13-1Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Chapter 13
Oligopoly
13-2Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Learning objectives• Define oligopoly in greater detail than in
Chapter 8, assess its occurrence and note the reasons for its existence
• Examine the behaviour of oligopoly in terms of a simple game theory framework
• Survey four models of the possible courses of price–output behaviour that oligopolistic industries might follow
13-3Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Learning objectives (cont.)• Discuss the role of non-price competition;
that is, competition on the basis of product development and advertising in oligopolistic industries
• Provide some comments on the economic efficiency and social desirability of oligopoly
13-4Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Characteristics of oligopoly• ‘Fewness’: few firms dominate the market
– Firms are mutually interdependent and must consider the possible reactions of rivals to its price and product development decisions
– Firms may collude or act independently
13-5Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Characteristics of oligopoly (cont.)
• Product differentiation?– Homogeneous or differentiated product– Examples
Petroleum products Aluminium Insurance Motor vehicles
• Concentration ratios: the percentage of total industry sales accounted for by a given number of the largest firms in each industry
13-6Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Characteristics of oligopoly (cont.)
High barriers to entry• Causes
– Economies of scale– Mergers
The combining of two or more competing firms, with a resulting increase in size, market share and economic power
– Ownership of patents, copyrights– Control of strategic raw materials– Technological progress
13-7Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Oligopoly behaviour: a game theory approach• Compare the behaviour of oligopolists to
a simple duopoly game of strategy, actions and pay-offs as shown in the profit pay-off matrix
• Mutual interdependence– The fate of one firm lies partially or wholly with
the performance or decisions of other firms in that same industry
13-8Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Oligopoly behaviour: a game theory approach (cont.)• Incentives to collude through some formal
or informal arrangement to coordinate pricing strategies or fix prices
• Incentive to cheat on a collusive agreement
13-9Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Profit payoffs for a duopolyGiant’s pricing strategy
High Low
Big
’s p
rici
ng
str
ateg
y
Hig
hL
ow
$12m
$12m
$6m
$6m
$8m
$8m$15m
$15mA
C
B
D
13-10Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Maximum strategies and optimal pricing strategy
Maximum strategies• Strategies chosen by players in a game
to maximise their minimum expected pay-off from the game
• The equilibrium pair of strategies under this rule will result in a Nash equilibrium, which is for each firm to charge a low price, regardless of the choice the other firm makes
13-11Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Price–output behaviour in four models• Four models of oligopoly
– The kinked demand curve– Collusive pricing– Price leadership models– Cost-plus pricing
• No standard model of oligopoly due to:– Diversity – Interdependence
13-12Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Kinked demand: non-collusive oligopoly model• Output occurs where MR = MC• Price remains stable over a variety of cost
scenarios– Avoiding price wars– Firms ignore price increases– Firms match price decreases
• Criticisms– How is the current price set?– Prices may not be as inflexible as model suggests
13-13Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
The kinked demand curveP
QD1
MR1
The firm’s demandand marginal
revenue curves
13-14Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
The kinked demand curve P
QD1
MR1
The rival’s demandand marginal
revenue curves
MR2
D2
13-15Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
The kinked demand curve (cont.)P
QD1
MR1
MR2
D2
Rivals tend tofollow a price cut
13-16Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
The kinked demand curve (cont.)P
QD1
MR1
MR2
D2
Rivals tend tofollow a price cut
or ignore aprice increase
13-17Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
The kinked demand curve (cont.)P
QD1
MR1
MR2
D2
Effectively creating…
13-18Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
The kinked demand curve (cont.)P
QD1
MR1
Effectively creatinga kinked demand
curve
P
X
Q
D2
MC2
MC1
MR2
13-19Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Collusion and cartels• Overt or covert agreements to fix prices, divide
up or share the market or limit competition between firms
• Output and price: same as a monopolist • Forms
– Cartels Groups of firms that agree either formally or
informally to set prices and output levels of a product among members
– Gentlemen’s agreements Groups of firms agree verbally to set prices and
output levels, usually in an informal setting such as a golf course
13-20Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Economicprofit
Collusion and profit maximisation
Q
MC
ATCP
MR
Pri
ce
Q
MR = MC
D
13-21Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Obstacles to collusion• Demand and cost differences between firms• Numbers of firms• Cheating• Recession• Legislative obstacles: Trade Practices Law
13-22Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Price leadership: tacit collusion modelPrice leadership: tacit collusion• A type of gentlemen’s agreement in which
oligopolists automatically follow the price initiatives of the dominant firm in an industry
13-23Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Price leadership: tacit collusion model (cont.)• Infrequent price changes by price leader• Price announcements often made through
indirect channels such as trade publications• Price leader may choose strategies to block
potential entrants: limit-pricing or price blocking
13-24Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Cost-plus pricing model• An oligopolist uses a standard formula
to estimate cost per unit of output and adds a mark-up to determine price
• Advantages for multi-product firms• Consistent with outright collusion
13-25Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Non-price competition• Oligopolists dislike competing on price• Oligopolists must rely on non-price competition
– Advertising– Product development
• Oligopolists typically have substantial resources to support non-price competition
13-26Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Oligopoly and economic efficiency• Productive inefficiency
– Minimum ATC is not necessarily chosen Under-allocation of resources
• Allocative inefficiency– Price does not necessary equal MC
Output is restricted
13-27Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Oligopoly and economic efficiency (cont.)
Dynamic efficiency• Long-term improvements in product quality
and production methods may occur– Competitive view– Schumpeter–Galbraith view
Oligopolists have both the incentive and financial and technical resources to be more technologically progressive than competitive firms
13-28Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Oligopoly and economic efficiency (cont.)• Technical advance — what is the evidence?
– Giant corporate oligopolies are probably not the leaders in technological advance
– In Australia in the 1980s and 1990s more than half of the research and development efforts were supported by government rather than business
– The private sector has imported much of the technology through parent overseas companies
– Technological advances in Australian industry is science- based and research-orientated ratherthan market driven
13-29Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia
Next chapter:
The demand for economic resources