Transcript Oligopoly and Strategic Behavior

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Oligopoly and
Strategic
Behavior
Oligopoly Policy:
Antitrust
• Antitrust policy
– Government efforts that attempt to prevent
oligopolies from behaving like monopolies
• Sherman Act of 1890
– “Every person who shall monopolize, or
attempt to monopolize, or combine or
conspire with any other person or persons, to
monopolize any part of the trade or commerce
among the several States, or with foreign
nations, shall be deemed guilty of a felony.”
Oligopoly Policy:
Antitrust
• Clayton Act of 1914 added a few more
items that were considered detrimental
– Price discrimination that lessens competition
– Exclusive dealings that restrict the ability of a buyer to
deal with competitors
– Tying arrangements (similar to bundling)
– Mergers that lessen competition
– Prevents a person from serving as a director on more
than one board in the same industry
Strategic Behavior
• Perfect Competition
– Only strategy is to reduce costs
• Price-taker => output decisions do not affect market price
– cross-price elasticity = -1 (perfect substitutes)
– Own-price = -∞
• Monopoly
– Price-Searcher: output decision determines price
• Cross-price = 0 (no substitutes)
• Own-price: <= |1|
• Oligopoly
– Cross-price elasticity < |1|
– Own-price elasticity ~ |1|
– Will have to take into account actions of other similar firms when making
output/pricing decisions
– Much more strategy
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Oligopoly Behavior
• Cooperative Oligopoly
– Cartels
• Agree to collude; act/price like a single firm monoploist
– Price leadership (Stackleberg leader)
• Dominant firm establishes the price; other firms react to
“leader”
• Non-cooperative Oligopolies
– Sticky prices (kinked demand curve)
• Sticky upward
– Nash equilibrium
• Characterized by stable prices
– Perfect competition
• Completely rivalarous
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Cooperative Oligopolies
• Cartels (highly cooperative)
– Firms act as single-firm monopolist
• Stackelberg Price Leader (passive
cooperation)
- leader firm moves first and then the
follower firms move sequentially
– Stackelberg leader is sometimes
referred to as the Market Leader.
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Where We’re Going
• How do we tell if a market is an
oligopoly?
– Market Concentration
• CR4: market share for the 4 largest firms
• Herfindahl Index (HHI): computed from the
squares of the market shares
• Strategic behavior (how do they
behave in the market place)
– Collusive: act together
– Non-collusive: act separately and/or strategically
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How do we tell?
• Market concentration
– size and distribution of firm market
shares and the number of firms in the
market.
• Economists use two measures of
industry concentration:
– Four-firm Concentration Ratio (CR4)
– The Herfindahl-Hirschman Index (HHI)
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Attempts to Measure
Market Concentration
• four-firm concentration ratio
– market share of the four largest firms in an industry
• Herfindahl index,
– also known as Herfindahl-Hirschman Index or HHI,
– widely applied in competition law and antitrust.
– sum of the squares of the market shares of each
individual firm.
– Decreases in the Herfindahl index generally indicate a
loss of pricing power and an increase in competition,
whereas increases imply the opposite.
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Four-Firm Concentration
Ratio
• The four-firm concentration ratio
(CR4) measures market
concentration by adding the market
shares of the four largest firms in an
industry.
– If CR4 > 60, then the market is likely to
be oligopolistic.
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Example
Firm
Nike
Market Share
62%
New Balance
15.5%
Asics
10%
Adidas
4.3%
CR 4 = 62 15.5 10  4.3  91.8
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Figure 12.11 Four-Firm
Concentration Ratio (CR4) for
Selected Industries in 1997
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The Herfindahl-Hirschman
Index
• The Herfindahl-Hirschman index
(HHI) is found by summing the
squares of the market shares of all
firms in an industry.
– Advantages over the CR4 measure:
• Measures how “concentrated” the market is
– Large market shares -> squared -> HHI increases
exponentially (rather than linearly)
• Uses data on all firms
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Example
Firm
Market Share
Nike
62%
New Balance
15.5%
Asics
10%
Adidas
4.3%
HHI  62 15.5 10  4.3  4,202.74
2
2
2
2
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Example (cont’d)
What happens if market shares are evenly distributed?
