econ 202: principles of microeconomics chapter 13 oligopoly

ECON 202: Principles of Microeconomics

Chapter 13

Oligopoly

Oligopoly 2ECON 202: Princ. of Microeconomics

Oligopoly

1. Oligopoly and Barriers to Entry.

2. Using Game Theory to Analyze Oligopoly.

3. Sequential Games and Business Strategy.

4. The Five Competitive Forces Model.


Introduction Oligopoly is market structure where:

Few competitors. Identical or differentiated products. Restrictions to entry.

In case of oligopolistic markets, revenues of the firms depend on actions of other competitors.

If a firm cut its price, number of units sold depends on how other firms react. If other firms don’t do anything, sell more. If other firms also cut prices, sales will not increase much or can

even decrease. Marginal revenue depends on actions of other firms. Approach to analyze oligopolies: game theory.


1. Oligopoly and Barriers to Entry Oligopolistic markets have few firms

How many firms is “few”? US Bureau of Census publishes 4-firm concentration

ratios per industry. More than 40% indicates oligopolistic market.

Critics Consider only sales by national firms In some industries, competition is mainly local. (restaurants) Some firms compete in different industries. (Wal Mart in discount

department stores, supermarkets and retail toy stores) Herfindahl-Hirschman Index (HHI)

Sum of squared shares: 302 + 302 + 202 + 202 = 2,600 HHI > 1,800 : oligopolistic markets.


1. Oligopoly and Barriers to Entry

RETAIL TRADE MANUFACTURING

INDUSTRYFOUR-FIRM

CONCENTRATION RATIO

INDUSTRYFOUR-FIRM

CONCENTRATION RATIO

Discount Department Stores 95% Cigarettes 95%

Warehouse Clubs and Supercenters 92% Beer 91%

Hobby, Toy, and Game Stores 72% Breakfast Cereal 82%

Athletic Footwear Stores 71% Aircraft 81%

College Bookstores 70% Automobiles 76%

Radio, Television, and Other Electronic Stores

69% Dog and Cat Food 76%

Pharmacies and Drugstores 53% Dog and Cat Food 64%



Barriers to entry Economies of scale



Ownership of a Key Input Aluminum Company of America (Alcoa) access to high-quality

bauxite. De Beers Company of South Africa access to diamonds.

Government-imposed barriers Occupational licensing (doctors and dentists) Restrictions to international trade (tariffs and quotas)

Since entry is restricted, firms can sustain economic profits over a long period.


2. Using Game Theory to Analyze Oligopoly

Game theory: The study of how people make decisions in situations in which

attaining their goals depends on their interactions with others.

Games have three characteristics: Rules. Strategies. Payoffs.



Duopoly: price competition between two firms.

Firms can collude, but is against the law. (Sherman Act)



For each firm, to charge $400 is a dominant strategy. The best strategy for a player, regardless of what the other

players decide. ($400, $400) is a Nash equilibrium.

A situation where each player is choosing its best strategy, given the others players’ strategies.

A situation where no player has an incentive to change of strategy.

Equilibrium is not best possible result for the firms, but it results because each firm pursues its own interest. Noncooperative equilibrium.

If firms decide to cooperate and play ($600, $600), then result increases their mutual payoff. Cooperative equilibrium.



Types of games where individual maximization of payoff leaves everyone worse off are called prisoner’s dilemma.

Nash Equilibrium is (defect, defect). Challenge to Adam Smith’s idea of self-interest.



In most business situations games are played repeatedly. Firms can collude implicitly to reach the cooperative equilibrium.

Example: “lowest price guarantee” Firms send a signal to competitors that if they charge lower

price, its strategy will be the same. Firms have the incentive to keep the high price.



When firms can collude: cartels (OPEC) However, firms can have incentives to stop cooperation,

which makes difficult to sustain agreements.


3. Sequential Games and Business Strategy

Oligopolistic firms can deter the entry of new firms.

Best strategy for WalMart is to build the large store, deterring entry from Target.



Best strategy for firm is to build the small store and let Target entry the market.



Bargaining

If TruImage says that will not accept a deal at $20: noncredible threat.


4. The Five Competitive Forces Model

Forces that determine the level of competition in an industry.


4. The Five Competitive Forces Model

Competition from existing firms. Educational testing service: SAT and ACT vs. GRE.

Threat from potential entrants. Railways.

Competition from substitute goods or services. Train vs. flight

Bargaining power of buyers. Automobile makers and tire suppliers.

Bargaining power of suppliers. Technicolor and color movies.

ECON 202: Principles of Microeconomics

Chapter 13

Oligopoly

econ 202: principles of microeconomics chapter 13 oligopoly

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