Chapter 9 Market Structure: Oligoploy. Examples of Oligopolistic Industries Airlines Soft Drinks Doughnuts Parcel and Express Delivery Copyright © 2010

Chapter 9

Market Structure: Oligoploy

Examples of Oligopolistic Industries

Airlines Soft Drinks Doughnuts Parcel and Express Delivery

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

2

Oligopoly Models

Noncooperative oligopoly models are models of interdependent oligopoly behavior that assume that firms pursue profit-maximizing strategies based on assumptions about rivals’ behavior and the impact of this behavior on the given firm’s strategies.

Cooperative oligopoly models are models of interdependent oligopoly behavior that assume that firms explicitly or implicitly cooperate with each other to achieve outcomes that benefit all the firms.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall3

Noncooperative Oligopoly Models

The Kinked Demand Curve Model Game Theory Models Strategic Entry Deterrence Predatory Pricing


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Kinked Demand Curve

The kinked demand curve model of oligopoly incorporates assumptions about interdependent behavior and illustrates why oligopoly prices may not change in reaction to either demand or cost changes.


MC

$

Q

D2: Rivals don’tfollow

D1: Rivals do followMR1

MR2

P1

Q1

Chapter 12

6

Price Rigidity

Firms have strong desire for stability Price rigidity – characteristic of oligopolistic

markets by which firms are reluctant to change prices even if costs or demands change– Fear lower prices will send wrong message to

competitors leading to price war– Higher prices may cause competitors to raise theirs

Chapter 12

7

Price Rigidity

Basis of kinked demand curve model of oligopoly– Each firm faces a demand curve kinked at the

currently prevailing price, P*– Above P*, demand is very elastic

If P>P*, other firms will not follow– Below P*, demand is very inelastic

If P<P*, other firms will follow suit

Chapter 12

8

Price Rigidity

With a kinked demand curve, marginal revenue curve is discontinuous

Firm’s costs can change without resulting in a change in price

Kinked demand curve does not really explain oligopolistic pricing– Description of price rigidity rather than an

explanation of it

Chapter 129

The Kinked Demand Curve$/Q

Quantity

MR

D

If the producer lowers price, thecompetitors will follow and the

demand will be inelastic.

If the producer raises price, thecompetitors will not and the

demand will be elastic.

Chapter 1210

The Kinked Demand Curve$/Q

D

P*

Q*

MC

MC’

So long as marginal cost is in the vertical region of the marginal

revenue curve, price and output will remain constant.

MR

Quantity

Chapter 12

11

Price Signaling and Price Leadership

Price Signaling– Implicit collusion in which a firm announces a price

increase in the hope that other firms will follow suit Price Leadership

– Pattern of pricing in which one firm regularly announces price changes that other firms then match

Chapter 12

12

Price Signaling and Price Leadership

The Dominant Firm Model– In some oligopolistic markets, one large firm has a

major share of total sales, and a group of smaller firms supplies the remainder of the market.

– The large firm might then act as the dominant firm, setting a price that maximizes its own profits.

Game Theory Models

A set of mathematical tools for analyzing situations in which players make various strategic moves and have different outcomes or payoffs associated with those moves.


13

Dominant Strategies and the Prisoner’s Dilemma

This payoff matrix shows the various prison terms for Bonnie and Clyde that would result from the combination of strategies chosen when questioned about a crime spree.

The Prisoner’s Dilemma

Bonnie

Clyde

Don’t Confess

Confess

Don’tConfess

2 yr,2 yr

10 yr,0 yr

Confess 0 yr,10 yr

5 yr,5 yr


Prisoner’s Dilemma – Dominant Strategy

A dominant strategy is one that results in the best outcome or highest payoff to a given player no matter what action or choice the other player makes.


15

The Prisoner’s Dilemma

Bonnie

Clyde

Don’t Confess

Confess

Don’tConfess

2 yr,2 yr

10 yr,0 yr

Confess0 yr,10 yr

5 yr,5 yr

Nash Equilibrium

Nash equilibrium is a set of strategies from which all players are choosing their best strategy, given the actions of the other players.

Cigarette Television Advertising

Company A

Company B

Do notAdvertise

Advertise

Do notAdvertise

50,50 20,60

Advertise 60,20 27,27


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Strategic Entry Deterrence

Limit pricing is a policy of charging a price lower than the profit-maximizing price to keep other firms from entering the market.


