oligopoly and duopoly
TRANSCRIPT
OLIGOPOLY
GROUP NO. # 10
MEMBERS:Roll Nos.
Abhishek Verma 105
Abhishek Patil 085
Gauri Patil 091
Namrata Verma 065
Ravi Prakash Singh 090
Santosh Nair 084
Vikrant Gole 075
INDEX Introduction Examples of Oligopoly Characteristics of Oligopoly Determinants of Oligopoly Forms of Oligopoly Kinked Demand Curve Why Oligopoly exist? Game Theory Approach Dominant Strategy Prisoner’s Dilemma Price Leadership Strategy Price Discrimination Strategy Characteristics of different types of markets
INTRODUCTION The term ‘Oligopoly’ has been derived from two
Greek words: ‘Oligi’ which means few and ‘Polien’ means
sellers. Thus, Oligopoly is a competition among few big
sellers each of them selling either homogenous or heterogeneous products.
Oligopoly refers to a market situation where there are a few sellers(2-10), selling homogenous or differentiated products in a market.
Oligopoly is often describes as ‘Competition among few’.
INTRODUCTION
An oligopoly is a market dominated by a small number of strategically interdependent firms.
When just a few large firms dominate a market:Actions of each one have an important impact
on the others. In such a market, each firm recognizes its
strategic interdependence with others. When the products of a few sellers are
homogenous, it is known as ‘Pure Oligopoly’. When the products of a few sellers are
differentiated, but close substitutes of each other, it is known as ‘Differentiated Oligopoly’.
EXAMPLES OF OLIGOPOLY
Automobiles Cereals Steel Soup
CHARACTERISTICS OF OLIGOPOLY
Few Sellers An oligopoly market can be characterized by a few
sellers and their number is limited. (usually not more than 10)
Oligopoly is a special type of imperfect market. It has a large number of buyers but a few sellers.
Homogenous or Differentiated Product The Oligopolists produce either homogenous or
differentiated products. Products may be differentiated by way of design ,
trademark or service
CHARACTERISTICS OF OLIGOPOLY Interdependence The most important feature of Oligopoly is the
interdependence in decision making of the few firms which comprise the industry.
The reactions of the rival firms may be difficult to guess. Hence price is indeterminate under Oligopoly.
High Cross Elasticities The cross elasticity of demand for the products
of oligopoly firms is very high. Hence there is always the fear of retaliation by rivals.
Each firm is conscious about the possible action and reaction of competitors while making any change in price or output.
CHARACTERISTICS OF OLIGOPOLY
Competition Competition is unique in an oligopoly market. It
is a constant struggle against rivals. Uncertainty The interdependence of other firms for one’s own
decision creates an atmosphere of uncertainty about price and output
Price Rigidity In an oligopoly market each firm sticks to its own
price to avoid a possible price war. The price remains rigid because of constant
fear of retaliation from rivals.
Market Structure Continuum
PureCompetition
PureMonopoly
MonopolisticCompetition Oligopoly
Oligopoly:•A Few Large Producers•Homogeneous or Differentiated Products
•Control Over Price, But Mutual Interdependence
•Strategic Behavior•Entry Barriers
MARKET STRUCTURE
What determines if market is an Oligopoly?
The concentration ratio can be used as a guide
CONCENTRATION RATIO
Concentration ratios are measures of the total output that is produced in an industry by a given number of firms in the industry.
The most common concentration ratios are the CR4 and the CR8, which means the 4 and the 8 largest firms.
Two Common Ratios Four-Firm Concentration Ratio: It measures the
total market share of the 4 largest firms in an industry.
Eight-Firm Concentration Ratio: It measures the total market share of the 8 largest firms in an industry.
What concentration ratio constitutes an Oligopoly?
There is no magic number, but if a large percentage of the sales are from the 4 largest firms, it’s
an Oligopoly.
What is an example of a high concentration ratio?
In the Mobile Phone Industry the leading 4 constitutes 71% of
total sales.http://www.ft.com/cms/s/0/1c7540a4-d831-11dd-bcc0-000077b07658.html
What determines if market is an Oligopoly?
Herfindahl-Hirschman Index or HHI can also be used.
HERFINDAHL-HIRSCHMAN INDEX (HHI)
It is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them.
A measure of industry concentration, calculated as the sum of the squares of the market shares held by each firm in the industry.
Calculation of HHI HHI = s1
2 + s22 + …..sn
where Si = the ith firms market share,
n= number of firms in industry
HERFINDAHL-HIRSCHMAN INDEX(HHI)
Examples 1) For an industry with only 1 firm, (monopoly),
what would be the HHI?
2) Suppose the industry has 10 equal size firms, what is the HHI?
