OligopolyOligopoly

Alexa HartmayerAlexa Hartmayer

Key ConceptsKey Concepts

A market Situation in which there are A market Situation in which there are very few sellers. Each seller knows very few sellers. Each seller knows

that the other sellers will react to its that the other sellers will react to its changes in prices and quantities.changes in prices and quantities.

- Economics Today (pg 619)- Economics Today (pg 619)

Characteristics Characteristics Small Number of FirmsSmall Number of Firms Homogeneous or Differentiated productsHomogeneous or Differentiated products

• Homogeneous: Cement, Zinc, CopperHomogeneous: Cement, Zinc, Copper• Differentiated: Automobiles, Greeting CardsDifferentiated: Automobiles, Greeting Cards

Interdependent: Every individual firm Interdependent: Every individual firm must consider the actions of other firmsmust consider the actions of other firms• Strategic Dependence: When one firm Strategic Dependence: When one firm

counters another’s price, quality, advertising, counters another’s price, quality, advertising, to ensure the firms welfare to ensure the firms welfare

Causes of Oligopolies (1)Causes of Oligopolies (1)

Economies of Scale: Economies of Scale: • Firms total cost curve will slope Firms total cost curve will slope

downward as more outputs are downward as more outputs are produced. Average total cost will be produced. Average total cost will be reduced as firms expand the scale of reduced as firms expand the scale of their operation. their operation.

• Smaller firms will have a tendency to be Smaller firms will have a tendency to be inefficient (ATC greater than large inefficient (ATC greater than large firms). They are either absorbed or go firms). They are either absorbed or go out of business. out of business.

Causes of Oligopolies (2)Causes of Oligopolies (2)

Barriers to Entry: Difficult to EnterBarriers to Entry: Difficult to Enter• Legal Barriers (patents)Legal Barriers (patents)• Control over Resources Control over Resources • Cartels (OPEC)Cartels (OPEC)• Collusion (illegal in United States)Collusion (illegal in United States)

Causes of Oligopolies (3)Causes of Oligopolies (3)

Mergers: Joining of two or more firms Mergers: Joining of two or more firms under single ownership and controlunder single ownership and control• Horizontal Merger: Joining of firms that Horizontal Merger: Joining of firms that

are producing or selling a similar are producing or selling a similar productproduct

• Vertical Merger: Joining of a firm with Vertical Merger: Joining of a firm with another to which it sells an output or another to which it sells an output or from which it buys an input from which it buys an input

Game TheoryGame Theory

Analytical framework in which two or more Analytical framework in which two or more individuals, companies, or nation compete individuals, companies, or nation compete for certain payoffs that depend on the for certain payoffs that depend on the strategy that others employstrategy that others employ• Low Price/High Price=Winner and LoserLow Price/High Price=Winner and Loser• Low Price/Low Price=Winner and WinnerLow Price/Low Price=Winner and Winner• High Price/High Price=Big Winner and Big High Price/High Price=Big Winner and Big

WinnerWinner Collusion (illegal in US)Collusion (illegal in US)

Nash Equilibrium: When the strategies of all Nash Equilibrium: When the strategies of all the player are optimum (self enforcing)the player are optimum (self enforcing)

Kinked Demand CurveKinked Demand Curve

Price inflexibility Price inflexibility Above P1 is Above P1 is

relatively elasticrelatively elastic Below P1 is Below P1 is

relatively inelasticrelatively inelastic MC=MR is profit MC=MR is profit

maximization maximization

Losses & ProfitsLosses & Profits

Breaking EvenBreaking Even

Comparing Market StructuresComparing Market Structures

Refer to page 633 in textbookRefer to page 633 in textbook

Oligopoly Question (1)Oligopoly Question (1)

(E)- The strategy for (E)- The strategy for Bright is fully Bright is fully dependant on dependant on Sparkle’s strategy, Sparkle’s strategy, and Sparkle’s and Sparkle’s dominant strategy dominant strategy is strategy 1is strategy 1

(2)(2) Produces the Best Produces the Best

results for every results for every possible action the possible action the other participants other participants taketake

Firms will try to Firms will try to maximize their profits maximize their profits by picking their by picking their dominant strategy, or dominant strategy, or by watching the by watching the other firms dominant other firms dominant strategystrategy

(3)(3)

Interdependence in Interdependence in an industry.an industry.

Game theory is a Game theory is a way of describing way of describing the various the various outcomes in any outcomes in any situation involving situation involving two or more two or more competing firms.competing firms.

Answers to Free ResponseAnswers to Free Response

a)a) Mutual Interdependence, the behavior of one Mutual Interdependence, the behavior of one firm affects the other.firm affects the other.

b)b) Evening Departure would be the best Evening Departure would be the best strategy.strategy.

c)c) Morning Departure is dominant for Windward.Morning Departure is dominant for Windward.

d)d) Choosing an evening strategy is not Choosing an evening strategy is not dominant. Airtouch does not have a dominant dominant. Airtouch does not have a dominant strategy because its best payoff depends on strategy because its best payoff depends on Windwards strategy.Windwards strategy.

e)e) $700 will be Windwards daily profit.$700 will be Windwards daily profit.

Ode to the OligopolyOde to the Oligopoly

They rise from ashes of enemies past;They rise from ashes of enemies past;the truest gluttons any shall see.the truest gluttons any shall see.

Consuming the horizon, the zenithConsuming the horizon, the zenithof humanities sullen world.of humanities sullen world.

Asking in voices of sinister mirthAsking in voices of sinister mirth““Shall we play a game?”Shall we play a game?”

Failing to follow in suite will lead to lossFailing to follow in suite will lead to lossYet complying without a care Yet complying without a care

Will cause lady of law to weigh her scalesWill cause lady of law to weigh her scalesLaying your avarice bare to blinded eyesLaying your avarice bare to blinded eyes

Real World LinksReal World Links

1.1. http://www.torontosun.com/money/http://www.torontosun.com/money/2011/01/19/16951226.html2011/01/19/16951226.html

2.2. http://www.dofonline.co.uk/content/http://www.dofonline.co.uk/content/view/5080/152/view/5080/152/