Transcript Oligopoly - HCC Learning Web

Oligopoly
Look for:
1. Determination of the profit
maximizing price and quantity.
2. Implications for efficiency
Issues of Oligopoly
• Game theory and collusion
• 3 oligopoly models
• Profit maximization
• Efficiency
Please listen to the audio as you work through the
slides.
Learning objectives
Students should be able to thoroughly and
completely explain:
1. The characteristics of oligopoly
2. The conditions under which the Oligopolist firm
achieves profit maximization and loss
minimization.
3. Oligopoly Behavior, including collusion and
game theory.
Some Oligopoly examples
• In the US, 90% of the music produced and sold comes from one
of 4 studios: Universal, Sony, Warner, or EMI. Limited price
competition. Talent search and marketing are critical to gain
advantage.
• The $1 billion stent market is dominated by 3 firms: Boston
Scientific, Johnson & Johnson, and Medtronic. Limited price
competition. R&D is the competitive advantage tool.
• Two companies control US grain trading: Cargil – Continental,
and Archer, Daniels, Midland (ADM).
• 3 Companies control 44% of the global proprietary seed market:
Monsanto, DuPont, and Syngenta.
Some Oligopoly examples
• 4 Companies control over 80% of the US beef market: Tyson,
Cargil, Swift, and National Beef Packing Company
• Airlines – fierce price competition among a small number of
firms. Industry consolidation.
• 4 firms dominate the market for tennis balls – Wilson, Penn,
Dunlop, Spalding
• Oligopolies compete on:
– price, new product development, marketing,
advertising, and development of complements.
The market structures –
compare the characteristics
•
•
•
•
•
•
Type of products
Control over price
Exit and entry
Non price competition
Price output determination
Efficiency
Four Market Models
Oligopoly: characteristics
• A Few Large Producers with large market share:
– “big 3”, “big 6”
• Homogeneous (standardized) or Differentiated Products
•Steel, lead, aluminum, cement – industrial products
•Automobiles, tires, electronic equipment, breakfast
cereals, cigarettes (non-price competition / advertising) –
consumer products
Pure
Competition
Monopolistic
Competition
Oligopoly
Market Structure Continuum
Pure
Monopoly
Four Market Models
Oligopoly: characteristics
• Control Over Price – price makers,
• Mutual Interdependence – profits depend on strategies of others
• Strategic Behavior – self interested behavior that takes into
account the reactions of others.
• Entry Barriers –
•Economies of scale – they have it and exploit it
•Large capital expenditures – refineries, auto assemblers,
commercial aircraft, large scale mfg. facilities.
•Ownership of raw materials – mining, food production
•Patents – big pharma, electronics, seeds
•Preemptive and retaliatory pricing and ad strategies
Pure
Competition
Monopolistic
Competition
Oligopoly
Market Structure Continuum
Pure
Monopoly
Evolution of Oligopolies
Where do Oligopolies come from?
Growth of dominant firms – they just get big
Mergers – auto industry, banking, food manufacturers,
airlines,
They attempt to achieve monopoly power – without
attracting the attention of the anti-trust division of the
Justice Dept.
Oligopoly Behavior
Game theory – a subfield of economics that analyzes the
choices made by rival firms, people, and even governments
as they try to maximize their own well-being while
anticipating and reacting to the actions of others in their
environment.
A key tool during the Cold War period.
