oligopoly - seneca valley school district / overvie€¦ · ppt file · web view · 2016-12-14how...
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OLIGOPOLY**READ PGS. 286-298
1Copyright ACDC Leadership 2015
FOUR MARKET MODELS
Characteristics of Oligopolies:•A Few Large Producers (Less than 10)•Homogeneous or Differentiated Products
•High Barriers to Entry •Control Over Price (Price Maker)•Mutual Interdependence•Firms use Strategic Pricing
PerfectCompetition
PureMonopoly
MonopolisticCompetition Oligopoly
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EXAMPLES• Tennis Balls: Wilson, Penn, Dunlop and
Spalding.• Cars: GM, Ford, DaimlerChrysler• Cereal: Quaker, Ralston Food, Kellogg, Post
and General Mills.• Aircraft: Boeing (McDonnell Douglas) and
Lockheed Martin• Grocery stores: (Giant Eagle, Shopn’Save,
Wal-Mart)
• Oligopolies occur when only a few large firms start to control an industry.
• High barriers to entry keep others from entering. • What are some Barriers to Entry?
1. Economies of Scale2. High Start-up Costs3. Ownership of Raw Materials4. Patents
• Mergers…
HOW DO OLIGOPOLIES OCCUR?
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???
HORIZONTAL MERGER
How does the government decide if it will allow a merger?
Does it reduce competition in a way that will hurt consumers?
Announced, March 2011
Abandoned, Dec. 2011
HORIZONTAL MERGER
HORIZONTAL MERGER
Period 3
Period 8
GAME THEORY
How do firms in Oligopoly behave strategically to choose price/output?
Mutual interdependence• Pricing policy
Collusion• Enhances profit
Incentive to cheatPrisoner’s dilemma
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Game Theory
An understanding of game theory helps firms in an oligopoly maximize profit.
The study of how people behave in strategic situations
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JOHN NASH AND GAME THEORY
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The Prisoner’s DilemmaCharged with a crime, each
prisoner has one of two choices: Deny or Rat
Prisoner 2
Prisoner 1
Both Deny = 5 Years in jail each
Both Rat = 10 Years in jail each
Deny Confess
Deny
ConfessRat = Free
Deny = 20 Years
Rat = Free
Deny =20 Years
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What did we learn?1. Oligopolies must use strategic
pricing (they have to worry about the other guy)
2. Oligopolies have a possibility to collude to gain profit.(Collusion is the act of cooperating with
rivals in order to “rig” a situation)3. Collusion results in the incentive to
cheat.4. Firms make informed decisions
based on their dominant strategies Copyright ACDC Leadership 2015
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2008 Audit Exam
2007 FRQ #3Payoff matrix for two competing bus companies
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OLIGOPOLY GRAPHS
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Because firms are interdependentThere are 3 types of Oligopolies1. Price Leadership (no graph)2. Colluding Oligopoly3. Non Colluding Oligopoly
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#1. PRICE LEADERSHIP
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Example: Small Town Gas StationsTo maximize profit what will they do?
OPEC does this with OILWho is the “leader” with OPEC?Copyright
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Price Leadership•Collusion is ILLEGAL.•Firms CANNOT set prices.•Price leadership is a strategy used by firms to coordinate prices without outright collusionGeneral Process: 1. “Dominant firm” initiates a price change2. Other firms follow the leader
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PRICE LEADERSHIP MODELLeadership tacticso Usually largest/most efficient firmo Infrequent price changeso Communicationso Limit pricing to keep barriers to
entryo How might Price Leadership break
down?:11-27
Breakdowns in Price Leadership •Temporary Price Wars may occur if other firms don’t follow price increases of dominant firm.
•Each firm tries to undercut each other.
Examples…
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Price Leadership
#2. COLLUDING OLIGOPOLIES
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A cartel is a group of producers that create an agreement to fix prices high.
Why didn’t your cartel work? 1. Cartels set price and output at an
agreed upon level 2. Firms require identical or highly
similar demand and costs 3. Cartel must have a way to punish
cheaters4. Together they act as a monopoly
Cartel = Colluding Oligopoly
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Firms in a colluding oligopoly act as a monopoly and share the profit
**easier with homogenous product
D
MC ATC
Q
P
MR
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CARTELS AND OTHER COLLUSIONCovert collusion
•Tacit understandingsObstacles to collusion
•Demand and cost differences•Number of firms•Cheating•Recession (increases in ATC)•Potential entry of new firms•Legal obstacles: antitrust law
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#3. NON-COLLUDING OLIGOPOLIES
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1. Match price-If one firm cuts it’s prices, then the other firms follow suit causing inelastic demand
2. Ignore change-If one firm raises prices, others maintain same price causing elastic demand
Kinked Demand Curve Model
If firms are NOT colluding they are likely to react to competitor’s pricing in two ways:
The kinked demand curve model shows how noncollusive firms are interdependent
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DQ
If this firm increases it’s price, other firms will ignore it and keep prices the same
P
Pe
Qe
As the only firm with high prices, Qd for this firm will decrease a lot (Qe to Q1)
P1
Q1
Elastic
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DQ
If this firm decreases it’s price, other firms will match it and lower their prices
P
Pe
Qe
Since all firms have lower prices, Qd for this firm will increase only a little (Qe to Q2)
P2
Q2
Inelastic P1
Q1
Elastic
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DQ
Where is Marginal Revenue?
P
Pe
Q
MR has a vertical gap at the kink. The result is that MC can move and Qe won’t change. Price is sticky.
MC
MRCopyright ACDC Leadership 2015
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Criticisms of the model•How does price get to P0
•Explains inflexibility, not price• Price/Quantity remains the profit
maximizing level for a wide range of cost structures
•Prices are not that rigid (unstable economy)
•Price wars (often due to recession)
Kinked-Demand Curve
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