3) What if the industry has 100 equal size firms?
HERFINDAHL-HIRSCHMAN INDEX(HHI)
Answers 1) 10,000 2) 1000 3) 100
FORMS OF OLIGOPOLY
Oligopoly can be classified into several forms. Some of the important forms of Oligopoly are as follows:
Balanced & Unbalanced Oligopoly Balanced Oligopoly An oligopoly in which the sales of the leading
firms are distributed fairly evenly among them. Unbalanced Oligopoly An oligopoly in which the sales of the leading
firms are distributed unevenly among them.
FORMS OF OLIGOPOLY
Perfect and Imperfect Oligopolies If the product of the rival firm are
homogenous then it is Perfect Oligopoly, if the product are differentiated it is Imperfect Oligopoly.
Open and Closed Oligopolies If entry is open to new firms it is termed as
Open Oligopoly, and if entry is strictly restricted it is termed as Closed Oligopoly.
FORMS OF OLIGOPOLY
Collusive Oligopoly/Collusion The practice of firms to negotiate price and
market decisions that limit competition. Collusion may take place in the form of a common
agreement or an understanding between the firms.
FORMS OF OLIGOPOLY
Cartel One model of collusion that can be used is the
cartel model. A group of firms that collude to limit competition
in a market by negotiating and accepting agreed-upon price and market shares.
Internationally, some cartels like OPEC exist (public cartel).
http://www.opec.org Cartel is difficult to implement because: 1) Firms want to cheat (to increase profit) 2) Firms want to enter
FORMS OF OLIGOPOLY
Graphs showing Cartel
A CARTEL PICKS THE MONOPOLY PRICE
In a cartel arrangement, two firms act as one. In this case, they split the market output—each serving 75 passengers per day, and charge $400 per ticket.
• The firms also split the profit. The firms also split the profit. Each firm earnsEach firm earns$7,500 = [(400-300) x 150]/2.$7,500 = [(400-300) x 150]/2.
FORMS OF OLIGOPOLY
Duopoly Specific type of oligopoly where only two
producers exist in one market. In reality, this definition is generally used where
only two firms have dominant control over a market.
There are two principal duopoly models: Cournot Model: Two firms assume each
others output and treat this as a fixed amount, and produce in their own firm according to this.
Bertrand Model: Both firms assume that the other will not change prices in response to its price cuts. When both firms use this logic, they will reach a Nash Equilibrium.
FORMS OF OLIGOPOLY Nash Equilibrium An equilibrium in which each player takes the best
possible action given the action of the other player.
Set of strategies is in Nash equilibrium if, Holding strategies of all other players (firms)
constant, No player (firm) can obtain a higher payoff (profit)
by choosing a different strategy.
In Nash equilibrium, no firm changes its strategy because each firm is using its:
Best response.Strategy that maximizes its profit given its beliefs
about its rivals' strategies.
STACKELBERG’S MODEL OF OLIGOPOLY
Stackelberg model is an oligopoly model in which firms choose quantities sequentially.
One firm, a follower, takes the output of the other firm , a leader, and adjusts its output accordingly.
COMPETING DUOPOLISTS PICK A LOWER PRICE
When two firms compete against one another, they end up serving 100 passengers each, at a price of $350.
Each firm earns a profit of Each firm earns a profit of $5,000, compared to a $5,000, compared to a profit of $7,500 if they had profit of $7,500 if they had acted as one firm. acted as one firm.
DUOPOLY VERSUS CARTEL PRICING
• The duopoly produces more output and charges a lower The duopoly produces more output and charges a lower price than the cartel.price than the cartel.
THE KINKED DEMAND CURVE
• The The kinked demand modelkinked demand model is a model is a model under which firms in an oligopoly match under which firms in an oligopoly match price reductions by other firms but do not price reductions by other firms but do not match price increases by other firms.match price increases by other firms.
• Hence, each firm faces a “kinked” demand curve, with 2 sections to it: more elastic above the existing price, since rivals won’t match a price increase, and less elastic below the existing price, since rivals quickly match price cuts.