17

$

Q

DMR

MC

ATCPπmax

Qπmax

PLP =ATCEN

QLP

Predatory Pricing

Pedatory pricing:– Japanese share of market

QP - QUS = NM = RG– Loss per unit to Japanese

firms PC - PP = NR – Total loss to Japanese

firms NRGM


18

$

Q

PUS

PJ

PC

PP

QUS QcQJ QP

K

L

J G

MN

E

R S

T

Cooperative Oligopoly Models

Cartels Tacit Collusion


19

Cartels - Examples

OPEC Diamond Cartel


20

Cartel Behavior

A cartel is an organization of firms that agree to coordinate their behavior regarding pricing and output decisions in order to maximize the joint profits for the organization.


21


Model of Joint Profit Maximization

MC2

D

MC1

$ $$

Q Q Q

MC2 MCc

MCcMC1

PC

MRQCQ2*Q1*

Firm 1 Firm 2 Cartel

Success in Cartels

A cartel is likely to be the most successful when:– It can raise the market price without inducing

significant competition from noncartel members.– The expected punishment for forming the cartel is

low relative to the expected gains.– The costs of establishing and enforcing the

agreement are low relative to the gains.


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Tacit Collusion

Because cartels are illegal in the United States due to the antitrust laws, firms may engage in tacit collusion, coordinated behavior that is achieved without a formal agreement.


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Practices that facilitate tacit collusion

Uniform prices A penalty for price discounts Advance notice of price changes Information exchanges Swaps and exchanges


25

Chapter 12

26

The Dominant Firm Model

Dominant firm must determine its demand curve, DD.– Difference between market demand and supply of

fringe firms To maximize profits, dominant firm produces

QD where MRD and MCD cross.

At P*, fringe firms sell QF and total quantity sold is QT = QD + QF

Chapter 1227

Price Setting by a Dominant Firm

Price

Quantity

D

DD

QD

P*

At this price, fringe firmssell QF, so that total

sales are QT.

P1

QF QT

P2

MCD

MRD

SFThe dominant firm’s demand

curve is the difference betweenmarket demand (D) and the supply

of the fringe firms (SF).

Chapter 12

28

Cartels

Producers in a cartel explicitly agree to cooperate in setting prices and output.

Typically only a subset of producers are part of the cartel and others benefit from the choices of the cartel

If demand is sufficiently inelastic and cartel is enforceable, prices may be well above competitive levels

Chapter 1229

Cartels

Examples of successful cartels– OPEC– International Bauxite Association– Mercurio Europeo

Examples of unsuccessful cartels– Copper– Tin– Coffee– Tea– Cocoa

Chapter 12

30

Cartels – Conditions for Success

1. Stable cartel organization must be formed – price and quantity settled on and adhered to

– Members have different costs, assessments of demand and objectives

– Tempting to cheat by lowering price to capture larger market share

Chapter 12

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Cartels – Conditions for Success

2. Potential for monopoly power– Even if cartel can succeed, there might be little

room to raise price if faces highly elastic demand– If potential gains from cooperation are large, cartel

members will have more incentive to make the cartel work

Chapter 12

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Analysis of Cartel Pricing

Members of cartel must take into account the actions of non-members when making pricing decisions

Cartel pricing can be analyzed using the dominant firm model– OPEC oil cartel – successful– CIPEC copper cartel – unsuccessful

Chapter 1233

The OPEC Oil CartelPrice

Quantity

MROPEC

DOPEC

TD SC

MCOPEC

TD is the total world demandcurve for oil, and SC is the

competitive supply. OPEC’s demand is the difference

between the two.

QOPEC

P*

OPEC’s profits maximizingquantity is found at the

intersection of its MR andMC curves. At this quantity

OPEC charges price P*.

Chapter 12

34

Cartels

About OPEC– Very low MC– TD is inelastic– Non-OPEC supply is inelastic– DOPEC is relatively inelastic

Chapter 1235

The OPEC Oil CartelPrice

Quantity

MROPEC

DOPEC

TD SC

MCOPEC

QOPEC

P*

The price without the cartel:• Competitive price (PC) where DOPEC = MCOPEC

QC QT

Pc

Chapter 1236

The CIPEC Copper CartelPrice

Quantity

MRCIPEC

TD

DCIPEC

SCMCCIPEC

QCIPEC

P*PC

QC QT

• TD and SC are relatively elastic

• DCIPEC is elastic• CIPEC has little

monopoly power• P* is closer to PC

Chapter 12

37

Cartels

To be successful:– Total demand must not be very price elastic– Either the cartel must control nearly all of the world’s

supply or the supply of noncartel producers must not be price elastic

Documents

Chapter 9 Market Structure: Oligoploy. Examples of Oligopolistic Industries Airlines Soft Drinks Doughnuts Parcel and Express Delivery Copyright © 2010