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ECON 202 Principles of Microeconomics

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					ECON 202: Principles
of Microeconomics

Chapter 13
Oligopoly
Oligopoly
1.      Oligopoly and Barriers to Entry.
2.      Using Game Theory to Analyze Oligopoly.
3.      Sequential Games and Business Strategy.
4.      The Five Competitive Forces Model.




ECON 202: Princ. of Microeconomics   Oligopoly    2
Introduction
   Oligopoly is market structure where:
         Few competitors.
         Identical or differentiated products.
         Restrictions to entry.
   In case of oligopolistic markets, revenues of the firms
    depend on actions of other competitors.
   If a firm cut its price, number of units sold depends on
    how other firms react.
         If other firms don’t do anything, sell more.
         If other firms also cut prices, sales will not increase much or can
          even decrease.
   Marginal revenue depends on actions of other firms.
   Approach to analyze oligopolies: game theory.
ECON 202: Princ. of Microeconomics                Oligopoly                     3
1. Oligopoly and Barriers to Entry
   Oligopolistic markets have few firms
         How many firms is “few”?
   US Bureau of Census publishes 4-firm concentration
    ratios per industry.
         More than 40% indicates oligopolistic market.
   Critics
         Consider only sales by national firms
         In some industries, competition is mainly local. (restaurants)
         Some firms compete in different industries. (Wal Mart in discount
          department stores, supermarkets and retail toy stores)
   Herfindahl-Hirschman Index (HHI)
         Sum of squared shares: 302 + 302 + 202 + 202 = 2,600
         HHI > 1,800 : oligopolistic markets.

ECON 202: Princ. of Microeconomics           Oligopoly                    4
  1. Oligopoly and Barriers to Entry

                       RETAIL TRADE                                       MANUFACTURING
                                         FOUR-FIRM                                    FOUR-FIRM
           INDUSTRY                    CONCENTRATION                INDUSTRY        CONCENTRATION
                                           RATIO                                        RATIO
Discount Department Stores                  95%        Cigarettes                         95%
Warehouse Clubs and Supercenters            92%        Beer                               91%

Hobby, Toy, and Game Stores                 72%        Breakfast Cereal                   82%

Athletic Footwear Stores                    71%        Aircraft                           81%

College Bookstores                          70%        Automobiles                        76%
Radio, Television, and Other                69%        Dog and Cat Food                   76%
Electronic Stores
Pharmacies and Drugstores                   53%        Dog and Cat Food                   64%




  ECON 202: Princ. of Microeconomics                       Oligopoly                            5
1. Oligopoly and Barriers to Entry
Barriers to entry
 Economies of scale




ECON 202: Princ. of Microeconomics   Oligopoly   6
1. Oligopoly and Barriers to Entry
   Ownership of a Key Input
         Aluminum Company of America (Alcoa) access to high-quality
          bauxite.
         De Beers Company of South Africa access to diamonds.
   Government-imposed barriers
         Occupational licensing (doctors and dentists)
         Restrictions to international trade (tariffs and quotas)
   Since entry is restricted, firms can sustain economic
    profits over a long period.




ECON 202: Princ. of Microeconomics             Oligopoly               7
2. Using Game Theory to Analyze Oligopoly
   Game theory:
         The study of how people make decisions in situations in which
          attaining their goals depends on their interactions with others.
   Games have three characteristics:
         Rules.
         Strategies.
         Payoffs.




ECON 202: Princ. of Microeconomics           Oligopoly                       8
2. Using Game Theory to Analyze Oligopoly
   Duopoly: price competition between two firms.




   Firms can collude, but is against the law. (Sherman Act)

ECON 202: Princ. of Microeconomics   Oligopoly                 9
2. Using Game Theory to Analyze Oligopoly
   For each firm, to charge $400 is a dominant strategy.
         The best strategy for a player, regardless of what the other
          players decide.
   ($400, $400) is a Nash equilibrium.
         A situation where each player is choosing its best strategy, given
          the others players’ strategies.
         A situation where no player has an incentive to change of
          strategy.
   Equilibrium is not best possible result for the firms, but it
    results because each firm pursues its own interest.
         Noncooperative equilibrium.
   If firms decide to cooperate and play ($600, $600), then
    result increases their mutual payoff.
         Cooperative equilibrium.
ECON 202: Princ. of Microeconomics            Oligopoly                   10
2. Using Game Theory to Analyze Oligopoly
   Types of games where individual maximization of payoff
    leaves everyone worse off are called prisoner’s
    dilemma.




   Nash Equilibrium is (defect, defect).
   Challenge to Adam Smith’s idea of self-interest.
ECON 202: Princ. of Microeconomics   Oligopoly           11
2. Using Game Theory to Analyze Oligopoly
   In most business situations games are played
    repeatedly.
         Firms can collude implicitly to reach the cooperative equilibrium.
   Example: “lowest price guarantee”
         Firms send a signal to competitors that if they charge lower
          price, its strategy will be the same.
         Firms have the incentive to keep the high price.




ECON 202: Princ. of Microeconomics            Oligopoly                    12
2. Using Game Theory to Analyze Oligopoly




ECON 202: Princ. of Microeconomics   Oligopoly   13
2. Using Game Theory to Analyze Oligopoly
   When firms can collude: cartels (OPEC)
   However, firms can have incentives to stop cooperation,
    which makes difficult to sustain agreements.




ECON 202: Princ. of Microeconomics   Oligopoly            14
3. Sequential Games and Business Strategy
   Oligopolistic firms can deter the entry of new firms.




   Best strategy for WalMart is to build the large store,
    deterring entry from Target.
ECON 202: Princ. of Microeconomics   Oligopoly               15
3. Sequential Games and Business Strategy




   Best strategy for firm is to build the small store and let
    Target entry the market.
ECON 202: Princ. of Microeconomics    Oligopoly                  16
3. Sequential Games and Business Strategy
   Bargaining




   If TruImage says that will not accept a deal at $20:
    noncredible threat.
ECON 202: Princ. of Microeconomics   Oligopoly             17
4. The Five Competitive Forces Model
   Forces that determine the level of competition in an
    industry.




ECON 202: Princ. of Microeconomics   Oligopoly             18
4. The Five Competitive Forces Model
   Competition from existing firms.
         Educational testing service: SAT and ACT vs. GRE.
   Threat from potential entrants.
         Railways.
   Competition from substitute goods or services.
         Train vs. flight
   Bargaining power of buyers.
         Automobile makers and tire suppliers.
   Bargaining power of suppliers.
         Technicolor and color movies.



ECON 202: Princ. of Microeconomics          Oligopoly         19
ECON 202: Principles
of Microeconomics

Chapter 13
Oligopoly

				
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