Firm
Market Share
Nike
22.95%
New Balance
22.95%
Asics
22.95%
Adidas
22.95%
HHI  22.95 2  22.95 2  22.95 2  22.95 2  2,106.81
CR 4  91.8
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Non-competitive Oligopolies
• Non-competitive/collusive behavior (cooperative
oligopolies)
– Cartels: firms may collude to raise prices and restrict production
in the same way as a monopoly. Where there is a formal
agreement for such collusion, this is known as a cartel.
– Dominant Firm/Price Leader:
• collude in an attempt to stabilize unstable markets, so as to reduce
the risks inherent in these markets for investment and product
development.
• does not require formal agreement
– although for the act to be illegal there must be a real communication
between companies
– for example, in some industries, there may be an acknowledged market
leader which informally sets prices to which other producers respond,
known as price leadership.
– Stackleberg price-leader model
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An Example of a Cartel
• Organization of the Petroleum Exporting Countries (OPEC) is an
international cartel made up of Algeria, Angola, Ecuador, Indonesia,
Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United
Arab Emirates, and Venezuela.
• Principal aim of the organization, according to its Statute, is the
determination of the best means for safeguarding their interests,
individually and collectively; devising ways and means of ensuring
the stabilization of prices in international oil markets with a view to
eliminating harmful and unnecessary fluctuations
• OPEC triggered high inflation across both the developing and
developed world using oil embargoes in the 1973 oil crisis.
• OPEC's ability to control the price of oil has diminished due to the
subsequent discovery/development of large oil reserves in the Gulf
of Mexico and the North Sea, the opening up of Russia, and market
modernization.
• OPEC nations still account for two-thirds of the world's oil reserves,
and, in 2005, 41.7% of the world's oil production,
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Game Theory Models
of Oligoploy
• Stackelberg's duopoly. In this model the firms move
sequentially (see Stackelberg competition).
• Cournot's duopoly. In this model the firms simultaneously
choose quantities (see Cournot competition).
• Bertrand's oligopoly. In this model the firms
simultaneously choose prices (see Bertrand
competition).
• Monopolistic competition. A market structure in which
several or many sellers each produce similar, but slightly
differentiated products. Each producer can set its price
and quantity without affecting the marketplace as a
whole.
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Anti-Competitive Pricing Tactics
Predatory Pricing
• Predatory pricing
– Firms set prices below AVC with the intent
of driving rivals from the market
– Illegal, but difficult to prosecute
– Often difficult to distinguish between
predatory pricing and intense market
competition
• Examples:
– Wal-Mart is often assumed to be a
predator but is never prosecuted
– Microsoft was prosecuted eventually for
tying, but not for predatory pricing
Predatory Pricing Scheme
$
Incumbent
Firm’s
Price
AVC,MC
Competitor
Enters
Competitor
Leaves
Time
Network Externalities
• Network externality
– Occurs when the number of customers who
purchase a good influences the quantity
demanded
– Often is a factor in whether the resulting
market structure is oligopoly
– Classic examples include technologies
such as cell phones and fax machines
• A new technology has to reach “critical mass”
before it is effective for consumers
• How useful would a fax machine be if only 10
people had the machine?
Network Externalities
• Positive network externalities
– Bandwagon effect
– Individual preferences for a good
increase as the number of people
buying the good increases
– Internet, social networks, cell
phones, fax machines,
MMORPGs, video game
consoles, fads, night clubs
Network Externalities
• Negative network externalities
– Snob effect
– Individual preferences for a good
decrease as the number of people buying the good
increases
– Exotic pets and sports cars
– Hipsters
– Services that are prone to “congestion.” Pool,
beach, student union gets “too crowded,” and you
don’t want to go.
