ECON 300 Micro Economics Ch 10 13 11 12 Ch 4 Appendix Chapter 10 Oligopoly Strategic Behavior Oligopoly is characterized by 1 Few sellers No specific number of firms Mutual dependence A condition of oligopoly in which an action by one firm may cause a reaction from other firms Market structure with few powerful firms makes it easier for oligopolistic to collude Oligopoly consequence of the market price When the firms are so large relative to the total market that they can affect 2 Homogeneous or differentiated product Identical or differentiated Buyers in an oligopoly may or may not be in different as to which seller product they buy o Homogeneous or standardized product industries include steel oil and Examples o Differentiated product industries include automobile detergents and aluminum breakfast cereals 3 Difficult entry Barriers to entry protect firms from new entrants Exclusive financial requirements Control over essential resources Patent rights other legal barriers Price Output Decisions Oligopoly can have many different possible reactions to price non price output charges another firm Mutual interdependence makes this market structure more difficult to analyze than PC M and MC Making price output decisions not MR MC Type of Oligopoly Models 1 Nonprice competition Major oligopolistic compete using advertising and product differentiation o Trying to capture business rivals using ads and improved products not price cuts Because of a differentiated product there is competition in ways other than price such as developing new products and advertising Why ad expenditures large in cigarette automobile industry why R D important for oligopoly Competitor use nonprice because rivals can match price reduction easily quickly more difficult to combat a clever important product improvement 2 Kinked Demand Curve a demand curve facing an oligopolistic that assumes rivals will match a price decrease but ignore a price increase Why prices change less than in a perfect market Exists because management tacitly believes that competition will to be undersold Oligopolistic price makers Kinked demand curve high degree of interdependence among oligopolist restricts their pricing decision price increase demand elastic price decrease demand inelastic lower price others lower to keep market share but lower price does attract some new buyers Prices established at kinks change very infrequently 3 Price Leadership A pricing strategy in which a dominant firm sets the price for an industry and the other firms follow Firms in an industry match the price of the biggest firm but not always 4 The Cartel a product Cartel A group of firms formally agreeing to control the price and output of o Avoid price wars by informally playing by established pricing rules peace treaty weakness of a cartel to reap monopoly profits by replacing Instead of allowing mutual interdependence to lead to rivalry firms openly or secretly conspire to form a monopoly called cartel Goal competition with corporation benefits exceed the costs cheating can threaten formal or informal agreements among oligopolists to maximize joint profits Examples As long as the o Organization of Petroleum Exporting Countries OPEC o International Telephone Cartel ITU o International Airline Cartel IATA formal collusion A group of firms openly agree to control the price and output of a product o Is formal collusion legal No it is against the law in the U S for firms to come together and agree on the price or output for products But this is not true outside the U S informal collusion Companies find alternative ways to agree on a price without any tacit communication For example firms follow established rules of an industry 5 Game Theory a model of the strategic moves and countermoves of rivals mutually interdependent if action by one causes reaction in another both charge lower in equilibrium The payoff matric demonstrates why a competitive oligopoly tends to result in both rivals using a low price strategy that does not maximize mutual profits Two pricing methods 1 tit for tat Under this informal approach a player will do whatever the other player did the last time use to avoid low fare outcome and stabilize the more jointly profitable high fare payoff 2 price leadership Another informal approach is to play follow the leader in which firms set whatever price the leader sets If cartels were legal Another approach would be for firms to make a formal agreement To avoid cheating rivals could agree on a penalty for cheaters An Evaluation of Oligopoly The price charged for the product will be higher than under perfect competition because smaller of firms and difficult entry means can charge more More money is spent on forms of nonprice competition product differentiation In long run can earn economic profits because of difficult entry Depending on assumptions it can act like PC or M o Hard to evaluate none of the models give definite answers to questions of efficiency under oligopoly Chapter 13 Antitrust Regulations of Monopoly Power Antitrust Trust A combination or cartel consisting of firms that place their assets in the custody of a board of trustees Allows firms that haven t form cartel groups to charge monopoly prices and earn higher profits Predatory pricing The practice of one or more firms temporarily reducing prices in order to eliminate competition and then raising prices In 1888 congress passed laws aiming to prevent anticompetitive activities When was the age of the robber barons o In the later part of the 1800 s Major Antitrust Legislation Sherman Act The federal antitrust law enacted in 1890 that prohibits monopolization and conspiracies to restrain trade Prohibits interstate price fixing and other conspiracies and combinations that restrain trade and attempt to monopolize Vague language resulted in numerous court battles First notable case was Standard Oil and American Tobacco more recent is Archer Daniels Midland Company Clayton Act A 1914 amendment that strengthens the Sherman Act by making it illegal for firms to engage in certain anticompetitive business practices 1 Price discrimination a firm charges different customers different prices for the same product with price differences not related to cost differences 2 Exclusive dealing a manufacture requires a retailer to sign an agreement stipulating the condition that the reseller will not carry any rival products 3 Tying contracts the seller of 1 product requires the buyer to purchase some