Transcript Mankiw Chapter 16

Chapter 16
Oligopoly
Ratna K. Shrestha
Duopoly in Computer CPUs
 In CPU market,
Intel Corporation and
AMD Inc. are two
major players.
Each of them must
take the Price and
Output of the other
into consideration
while making its own
Pricing and Output
decisions. Why?
Overview




Monopoly & Perfect Competition
Markets with only a Few Sellers--Oligopoly
Game Theory and The Economics of Cooperation
Public Policy Towards Oligopolies
Four Types of Market Structure
Number of Firms?
One
firm
Monopoly
Many
firms
Few
firms
Type of Products?
Differentiated
products
Oligopoly
Monopolistic
Competition
• Tennis balls
• Tap water
• Novels, CD
• Crude oil
• Cable TV
• Movies
•Hockey Skates
•Toothpaste
Identical
products
Perfect
Competition
• Wheat
• Milk
Imperfect Competition
 Monopolistic Competition
Many firms selling products that are similar but not
identical.
e.g. Movies, Soap, Toothpaste, Pizza.
 Oligopoly
Only a few sellers, each offering a similar or
identical product.
e.g. Hockey skates (Bauer and CCM), Crude Oil
(OPEC), Automobiles, Steel, Petrochemicals.
Markets with only a Few Sellers
Oligopoly:
Because of the few sellers, the actions of any one
seller in the market can have a large impact on the
profits of all the other sellers.
 Few sellers offering similar product
 Interdependence among firms in industry.
 Best off by co-operating and acting like a monopolist.
 But such explicit cooperation may not be possible due
to antitrust laws or due to temptation for cheating.

A duopoly is an oligopoly with only two members. It is
the simplest type of oligopoly.
Demand Schedule for Water (MC = 0)
Quantity
0
10
20
30
40
50
60
70
80
90
100
110
120
Price
$120
110
100
90
80
70
60
50
40
30
20
10
0
Total Revenue
$
0
1,100
2,000
2,700
3,200
3,500
3,600
3,500
3,200
2,700
2,000
1,100
0
Price and Quantity Supplied
 The price of water in a perfectly competitive market
would be driven to where MC = 0:
P = MC = $0; Q = 120 gallons
 The price and quantity in a monopoly market would
be where total profit is maximized:
P = $60; Q = 60 gallons
 Oligopoly Q = ??
Competition, Monopolies, and Cartels
 Collusion/Cartel
 The

two firms may agree on the quantity to
produce and the price to charge.
 The two firms may join together and act in
unison, in effect as a monopolist. Examples:
OPEC, NCAA.
Although oligopolists would like to form cartels and
earn monopoly profits, Antitrust laws prohibit explicit
agreements among oligopolists as a matter of public
policy.
Equilibrium for an Oligopoly
 A Nash
equilibrium is a situation in which economic
agents interacting with one another each chooses
his/her best strategy given the strategies that all the
others have chosen.
 So Nash equilibrium is a non-cooperative equilibrium
concept. Each player is acting on its own given the
strategy of its rivals.
 In Nash equilibrium concept all the players make their
decisions at the same time (unless stated otherwise).
Cournot Duopoly Equilibrium
Firm 1’s reaction curve shows how much it
will produce as a function of how much
it thinks Firm 2 will produce.
Q1
100
75
Firm 2’s Reaction
Curve
Firm 2’s reaction curve shows how much it
will produce as a function of how much
it thinks Firm 1 will produce.
50 x
Nash Eqlbm
25
Firm 1’s Reaction
Curve
25
50
75
x
100
Q2
Non-Collusive Oligopoly
Oligopolies pursuing their own self-interest, but
acting independently.
Production is greater than the monopoly quantity but
less than the competitive industry quantity.
Market prices are lower than monopoly but greater
than competitive price (marginal cost.)
Total profits are less than the monopoly profit.
Size of Oligopoly & Market Outcome

When the number of sellers increase, it has two effects:
 The output effect: Because P > MC, selling more at
the going price raises profits.
 The price effect: Raising production lowers the price
and the profit per unit on all units sold.
 As the number of sellers grows, an oligopolistic market
looks more and more like a competitive market.
 The price approaches marginal cost, and the quantity
produced approaches the socially efficient level.
 The profits then tends to be smaller.
Case Study:OPEC and
World’s Oil Market

Like any Cartel, OPEC tries to raise price through
coordinated reduction in production.
For example during 2008, OPEC was able to co-ordinate
the cut in production of crude oil and hence charge higher
price. As a result the price of gasoline topped closed to
$1.50/L.
 However such coordination may not last or be
successful all the time. The problem is each member is
tempted to cheat by increasing production and capturing a
larger share of the market.
 OPEC was most successful as a cartel between 19731985.
Game Theory
Game
theory is the study of how people behave in
strategic situations.
Strategic decisions are those in which each person, in
deciding what actions to take, must consider how others
might respond to that action.
Prisoners’ Dilemma: illustrates the difficulty in maintaining
co-operation. Often people (firms) fail to co-operate with
one another even when co-operation would make them
better off.
The Prisoners’ Dilemma Story: A detective interrogating
two accused of crime in two different cells..
Prisoners’ Dilemma
Prisoner B
Confess
Don’t Confess
Confess
-5, -5
-1, -10
Don’t
Confess
-10, -1
-2, -2
Oligopolies and Prisoners’
Dilemma


In the previous prisoner’s dilemma game, each fears
that if he doesn’t confess, the other will confess and
get away with –1 (while he/she will be punished with
- $10. As a result, each of them will Confess with the
equilibrium outcome of (Confess, Confess).
Self-interest makes it difficult for both of them to
maintain cooperation even though that is best for
both of them.
Oligopolies and Prisoners’
Dilemma