Oligopoly Behavior
Game Theory
•
•
Mutual Interdependence
Collusive Tendencies
• Collusion – cooperation with rivals
1. Independent behavior of firms leads to lower prices
– a benefit to consumers
2. Collusive behavior of firms leads to higher prices - a
benefit to business
Incentive to Cheat
Introduction to Game Theory…
Oligopoly Behavior – 2 firms, 2 strategies
A Game-Theory Overview
RareAir’s Price Strategy
High
Uptown’s Price Strategy
A
$12
Low
B
$15
High
$12
C
$6
$6
D
Low
$15
$8
$8
Oligopoly Behavior
A Game-Theory Overview
RareAir’s Price Strategy
High
A
$12
Low
B
$15
Uptown’s Price Strategy
High
$12
C
$6
$6
D
Low
$15
$8
$8
Greatest
Combined
Profit
Oligopoly Behavior
A Game-Theory Overview
RareAir’s Price Strategy
High
A
$12
Low
B
$15
Uptown’s Price Strategy
High
$12
C
$6
$6
D
Low
$15
$8
$8
Independent
Actions
Stimulate
Response
Oligopoly Behavior
A Game-Theory Overview
RareAir’s Price Strategy
High
A
$12
Low
B
$15
Uptown’s Price Strategy
High
$12
C
$6
$6
D
Low
$15
$8
$8
Independent
Actions
Stimulate
Response
Gravitating
to the
Worst Case
Oligopoly Behavior
A Game-Theory Overview
RareAir’s Price Strategy
High
A
$12
Low
B
$15
Uptown’s Price Strategy
High
$12
C
$6
$6
D
Low
$15
$8
$8
Collusion
Invites a
Different
Solution.
Oligopoly Behavior
A Game-Theory Overview
RareAir’s Price Strategy
High
A
$12
Low
B
$15
Uptown’s Price Strategy
High
$12
C
$6
$6
D
Low
$15
$8
$8
Collusion
Invites a
Different
Solution.
Oligopoly Behavior
A Game-Theory Overview
RareAir’s Price Strategy
High
A
$12
Low
B
$15
Uptown’s Price Strategy
High
$12
C
$6
$6
D
Low
$15
Collusion
Invites a
Different
Solution.
$8
$8
But, the
incentive
to cheat
is very real.
Three Oligopoly Models
No Standard Model due to the diversity of oligopoly
Diversity of Oligopolies
1. Tight oligopolies – 2 to 3 firms dominate industry
2. Loose oligopolies – 6 to 7 firms share 70% or more of
the market (the smaller firms share the rest)
3. Both sell differentiated or standard products
Complications of Interdependence
1. Firms cannot (or have great difficulty) estimate their
demand or MR data, and are challenged to
determine their profit maximizing price and output
2. Can’t predict the reaction of rivals with certainty.
Three Oligopoly Models
Alternative models Two interrelated characteristics:
1. If the macro economy is stable then prices are typically inflexible
2. When prices do change, firms are likely to change their prices together
The 3 Models
1 – Kinked Demand Curve model*
2 – Cartels and Collusion model
3 – Price Leadership model
Kinked Demand Curve Theory
Assumptions:
•3 firms
•Independent pricing, no collusive behavior
•Differentiated products
What does a firms’ demand curve look like?
Location and shape depends on how rivals react to a price change
Two plausible assumptions about behavior of rivals.
1. The 2 rivals match price changes of firm #1
1. Firm 1 cuts price - firm #1 would achieve small sales increase because rivals also cut
price to match.
2. Firm 1 raises price – firm #1 has small sales loss because rivals also raise prices to
match.
2. The 2 rivals ignore price changes of firm #1
1. Firm 1 lowers price and rivals don’t. Firm 1 gains sales.
2. Firm 1 raises price and rivals don’t. Firm 1 looses sales.
Conclusion about strategy
• Rival behavior will depend on the direction of firm 1’s
price change!!
• Key point!
• There exists a price:
– below which they will match price decreases and
– above which they will ignore price increases.
• Given a price change by firm 1,
– Case 1:
• Rivals will ignore price increases above that price and gain
customers.
– Case 2:
• Rivals will match price decreases below that price to avoid losing
customers
Kinked Demand Theory:
Noncollusive Oligopoly
Price
Case 1.
Firm 1’s demand and marginal revenue
curves assuming a price decrease by firm 1
and the 2 rivals match the change. Firm 1
receives only a small increase in sales.
D1
Quantity
MR1
Kinked Demand Theory:
Noncollusive Oligopoly
Price
Case 2.
Firm 1’s Demand and marginal revenue
curves assuming a price increase by firm 1
and the 2 rivals ignore the price increase.
Firm 1 has only a small sales loss.