D1
MR1Quantity
The firm’s demand andmarginal revenue curves
Pri
ce
THE KINKED DEMAND CURVE
MR2D1
D2
MR1Quantity
The rival’s demand andmarginal revenue curves
Pri
ce
THE KINKED DEMAND CURVE
MR2D1
D2
MR1Quantity
Pri
ce
Rivals tend tofollow a price cut
THE KINKED DEMAND CURVE
MR2D1
D2
MR1Quantity
Pri
ce
Rivals tend tofollow a price cut
or ignore aprice increase
THE KINKED DEMAND CURVE
MR2D1
D2
MR1Quantity
Effectively creatinga kinked demand curve
Pri
ce
THE KINKED DEMAND CURVE
D
Quantity
Effectively creatinga kinked demand curve
Pri
ce
THE KINKED DEMAND CURVE
D
MR1Quantity
Effectively creatinga kinked demand curve
Pri
ce
MC2
MC1
MR2
THE KINKED DEMAND CURVE
D
Quantity
Profit maximizationMR = MC occurs
at the kink.P
rice
MC2
MC1
MR2
MR1
THE KINKED DEMAND CURVE
THE KINKED DEMAND CURVE (EXAMPLE)
Increase price: the other firms will not change their prices and quantity will decrease by a large amount (elastic)
After the initial price of $6, the firm has two options:
Decrease priceDecrease price: the other : the other firms will decrease their firms will decrease their prices, so quantity will prices, so quantity will increase only by a small increase only by a small amount (amount (inelasticinelastic))
THE KINKED DEMAND CURVE (EXAMPLE)
The demand curve of the typical firm has a kink at the prevailing price. It is relatively flat for higher prices, and relatively steep for lower prices.
There is little evidence, however, that oligopolistic firms really act this way—that firms will not go along with a higher price but only match a lower price.
THE KINKED DEMAND CURVE (EXAMPLE)
•The demand curve of the The demand curve of the typical firm has a typical firm has a kink at the kink at the prevailing priceprevailing price. It is . It is relatively flat for higher relatively flat for higher prices, and relatively steep for prices, and relatively steep for lower priceslower prices..
•There is little evidence, There is little evidence, however, that oligopolistic firms however, that oligopolistic firms really act this way—that really act this way—that firms firms will not go along with a will not go along with a higher price but only match a higher price but only match a lower pricelower price..
Why do Oligopolies exist?
MergersEconomies of Scale
ReputationStrategic Barriers
Government Barriers
WHY DO OLIGOPOLY EXIST?
Mergers Oligopolistic firms perpetually balance
competition against cooperation. One way to pursue cooperation is through merger--legally combining two separate firms into a single firm.
Merger gives the resulting firm greater market control-by giving the emerging oligopolists more monopoly power.
They result in more economies of scale and thereby increase that barrier to new entry.
WHY DO OLIGOPOLY EXIST?
Economies of Scale Cost advantages that a business obtains due to
expansion. They are factors that cause a producer’s
average cost per unit to fall as scale is increased.
This makes it virtually impossible for new firms to enter the industry.
A small firm could not produce at minimum cost and would soon be competed out of the business.
WHY DO OLIGOPOLY EXIST?
Reputation Established oligopolists are likely to have favorable
reputations. Investors decision: enter or not?
Critical thing: is it worthy to take the risk of being a new firm in such market?
If expected profit is greater than the initial loss, enter
If initial loss is too great, stay out.
WHY DO OLIGOPOLY EXIST?
Strategic Barriers Strategies designed to keep out potential
competitors, for example:
Maintain excess production capacity as a signal.Make special deals with distributors to receive
best shelf space in retail stores.Spend large amounts on advertising to make it
difficult for a new entrant to differentiate its product.
WHY DO OLIGOPOLY EXIST?
Government Barriers: The need for government authorization is one
entry barrier that can create oligopoly, especially if entry is limited to only a few firms.
It can also create monopolistic competition if
a larger number are allowed entry.
THE GAME THEORY APPROACH
Game Theory ApproachAn approach to modeling strategic interaction of
oligopolists in terms of moves and countermovesElements
Players Strategies Payoffs
Game treePayoff Matrix
THE GAME THEORY APPROACH
Game Tree
• A A game treegame tree is a graphical is a graphical representation of the representation of the consequences of alternative consequences of alternative strategies. Firms can use it to strategies. Firms can use it to develop pricing strategies.develop pricing strategies.
CARTEL AND DUOPOLYOUTCOMES IN THE GAME TREE
Two firms Two firms coordinating price coordinating price decisions choose decisions choose the high price.the high price.
Two firms acting Two firms acting rationally and rationally and interdependently interdependently choose the low choose the low price.price.
THE OUTCOME OF THE PRICE-FIXING GAME
Jack captures large share of market
Jill captures large share of market
Jill: Low PriceJill: Low Price Jack: High PriceJack: High Price
PricePrice $350$350 $400$400
QuantityQuantity 170170 1010
Average costAverage cost $300$300 $300$300
Profit per passengerProfit per passenger $50$50 $100$100
Total profitTotal profit $8,500$8,500 $1,000$1,000
THE DOMINANT STRATEGY
Irrational for Jack to choose high price
• Jack chooses the Jack chooses the low price when Jill low price when Jill chooses the high chooses the high price.price.
