must coordinate production decisions. QUESTIONS?