D2
D1
Quantity
MR1
MR2
Kinked Demand Theory:
Price
Noncollusive Oligopoly
Rivals tend to
follow a price cut
D2
D1
Quantity
MR1
MR2
Kinked Demand Theory:
Price
Noncollusive Oligopoly
Rivals tend to
follow a price cut
or ignore a
price increase
D2
D1
Quantity
MR1
MR2
Kinked Demand Theory:
Noncollusive Oligopoly
Price
Effectively creating
a kinked demand curve
For firm #1
D2
D1
Quantity
MR1
MR2
Kinked Demand Theory:
Noncollusive Oligopoly
Price
Effectively creating
a kinked demand curve
For firm #1
D
Quantity
Kinked Demand Theory:
Noncollusive Oligopoly
Price
Effectively creating
a kinked demand curve
For firm #1
Note: the MR curves
MR2
D
Quantity
MR1
Kinked Demand Theory:
Noncollusive Oligopoly
Profit maximization or
loss minimization for firm #1
occurs at the kink where
MR = MC
Price
MC1
MR2
MC2
D
Quantity
MR1
Cartels and Other Collusion
Oligopoly is conducive to collusion.
If a few firms face identical or highly
similar demand and costs...
they will tend to seek joint profit
maximization.
Graphically…
Cartels and Other Collusion
Price and costs
3 similar Colluding Oligopolists Will Split the Monopoly Profits by limiting
output and setting a single common price.
Economic
Profit
MC
P0
ATC
A0
D
MR = MC
MR
Q0
Cartels and Other Collusion
Overt Collusion
•Cartels with defined – written agreements
•The OPEC Cartel
Covert Collusion
•U.S. – It is Illegal
•Tacit Understandings – gentlemen's agreements
•1993 Borden, Pet, Dean Foods bid rigging on
milk products
•1996 ADM and 3 Japanese and South Korean
firms price fixing on livestock feed additives.
•1960’s - manufacturers of heavy electrical
equipment including General Electric
Cartels and Other Collusion
Obstacles to Collusion
• Demand and Cost Differences
• Number of Firms: more firms = less collusion
• Cheating
• Recession – pressure to lower prices.
• Potential Entry – successful collusion requires
blocking entry in some way.
• Antitrust Law
Price Leadership Model
Leadership Tactics Requires implicit understanding among the players such
that they can coordinate prices without engaging in
outright collusion based on formal agreements and
secret meetings. (General Mill, Post Foods, Kellogs)
•Infrequent Price Changes
•Communications – press conferences
•Limit Pricing
•They want to keep price below the short
run profit maximizing level to discourage
new competitors from entering.
Breakdowns in Price Leadership - Price Wars
Oligopoly and Advertising
•
•
•
•
•
Product development and advertising are less easily duplicated by
rivals
Oligopolists typically financially strong – Cash flow, economic profit
Positive Effects of Advertising
• Providing information to consumers
• Diminishes monopoly power – Toyota and Honda vs the Big 3 of
the USA (check out the 1989 pre-launch commercial)
• Enhance efficiency
• Greater competition, more technological progress, higher
output, lower LR ATC, better able to achieve economies of
scale.
Potential Negative Effects of Advertising
• Disinformation to consumers
• Barrier to entry
Brand Development
Oligopoly and efficiency
1. Many oligopolists sustain economic profit
2. Production often occurs where price > MC and
price > minimum ATC.
3. Production is below the output at which ATC is
minimized
4. Neither productive efficiency nor allocative
efficiency is achieved.
Oligopoly and efficiency
Pure Competition conditions:
Productive Efficiency: P = Minimum ATC and
Allocative Efficiency: P = MC
Oligopoly Situation relative to efficiency:
P > Minimum ATC
P > MC
Output is below the output at which ATC is minimized
monopolistic competition
product differentiation
nonprice competition
excess capacity
oligopoly
homogeneous oligopoly
differentiated oligopoly
strategic behavior
mutual interdependence
concentration ratio
interindustry competition
import competition
Herfindahl index
game-theory model
collusion
kinked-demand curve
price war
cartel
tacit understandings
price leadership