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Oligopoly markets

VIEWS: 32 PAGES: 39

									Market Structures &
Firm Equilibrium


Oligopoly
Oligopoly – Competition
amongst the few

    Industry dominated by small number of large firms
    High barriers to entry
    Products could be highly differentiated
    Non–price competition
    Price stability within the market - kinked demand
     curve?
    Potential for collusion?
    Abnormal profits
    High degree of interdependence among
     firms as very few sellers
    Assuming complete and full information
      Sources of Oligopoly
 Economies of scale
 Large capital investment required
 Patented production processes
 Brand loyalty
 Control of a raw material or resource
 Government franchise
 Limit pricing
       Measures of Oligopoly
 Concentration Ratios
     The degree by which an industry is dominated
      by few large firms is concentration ratios. This is
      given by percentage of total industry sales . 4, 8,
      or 12 largest firms in an industry


 Herfindahl Index (H)
     H = Sum of the squared market shares of all
      firms in an industry
Topics of Discussion
      Oligopoly
           Duopoly
           Kinked demand curve
           Perfect Collusion: Cartels
           Price Leadership
           Cournot Model
           Non price competition and game
            theory
Oligopoly

 Duopoly – case of 2 sellers
 Pure oligopoly – homogenous product
 Differentiated product – differentiated
  oligopoly
   e.g. Supermarkets, Banking industry,
  Chemicals, Oil, Medicinal drug,
  broadcasting
Duopoly
    Industry dominated by two large firms
   Possibility of price leader emerging – rival
    will follow price leaders pricing decisions
   High barriers to entry
   Abnormal profits likely
   Most scenarios in the long-run result in both
    competitors losing and one or both going
    out of business.
   In this situation a strategy of collusion or
    cooperative pricing for mutual benefit is
    optimal.
      No Collusion
      Kinked Demand Curve Model
 Proposed by Paul Sweezy
 If an oligopolist raises price, other firms will
  not follow, so demand will be elastic
 If an oligopolist lowers price, other firms will
  follow, so demand will be inelastic
 Implication is that demand curve will be
  kinked, MR will have a discontinuity, and
  oligopolists will not change price when
  marginal cost changes
Kinked demand curve

 Oligopolists prefer non price competition
 They face a demand curve with a kink at
  prevailing price
 This explains price rigidity in oligopoly
 The demand curve is highly elastic for
  price increase but much less elastic for
  price cuts
 Oligopolists recognise their
  interdependence but act without
  collusion
Kinked Demand Curve Model
Collusive oligopoly

 In collusive oligopoly, firms act in unison,
  in collusion with one another as to
a. Reduce degree of competition and helps
  in profit maximising
b.Reduces uncertainty surrounding market
c.Form a kind of barrier to entry of new
  firms
Perfect Collusion

 Collusion refers to a formal or informal
  agreement among oligopolists on what prices to
  charge and/or how to divide the market.
 Collusion is result of mutual interdependence
  among firms. It averts price wars and increases
  industry profits
 Overt collusion refers to a formal agreement
  such as cartel and may be illegal . Tacit
  collusion is an informal agreement as price
  leadership
       Cartels
 Collusion
     Cooperation among firms to restrict competition
      in order to increase profits, price fixing and
      market sharing
 Market-Sharing Cartel
     Collusion to divide up markets, geographic
 Centralized Cartel
     Formal agreement among member firms to set a
      monopoly price and restrict output
     Incentive to cheat
The Cartel:
 To maximize profit, cartel managers must allocate
  production based on the rule of marginal cost,
  which dictates that MR = MCA = MCB = …= MCn for
  all participants.
Centralized Cartel
Weakness of cartels

 Difficult to assess market demand
  acuurately
 Firms want greater profit or withdraw
 Members may cheat by selling more
  than quota
 Existence of monopoly profits may
  attract new firms
Price leadership

   A firm that is recognised as a price
    leader initiates a price change and
    then the other firms in the industry
    follow,

The price leader may be
a. Dominant firm
b. Low cost firm
c. Barometric firm
        Price Leadership

 Implicit Collusion
 Price Leader
      Largest, dominant, barometric or lowest cost
       firm in the industry sets price
      Demand curve is defined as the market demand
       curve less supply by the followers
 Followers
      Take market price as given and behave as
       perfect competitors, sell output where price =
       MCf
Price Leadership
Cournot Model

 Proposed by Augustin Cournot


 Behavioral assumption
     Firms maximize profits under the
      assumption that market rivals will not
      change their rates of production.
Cournot Model

 Example
     Two firms (duopoly)
     Identical products
     Marginal cost is zero
     Initially Firm A has a monopoly and then
      Firm B enters the market
       Cournot Model
 Adjustment process
     Entry by Firm B reduces the demand for Firm
      A’s product
     Firm A reacts by reducing output, which
      increases demand for Firm B’s product
     Firm B reacts by increasing output, which
      reduces demand for Firm A’s product
     Firm A then reduces output further
     This continues until equilibrium is attained
       Cournot Model
 Equilibrium
     Firms are maximizing profits simultaneously
     The market is shared equally among the firms
     Price is above the competitive equilibrium and
      below the monopoly equilibrium
Equilibrium in oligopoly

 Short run – firms can earn a profit, break
  even or incur a loss. Even if it is incurring
  loss, it will produce till P>AVC.

 In long run, the oligopolist will earn profit
  (or at least break even) by constructing
  best scale of plant to produce anticipated
  level of output.
      Efficiency of Oligopoly
 Price is usually greater then long-run average
  cost (LAC)
 Quantity produced usually does correspond
  to minimum LAC
 Price is usually greater than long-run
  marginal cost (LMC)
 When a differentiated product is produced,
  too much may be spent on advertising and
  model changes
      Sales Maximization Model
 Proposed by William Baumol
 Managers seek to maximize sales, after
  ensuring that an adequate rate of return has
  been earned, rather than to maximize profits
 Sales (or total revenue, TR) will be at a
  maximum when the firm produces a quantity
  that sets marginal revenue equal to zero (MR
  = 0)
Global Oligopolists

 Impetus toward globalization
     Advances in telecommunications and
      transportation
     Globalization of tastes
     Reduction of barriers to international trade
Architecture of the Ideal Firm

 Core Competencies
 Outsourcing of Non-Core Tasks
 Learning Organization
 Efficient and Flexible
 Integrates Physical and Virtual
 Real-Time Enterprise
The Creative Company

 The Knowledge Economy
     Efficiency in production
     Six sigma
     Moving to emerging markets
 The Creative Company
     Design strategy
     Consumer-centric innovation model
The Creative Company

 CENCOR
    Calibrate
    Explore
    Create
    Organize
    Realize
Extending the Firm

 Virtual Corporation
     Temporary network of independent
      companies working together to exploit a
      business opportunity
 Relationship Enterprise
     Strategic alliances
     Complementary capabilities and resources
     Stable longer-term relationships

								
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