Prisoners’ Dilemma illustrates the problem oligopolistic
firms face.
Self-interest makes it difficult for the oligopoly to
maintain the co-operative outcome, with low production,
high prices and so high profits.
Examples:
– International arms race
– Beer Advertising
– Management of Common Resources
– Cheating in Cartel.
Prisoner’s Dilemma: Arms Race
USA
Arm
Risk, Risk
Disarm
USSR
Arm
Risk, Safe
Disarm
Safe, Risk
Safe, Safe
Prisoner’s Dilemma: Beer Advertising
Labatt

Advertise
Don’t
Molsen
Advertise
Don’t
3, 3
5, 2
2, 5
4, 4
even though (Don’t, Don’t) is the best for both of
them,they end up with (Advertise, Advertise).
Dominant Strategy


Dominant Strategy: The best strategy for a player to
follow regardless of the strategies pursued by other
players.
In the game that follows,
If B chooses Advertise, A also chooses Advertise (10
vs. 6)
If B chooses Don’t Advertise, A again chooses
Advertise (15 vs. 10).
 No matter what B does, A’s best choice is Advertise!
Dominant Strategy in Advertising
Game
Firm B
Advertise
Don’t
Advertise
Advertise
10, 5
15, 0
Don’t
Advertise
6, 8
10, 2
Public Policy Toward Oligopolies




Firms in oligopolies have a strong incentive to collude in
order to:
– reduce production
– raise prices and in turn raise profits
At the same time they have strong incentives to drive
others out of business so that they can capture the
entire market.
From the standpoint of society, co-operation among
oligopolists is undesirable because
– it leads to production that is too low and
– prices that are too high
Then What should government do to protect the
consumers?
Public Policy Toward Oligopolies
Competition Act:
 Makes it illegal to restrain trade or attempt to
monopolize a market.
 Consists of:
– criminal provisions
– civil provisions
Competition Act


Criminal provisions may include:
– Price Fixing, Rigging Bids
– Resale Price maintenance
– Price Discrimination
– Predatory Pricing: Charge low price with the
intention of driving competitors out of the market.
Civil provisions include mergers which may not be in
the public interest.
Price Fixing and Bid Rigging


The basic intent of this section of the law is to
prevent the formation of cartels and is a part of
criminal code.
Commonly prosecuted practices are:
– Price-fixing: In the US, price fixing can be
prosecuted as a criminal felony offense under
Sherman Antitrust Act. In Canada, it is an
indictable criminal offence under section 45 of the
Competition Act.
– Bid-rigging: An collusion between two or more
competitors, in which one party of a group of
bidders (usually for government construction
contracts) will be designated to win the bid at a
much lower price/bid.
Price Fixing and Bid Rigging



In 1999, Vitamin producers agree to pay US$1 billion to
settle U.S. Justice Department investigation of price
fixing. The three top makers (Roche, BASF, RhonePoulec) accounting for 60% of market met to fix prices
for a decade. Bulk vitamin A sold for $11.59/lb in 1990
and $19.84/lb in 1998.
Notaries association in Quebec was fined $25,000 for
conspiracy to fix prices of real estate services.
Five snow removal companies in Quebec were fined $1
million for conspiring to share market.
Bid-Rigging in Govt. Contracts
On the news:
Ottawa, February 17, 2009 – Criminal charges have
been laid against 14 individuals and 7 companies accused
of rigging bids to obtain Government of Canada
contracts for information technology services, the
Competition Bureau announced today.
The Bureau found evidence indicating that several IT
services companies in the National Capital Region
secretly coordinated their bids in an illegal scheme to
defraud the government by winning and dividing
contracts, while blocking out honest competitors
Resale Price Maintenance (RPM)



If a supplier tries to ensure that retailers sell the
product at a particular price then supplier is engaged
in RPM.
Prosecution for RPM occurs more often than
prosecution for other pricing-related areas of
competition policy. From 1986-2004, there have been
3 to 4 cases every year on average.
On October 10, 2002, Stroh Brewery Company
(Quebec) Ltd. pleaded guilty in the Federal Court and
was sentenced to pay $250,000 for requiring retailers
to sell at the price specified by Stroh in order to be
eligible for volume discounts.
Predatory Pricing: Cases





In 1987, several QB driving schools colluded to fix the
price of driving school services and held almost 94% of
Sherbrooke market.
Shortly after the agreement, many of them broke off.
The major players threatened these renegade
competitors and also punished them with predatory
pricing.
Similarly, Hoffman-Loroche (a pharmaceutical company)
was successfully prosecuted for giving away certain
drugs in an effort to drive the producers of generic drugs
out of the market.
The Competition Bureau investigated a case against Air
Canada in 2001 accusing it of predatory pricing to hurt
rivals WestJet and CanJet.
Other Interesting Games


Location Game
Battle of Sexes
1. Beach Location Game
– Two competitors selling soft drinks for the same
price.
– Beach 200 yards long and Sunbathers are spread
evenly along the beach.
– Customers will buy from the closest vendor.
Beach Location Game
Ocean
C
0


B
Beach
A
200 yards
Where will the competitors locate (i.e. where is the
Nash equilibrium)?
Similar location game is played by gas stations, car
dealers, etc…
The Battle of the Sexes
Joan
Wrestling
Opera
Wrestling
2,1
0,0
Opera
0,0
1,2
Jim
What is the Nash Eqlbm. of this game?