Principles of Economics Chapter 14 Oligopoly PDF

Principles of Economics Thirteenth Edition Chapter 14 Oligopoly Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Chapter 14 Oligopoly Most industries in the United Stat...

Principles of Economics Thirteenth Edition Chapter 14 Oligopoly Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Chapter 14 Oligopoly Most industries in the United States fall somewhere between the two “pure” market structures: perfect competition and pure monopoly. oligopoly A form of industry (market) structure characterized by a few dominant firms. Products may be homogenous or differentiated. Oligopolists compete with one another not only in price but also in developing new products, marketing and advertising those products, and developing complements to use with the products. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Market Structure in an Oligopoly (1 of 2) Five Forces model A model developed by Michael Porter that helps us understand the five competitive forces that determine the level of competition and profitability in an industry. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 14.1 Forces Driving Industry Competition Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Table 14.1 Percentage of Value of Shipments Accounted for by the Largest Firms in High- Concentration Industries, 2002 Four Largest Eight Largest Industry Designation Number of Firms Firms Firms Primary copper 99 100 10 Cigarettes 95 99 15 Household laundry equipment 93 100 13 Cellulosic man-made fiber 93 100 8 Breweries 90 94 344 Electric lamp bulbs 89 94 57 Household refrigerators and 85 95 18 freezers Small arms ammunition 83 89 109 Cereal breakfast foods 82 93 45 Motor vehicles 81 91 308 Source: U.S. Department of Commerce, Bureau of the Census, 2002 Economic Census, Concentration Ratios: 2002 E C O 2-315R-1, May 2006. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Market Structure in an Oligopoly (2 of 2) One structural feature of an industry is the number and size distribution of firms. concentration ratio The share of industry output in sales or employment accounted for by the top firms. The threat of entry by new firms also plays an important role in industry competition. contestable markets Markets in which entry and exit are easy enough to hold prices to a competitive level even if no entry actually occurs. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Oligopoly Models (1 of 2) The Collusion Model cartel A group of firms that gets together and makes joint price and output decisions to maximize joint profits. tacit collusion Collusion occurs when price- and quantity-fixing agreements among producers are explicit. Tacit collusion occurs when such agreements are implicit. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Oligopoly Models (2 of 2) The Price-Leadership Model price leadership A form of oligopoly in which one dominant firm sets prices and all the smaller firms in the industry follow its pricing policy. The Cournot Model duopoly A two-firm oligopoly. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 14.2 Graphical Depiction of the Cournot Model Panel (a) shows a profit-maximizing output of 2,000 units for a monopolist with marginal cost of $2.00. Panel (b) shows output of 1,333.33 units each for two duopolists with the same marginal cost of $2.00, facing the same demand curve. Total industry output increases as we go from the monopolist to the Cournot duopolists, but it does not rise as high as the competitive output (here 4,000 units). Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Game Theory (1 of 2) game theory Analyzes the choices made by rival firms, people, and even governments when they are trying to maximize their own well-being while anticipating and reacting to the actions of others in their environment. dominant strategy In game theory, a strategy that is best no matter what the opposition does. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 14.3 Payoff Matrix for Advertising Game Both players have a dominant strategy. If B does not advertise, A will advertise because $75,000 beats $50,000. If B does advertise, A will also advertise because a profit of $10,000 beats a loss of $25,000. A will advertise regardless of what B does. Similarly, B will advertise regardless of what A does. If A does not advertise, B will advertise because $75,000 beats $50,000. If A does advertise, B will too because a $10,000 profit beats a loss of $25,000. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 14.4 The Prisoners’ Dilemma Both players have a dominant strategy and will confess. If Rocky does not confess, Ginger will because going free beats a year in jail. Similarly, if Rocky does confess, Ginger will confess because 5 years in the slammer is better than 7. Rocky has the same set of choices. If Ginger does not confess, Rocky will because going free beats a year in jail. Similarly, if Ginger does confess, Rocky also will confess because 5 years in the slammer is better than 7. Each will confess regardless of what the other does. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Game Theory (2 of 2) prisoners’ dilemma A game in which the players are prevented from cooperating and in which each has a dominant strategy that leaves them both worse off than if they could cooperate. Nash equilibrium In game theory, the result of all players’ playing their best strategy, given what their competitors are doing. maximin strategy In game theory, a strategy chosen to maximize the minimum gain that can be earned. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 14.5 Payoff Matrixes for Left/Right–Top/Bottom Strategies In the original game (a), C does not have a dominant strategy. If D plays left, C plays top; if D plays right, C plays bottom. D, on the other hand, does have a dominant strategy: D will play right regardless of what C does. If C believes that D is rational, C will predict that D will play right. If C concludes that D will play right, C will play bottom. The result is a Nash equilibrium because each player is doing the best that it can given what the other is doing. In the new game (b), C had better be very sure that D will play right because if D plays left and C plays bottom, C is in big trouble, losing $10,000. C will probably play top to minimize the potential loss if the probability of D’s choosing left is at all significant. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Repeated Games tit-for-tat strategy A repeated game strategy in which a player responds in kind to an opponent’s play. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 14.6 Payoff Matrix for Airline Game In a single play, both British Airways (BA) and Lufthansa Airlines (LA) have dominant strategies. If LA prices at $600, BA will price at $400 because $1.6 million beats $1.2 million. If, on the other hand, LA prices at $400, BA will again choose to price at $400 because $800,000 beats zero. Similarly, LA will choose to price at $400 regardless of which strategy BA chooses. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved A Game with Many Players: Collective Action Can Be Blocked by a Prisoner’s Dilemma Coordinated collective action in everybody’s interest can be blocked under some circumstances. A multiple-player game can result in a classic prisoners’ dilemma, where collusion if it could be enforced would result in an optimal outcome but where dominant strategies result in a suboptimal outcome. To break this dilemma, we pass laws that allow government to become a player. The only necessary condition of oligopoly is that firms are large enough to have some control over price. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Oligopoly and Economic Performance Except with the contestable-markets model, concentration in a market leads to pricing above marginal cost and output below the efficient level. However, vigorous product competition among oligopolistic competitors may produce variety and lead to innovation. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Industrial Concentration and Technological Change One of the major sources of economic growth and progress throughout history has been technological advance. Several economists, notably Joseph Schumpeter and John Kenneth Galbraith, argued that industrial concentration actually increases the rate of technological advance. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved A Proper Role for Government? One view concerning the role of government in regulating markets is that high levels of concentration lead to inefficiency and that government should act to improve the situation. An opposing view holds that the clearest examples of effective barriers to entry are those created by government. Further complicating the debate, firms that dominate a domestic market may be fierce competitors in the international arena. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Review Terms and Concepts cartel Herfindahl-Hirschman Index (HHI) Celler-Kefauver Act maximin strategy concentration ratio Nash equilibrium contestable markets oligopoly dominant strategy price leadership duopoly prisoners’ dilemma Five Forces model tacit collusion game theory tit-for-tat strategy Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved