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1、1 of 34chapter: 152009 Worth PublishersOligopoly2 of 34WHAT YOU WILL LEARN IN THIS CHAPTERThe meaning of oligopoly, and why it occurs Why oligopolists have an incentive to act in ways that reduce their combined profit, and why they can benefit from collusion How our understanding of oligopoly can be
2、 enhanced by using game theory, especially the concept of the prisoners dilemma How repeated interactions among oligopolists can help them achieve tacit collusion How oligopoly works in practice, under the legal constraints of antitrust policy3 of 34The Prevalence of OligopolyIn addition to perfect
3、competition and monopoly, oligopoly and monopolistic competition are also important types of market structure. They are forms of imperfect competition.Oligopoly is a common market structure. It arises from the same forces that lead to monopoly, except in weaker form. It is an industry with only a sm
4、all number of producers. A producer in such an industry is known as an oligopolist.When no one firm has a monopoly, but producers nonetheless realize that they can affect market prices, an industry is characterized by imperfect competition.4 of 34ECONOMICS IN ACTIONIs It An Oligopoly, or Not?To get
5、a better picture of market structure, economists often use a measure called the HerfindahlHirschman Index, or HHI. The HHI for an industry is the square of each firms share of market sales summed over the firms in the industry. For example, if an industry contains only 3 firms and their market share
6、s are 60%, 25%, and 15%, then the HHI for the industry is:HHI = 602 + 252 + 152 = 4,4505 of 34ECONOMICS IN ACTIONIs It An Oligopoly, or Not?According to Justice Department guidelines, an HHI below 1,000 indicates a strongly competitive market, between 1,000 and 1,800 indicates a somewhat competitive
7、 market, and over 1,800 indicates an oligopoly. In an industry with an HHI over 1,000, a merger that results in a significant increase in the HHI will receive special scrutiny and is likely to be disallowed.6 of 34Some Oligopolistic Industries7 of 34Understanding OligopolySome of the key issues in o
8、ligopoly can be understood by looking at the simplest case, a duopoly. An oligopoly consisting of only two firms is a duopoly. Each firm is a duopolist.With only two firms in the industry, each would realize that by producing more, it would drive down the market price. So each firm would, like a mon
9、opolist, realize that profits would be higher if it limited its production. So how much will the two firms produce?8 of 34Understanding OligopolyOne possibility is that the two companies will engage in collusion. Sellers engage in collusion when they cooperate to raise each others profits. The stron
10、gest form of collusion is a cartel, an agreement by several producers to obey output restrictions in order to increase their joint profits. They may also engage in non-cooperative behavior, ignoring the effects of their actions on each others profits.9 of 34Understanding OligopolyBy acting as if the
11、y were a single monopolist, oligopolists can maximize their combined profits. So there is an incentive to form a cartel. However, each firm has an incentive to cheatto produce more than it is supposed to under the cartel agreement. So there are two principal outcomes: successful collusion or behavin
12、g non-cooperatively by cheating. When firms ignore the effects of their actions on each others profits, they engage in non-cooperative behavior. It is likely to be easier to achieve informal collusion when firms in an industry face capacity constraints.10 of 34Competing in Prices vs. Competing in Qu
13、antitiesFirms may decide to engage in quantity or price competition.The basic insight of the quantity competition (or the Cournot model) is that when firms are restricted in how much they can produce, it is easier for them to avoid excessive competition and to “divvy up” the market, thereby pricing
14、above marginal cost and earning profits. It is easier for them to achieve an outcome that looks like collusion without a formal agreement.11 of 34Competing in Prices vs. Competing in QuantitiesThe logic behind the price competition (or the Bertrand model) is that when firms produce perfect substitut
15、es and have sufficient capacity to satisfy demand when price is equal to marginal cost, then each firm will be compelled to engage in competition by undercutting its rivals price until the price reaches marginal costthat is, perfect competition.12 of 34GLOBAL COMPARISONEurope Levels the Playing Fiel
16、d for Coke and PepsiIn the United States, Coke and Pepsi have maintained relatively similar market shares: 44% versus 32% in 2004. In that same year, thanks to the exclusivity deals that Coke regularly signed with shops, bars, and restaurants across Europe, Cokes market shares in Europe were several
17、 times Pepsis, as you can see in the following graphthat is, until European regulators finally made their move, also in 2004. Not surprisingly, Pepsi applauded the change in European policy toward exclusive dealing.13 of 34GLOBAL COMPARISONEurope Levels the Playing Field for Coke and PepsiFranceBelg
18、iumGermanyUnited States75%50250Coke and Pepsi Market Shares68%5%6%5%32%60%51%44%CokePepsi14 of 34ECONOMICS IN ACTIONThe Great Vitamin ConspiracyIn the late 1990s, some of the worlds largest drug companies agreed to pay billions of dollars in damages to customers after being convicted of a huge consp
19、iracy to rig the world vitamin market. The conspiracy began in 1989 when the Swiss company Roche and the German company BASF began secret talks about setting prices and dividing up markets for “bulk” vitamins sold mainly to other companies.How could it have happened? The main answer probably lies in
20、 different national traditions about how to treat oligopolists. The United States has a long tradition of taking tough legal action against price-fixing. European governments, however, have historically been much less stringent.15 of 34The Prisoners DilemmaWhen the decisions of two or more firms sig
21、nificantly affect each others profits, they are in a situation of interdependence.The study of behavior in situations of interdependence is known as game theory.The reward received by a player in a gamesuch as the profit earned by an oligopolistis that players payoff.A payoff matrix shows how the pa
22、yoff to each of the participants in a two player game depends on the actions of both. Such a matrix helps us analyze interdependence.16 of 34A Payoff MatrixADMAjinomotoProduce 30 million pounds ADM makes $180 million profitProduce 40 million pounds Produce 30 million pounds Produce 40 million pounds
23、 Ajinomoto makes $180 million profit.Ajinomoto makes $200 million profit.Ajinomoto makes $160 million profit.Ajinomoto makes $150 million profit.ADM makes $150 million profitADM makes $200 million profitADM makes $160million profit17 of 34The Prisoners DilemmaEconomists use game theory to study firm
24、s behavior when there is interdependence between their payoffs. The game can be represented with a payoff matrix. Depending on the payoffs, a player may or may not have a dominant strategy.When each firm has an incentive to cheat, but both are worse off if both cheat, the situation is known as a pri
25、soners dilemma.The game based on two premises: (1) Each player has an incentive to choose an action that benefits itself at the other players expense. (2) When both players act in this way, both are worse off than if they had acted cooperatively.18 of 34The Prisoners DilemmaDont confessDont confessC
26、onfessConfessLouiseLouise gets 2-year sentence.Louise gets 5-year sentence.Thelma gets 20-year sentence.Thelma gets 5-year sentence.Louise gets 15-year sentence.Louise gets 20-year sentence.Thelma gets 15-year sentence.Thelma gets 2-year sentence.Thelma19 of 34The Prisoners DilemmaAn action is a dom
27、inant strategy when it is a players best action regardless of the action taken by the other player. Depending on the payoffs, a player may or may not have a dominant strategy.A Nash equilibrium, also known as a non-cooperative equilibrium, is the result when each player in a game chooses the action
28、that maximizes his or her payoff given the actions of other players, ignoring the effects of his or her action on the payoffs received by those other players.20 of 34Overcoming the Prisoners DilemmaRepeated Interaction and Tacit CollusionPlayers who dont take their interdependence into account arriv
29、e at a Nash, or non-cooperative, equilibrium. But if a game is played repeatedly, players may engage in strategic behavior, sacrificing short-run profit to influence future behavior. In repeated prisoners dilemma games, tit for tat is often a good strategy, leading to successful tacit collusion. Tit
30、 for tat involves playing cooperatively at first, then doing whatever the other player did in the previous period.When firms limit production and raise prices in a way that raises each others profits, even though they have not made any formal agreement, they are engaged in tacit collusion.21 of 34Ho
31、w Repeated Interaction Can Support CollusionTit for tatTit for tatAlways cheatAlways cheatADMAjinomotoADM makes $180 million profit each year.Ajinomoto makes $180 million profit each year.Ajinomoto makes $200 million profit 1st year, $160 profit each later year.Ajinomoto makes $150 million profit 1s
32、t year, $160 million profit each later year.Ajinomoto makes $160 million profit each year.ADM makes $150 million profit 1st year, $160 million profit each later year.ADM makes $200 million profit 1st year, $160 million profit each later year.ADM makes $160 million profit each year.22 of 34The Kinked
33、 Demand CurveAn oligopolist who believes she will lose a substantial number of sales if she reduces output and increases her price, but will gain only a few additional sales if she increases output and lowers her price away from the tacit collusion outcome, faces a kinked demand curvevery flat above
34、 the kink and very steep below the kink.It illustrates how tacit collusion can make an oligopolist unresponsive to changes in marginal cost within a certain range when those changes are unique to her.23 of 34The Kinked Demand CurveQ *P*QuantityPrice, cost marginal revenueXWYDZMRMC2MC11. Any marginal
35、 cost in this region2. corresponds to this level of outputTacit collusion outcome24 of 34ECONOMICS IN ACTIONThe Rise and Fall and Rise of OPECOPEC includes 13 national governments (Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates,
36、 and Venezuela) and it controls 40% of the worlds oil exports and 80% of its proven reserves. In any given year it is in their combined interest to keep output low and prices high. So how successful is the cartel? Well, its had its ups and downs.OPEC first demonstrated its muscle in 1974: in the aft
37、ermath of a war in the Middle East, several OPEC producers limited their outputand they liked the results so much that they decided to continue the practice. 25 of 34ECONOMICS IN ACTIONThe Rise and Fall and Rise of OPECBy the mid-1980s, however, there was a growing glut of oil on world markets, and
38、cheating by cash-short OPEC members became widespread. The result, in 1985, was that producers who had tried to play by the rules.The cartel began to act effectively again at the end of the 1990s, thanks largely to the efforts of Mexicos oil minister to orchestrate output reductions. The cartels act
39、ions helped raise the price of oil from less than $10 a barrel in 1998 to a range of $20 to $30 a barrel in 2003.26 of 34The Ups and Downs of the Oil Cartel60$705040302010Price of crude oil (per barrel)YearCrude Oil Prices, 1947-2007(in constant 2006 dollars)1947 1950196019701980199020002007Iran-Ira
40、q War9/11/01Gulf WarIranian RevolutionRising world demand and Middle East tensionsYom Kippur War Arab Oil Embargo Series of OPEC output cutsOPEC 10% quota increase27 of 34Oligopoly in PracticeOligopolies operate under legal restrictions in the form of antitrust policy. Antitrust policies are efforts
41、 undertaken by the government to prevent oligopolistic industries from becoming or behaving like monopolies. But many succeed in achieving tacit collusion.Tacit collusion is limited by a number of factors, including:large numbers of firmscomplex products and pricing schemebargaining power of buyersc
42、onflicts of interest among firms28 of 34Product Differentiation and Price LeadershipWhen collusion breaks down, there is a price war.To limit competition, oligopolists often engage in product differentiation which is an attempt by a firm to convince buyers that its product is different from the prod
43、ucts of other firms in the industry.When products are differentiated, it is sometimes possible for an industry to achieve tacit collusion through price leadership.Oligopolists often avoid competing directly on price, engaging in non-price competition through advertising and other means instead.29 of
44、 34Product Differentiation and Price Leadership, contdIn price leadership, one firm sets its price first, and other firms then follow.Firms that have a tacit understanding not to compete on price often engage in intense nonprice competition, using advertising and other means to try to increase their
45、 sales.30 of 34SUMMARY1.Many industries are oligopolies: there are only a few sellers. In particular, a duopoly has only two sellers. Oligopolies exist for more or less the same reasons that monopolies exist, but in weaker form. They are characterized by imperfect competition: firms compete but poss
46、ess market power.2.Predicting the behavior of oligopolists poses something of a puzzle. The firms in an oligopoly could maximize their combined profits by acting as a cartel, setting output levels for each firm as if they were a single monopolist; to the extent that firms manage to do this, they eng
47、age in collusion. But each individual firm has an incentive to produce more than it would in such an arrangementto engage in noncooperative behavior. 31 of 34SUMMARY3.The situation of interdependence, in which each firms profit depends noticeably on what other firms do, is the subject of game theory
48、. In the case of a game with two players, the payoff of each player depends both on its own actions and on the actions of the other; this interdependence can be represented as a payoff matrix. Depending on the structure of payoffs in the payoff matrix, a player may have a dominant strategyan action
49、that is always the best regardless of the other players actions.32 of 34SUMMARY4.Duopolists face a particular type of game known as a prisoners dilemma; if each acts independently in its own interest, the resulting Nash equilibrium or Noncooperative equilibrium will be bad for both. However, firms t
50、hat expect to play a game repeatedly tend to engage in strategic behavior, trying to influence each others future actions. A particular strategy that seems to work well in such situations is tit for tat, which often leads to tacit collusion.5.The kinked demand curve illustrates how an oligopolist th
51、at faces unique changes in its marginal cost within a certain range may choose not to adjust its output and price in order to avoid a breakdown in tacit collusion.33 of 34SUMMARY6.In order to limit the ability of oligopolists to collude and act like monopolists, most governments pursue an antitrust
52、policy designed to make collusion more difficult. In practice, however, tacit collusion is widespread.7.A variety of factors make tacit collusion difficult: large numbers of firms, complex products and pricing, differences in interests, and bargaining power of buyers. When tacit collusion breaks dow
53、n, there is a price war. Oligopolists try to avoid price wars in various ways, such as through product differentiation and through price leadership, in which one firm sets prices for the industry. Another is through nonprice competition, like advertising.34 of 34The End of Chapter 15Coming attractionChapter 16: Monopolistic Competition and Product Differentiation