Dominant strategy: An action that is the best choice under all circumstances.
THE DOMINANT STRATEGY
• Jack chooses the Jack chooses the low price when Jill low price when Jill chooses the low chooses the low price.price.
Irrational for Jack to choose high price
• Dominant StrategyDominant Strategy: Jack chooses the low price : Jack chooses the low price regardless of Jill’s choice.regardless of Jill’s choice.
A GAME-THEORY OVERVIEW USING PAYOFF MATRIX
High
Low
High LowV
icky
Fre
igh
t’s
Pri
ce S
trat
egy
SantoshFreight’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
High
Low
High LowV
icky
Fre
igh
t’s
Pri
ce S
trat
egy
SantoshFreight’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
GreatestCombined
Profit
A GAME-THEORY OVERVIEW USING PAYOFF MATRIX
High
Low
High LowV
icky
Fre
igh
t’s
Pri
ce S
trat
egy
SantoshFreight’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
IndependentActions
StimulateResponse
A GAME-THEORY OVERVIEW USING PAYOFF MATRIX
High
Low
High LowV
icky
Fre
igh
t’s
Pri
ce S
trat
egy
SantoshFreight’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
IndependentActions
StimulateResponse
Gravitatingto the
Worst Case
A GAME-THEORY OVERVIEW USING PAYOFF MATRIX
High
Low
High LowV
icky
Fre
igh
t’s
Pri
ce S
trat
egy
SantoshFreight’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
CollusionInvites aDifferentSolution.
A GAME-THEORY OVERVIEW USING PAYOFF MATRIX
High
Low
High LowV
icky
Fre
igh
t’s
Pri
ce S
trat
egy
SantoshFreight’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
CollusionInvites aDifferentSolution.
A GAME-THEORY OVERVIEW USING PAYOFF MATRIX
High
Low
High LowV
icky
Fre
igh
t’s
Pri
ce S
trat
egy
SantoshFreight’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
But, theincentiveto cheat
is very real.
CollusionInvites aDifferentSolution.
A GAME-THEORY OVERVIEW USING PAYOFF MATRIX
THE DUOPOLISTS’ DILEMMA
• The The duopolists’ dilemmaduopolists’ dilemma is a is a situation in which both firms in a situation in which both firms in a market would be better off if they market would be better off if they chose the high price but each chose the high price but each chooses the low price.chooses the low price.
THE PRISONERS’ DILEMMA
The prisoners’ dilemma is a well-known game that demonstrates the difficulty of cooperative behavior in certain circumstances.
In the prisoner’s dilemma, mutual trust gets each one out of the dilemma, confessing is the rational choice.
The prisoners dilemma has its simplest application when the oligopoly consists of only two firms—a duopoly.
THE PRISONERS’ DILEMMA
The prisoners’ dilemma is the duopolists’ dilemma. Although both criminals would be better off if they both kept quiet, they implicate each other because the police reward them for doing so.
THE PRISONERS’ DILEMMA
PRICE LEADERSHIP IN OLIGOPOLY
Price leadership is an implicit agreement under which firms in a market choose a price leader, observe that firm’s price, and match it.
PRICE LEADERSHIP IN OLIGOPOLY
The problem with an implicit pricing agreement is that price signals sent by the leader may be misinterpreted.
Firms could interpret a price cut in two ways:Firms could interpret a price cut in two ways: A A change in market conditionschange in market conditions, in which , in which
case case firms just match the lower price firms just match the lower price and and price fixing continues.price fixing continues.
Under pricingUnder pricing, in which case a , in which case a price war price war may be triggeredmay be triggered, , destroying the price-destroying the price-fixing agreementfixing agreement..
What is Price Discrimination?
The practice of offering a specific good or service at different prices to different segments of the market
Why would a firm want to price discriminate?
Greater profits possible!!
TYPES OF PRICE DISCRIMINATION
Perfect Price Discrimination Charge each buyer the highest price they are
willing to pay. Groups Separate buyers into groups (based on age, sex,
region of country, etc). Groups should have different elasticities of
demand. Higher price to more inelastic group, lower to more
elastic.
IS OLIGOPOLY EFFICIENT?
In oligopoly, price usually exceeds marginal cost. So the quantity produced is less than the efficient
quantity. Oligopoly suffers from the same source and type of
inefficiency as monopoly. Because oligopoly is inefficient, antitrust laws and
regulations are used to try to reduce market power and move the outcome closer to that of competition and efficiency.
CHARACTERISTICS OFDIFFERENT TYPES OF MARKETS
REFERENCES
http://www.wikipedia.com http://www.ft.com http://www.census.gov http://www.antitrust.org http://www.opec.org Economics Principles & Tools(Prentice Hall
Publication)