Network Externalities
• Switching costs
– Costs that are incurred by a consumer when he
switches suppliers
– Another advantage to a firm having a large network
– Demand for existing product becomes more
inelastic if costs of switching to a new product are
higher
• Example: cellphone providers
– Early termination fees
– Free in-network calls
– FTC reduced switching costs in 2003 by requiring
phone companies to allow a consumer to take their
old phone number to a new provider
Price Taking
Perfect Competition
1. Many firms
Price Making
Monopolistic
Competition
1. Many firms
Oligopoly
Monopoly
1. Few firms
1. One firm
2. Extremely high
barriers to entry.
The firm has
significant control
over price.
2. Atomistic assumption—firms
are so small that no single
buyer or seller has ANY control
over price
2. Each firm has
some control over
price
2. Medium to high
entry barriers to
entry. The firm has
more control over
price.
3. Firms are so small that no
single buyer or seller has ANY
control over price
3. Product
differentiation
3. Mutual
interdependence
3. The firm IS the
industry
4. Easy entry/exit
4. Long run
economic profit
possible
4. Long run
economic profit
probable
4 Homogeneous output
5. There is perfect information
about product price and quantity
6. Easy entry/exit
5. Output can be
homogenous or
differentiated
Conclusion
• Oligopoly
– A market structure in which there are a small number
of firms
– Firms interact strategically
– Can be competitive (results closer to monopolistic
competition)
– Can be collusive (results closer to monopoly)
• Antitrust policies
– Restrain excessive market power
– Give incentives to compete instead of collude
– Each industry examined on a case-by-case basis
Summary
• Oligopoly: a small number of firms sell a
differentiated product in a market with significant
barriers to entry. The small number of sellers in
oligopoly leads to mutual interdependence.
– An oligopolist is like a monopolistic competitor in that
it sells differentiated products.
– It is also like a monopolist in that it enjoys significant
barriers to entry.
• Oligopolists have a tendency to collude and to
form cartels in hope of achieving monopolylike
profits.
Summary
• Oligopolistic markets are socially inefficient since
P > MC. The result under oligopoly will fall
somewhere between the competitive and
monopoly outcomes.
• Game theory helps determine when cooperation
among oligopolists is most likely.
– In many cases, cooperation fails to materialize
because decision-makers have dominant strategies
that lead them to be uncooperative.
– This causes firms to compete with price, advertising,
or R & D when they could potentially earn more profit
by curtailing these activities.
Summary
• A dominant strategy ignores the long run
benefits of cooperation and focuses solely on
the short run gains
– Whenever repeated interaction exists, decisionmakers fare better under tit for tat, an approach that
maximizes the long run profit
• Antitrust laws are complex and cases are hard to
prosecute, but they provide firms an incentive to
compete rather than collude
• The presence of significant positive network
externalities causes small firms to be driven out
of business or to merge with larger competitors
Practice What You Know
Which of the following is most likely to
become an oligopoly industry?
A. An industry without entry barriers
B. An industry where economies of scale are
very small
C. An industry with sizeable network effects
D. An industry with hundreds of competitors
Practice What You Know
Which of the following is true about
oligopoly?
A. Oligopolies are illegal in the United States
B. All oligopoly industries will try to collude
C. Oligopoly industries generally have a high
concentration ratio
D. Firms in an oligopoly act independently
from other firms in the oligopoly
Practice What You Know
Why do cartel deals tend not to last?
A. Each firm in the cartel has a dominant
strategy to be uncooperative and defect
from the cartel agreement
B. Cartel profits are lower than competitive
profits
C. Cartels create more competition
D. Firms know that cartels are often illegal
so they break the deal to escape
Practice What You Know
What is an example of a good with a
positive network effect?
A. An online multiplayer game
B. A fast-food burger
C. A dry-cleaning service
D. A cable TV subscription
Practice What You Know
How can a pure strategy Nash equilibrium
be accurately described?
A. It is always the overall best outcome
B. It’s an outcome in which neither player
wants to change strategies
C. It can only be reached by collusion
D. One exists in all games