UNIT 4.3:IMPERFECT COMPETITION

Oligopoly(Oli.)

•Identical Products•No advantage•D=MR=AR=P•Both efficiencies•Price-Taker•1000s

Perfect Competition Monopolistic Competition

Oligopoly Monopoly

No Similarities

•MR = MC•Shut-Down Point•Cost Curves•Motivation for Profit

•Excess Advertising•Differentiated Products•Excess Capacity• More Elastic Demand than

Monopoly•100s

•Low barriers to entry•No Long-Run Profit•Price = ATC

•Price Maker (D>MR)•Some Non-Price Competition•Inefficient

•Collusion•Strategic Pricing (Interdependence)•Game Theory•10 or less

•Unique Good•Price Discrimination•1

•Price Maker (D>MR)•High Barriers•Ability to Make LR Profit•Inefficient

Avocados

HammocksRetail Stores

CarsAppliances

Local

Utilities

© 2013 Pearson

Is two too few?

What is an Oligopoly?

Conditions of an Oligopoly

1) Less than 10 Firms

2) Products are generally identical (standardized)

3) High Barriers to Entry: Hard to enter the market because the competitors work together to control all the resources & prices. Plus it is very expensive to make the product.

4) The actions of one affects all the producers.

5) Behavior: either fierce competition or collusion(Price Fixing) an agreement to act together or behave in a cooperative manner.

6) Game Theory help explain why firms collude and also choose not to collude.

Example of Oligopoly: OPEC Organization of the Petroleum Exporting Countries

Game TheoryThe study of how people behave in

strategic situations

Price Behavior in Oligopoly

THE ICE CREAM MAN SIMULATION1. You are a ice cream salesmen at the

beach2. You have identical prices as another

salesmen.3. Beachgoers will purchase from the

closest salesmen4. People are evenly distributed along the

beach.5. Each morning the two firms pick

locations on the beach

Price Behavior in Oligopoly

Where should you put your firm?

You could choose to separate or share in the volume sale in the center of the

beach.

Game Theory

Why learn about game theory?Oligopolies are interdependent since they compete with only a few other firms.

Their pricing and output decisions must be strategic as to avoid economic losses. Game theory helps us

analyze their strategies.

Game Theory

The Prisoner’s DilemmaBen and Jerry have been caught stealing a car: sentence is 2 years in jail.

Rules

– Players cannot communicate with one another.

If both confess to the crime, each will receive a sentence of 5 years for the crime.

If one confesses and the accomplice does not, the one who confesses will receive a 10-year sentence, while the accomplice receives no sentence.

If neither confesses, both receive a 1-year sentence.

We must find each players’ dominate strategy:

– when one strategy is better than another strategy for one player, no matter how that player's opponents may play.

Game TheoryThe Prisoner’s Dilemma

Charged with a crime, each prisoner has one of two choices: Deny or Confess

STEP 1: Identify the two players’ dominate strategy (if any)

Ben has a dominate strategy to …..

Jerry has a dominate strategy to …..

   

    

Jerry

Ben

Ben = 5 Jerry = 5

DenyConfess

Deny

Confess

Ben = 10 Jerry = 0

Ben =0 Jerry = 10

Ben = 1 Jerry = 1

…confess

…confess

Game Theory

Equilibrium Strategy:

–Nash Equilibrium is an equilibrium in which each player takes the best possible action given the action of the other player.

– In other words, after the game has been played, the players are “stuck” in the strategy because it is more beneficial than any other strategy.

–NOT EVERY GAME HAS A NASH EQUILIBRIUM!!!

Game TheoryThe Prisoner’s Dilemma

Charged with a crime, each prisoner has one of two choices: Deny or Confess

STEP 2: Identify the Nash Equilibrium (if any)

There is no Nash equilibrium for Jerry and Ben. Why?

   

    

Jerry

Ben

Ben = 5 Jerry = 5

DenyConfess

Deny

Confess

Ben = 10 Jerry = 0

Ben =0 Jerry = 10

Ben = 1 Jerry = 1

In all possible outcomes both players (one at least one player) would be better off changing his/her strategy.

Dominant StrategyThe Dominant Strategy is the best move to

make regardless of what your opponent doesWhat is each firm’s dominate strategy?

   

    

Firm 2

Firm 1

$100, $50

High Low

High

Low

$50, $90

$80, $40 $20, $10

Firm 1 should go High

Firm 2 has no dominate strategy

Game Theory: Market Example

The Duopolists’ Dilemma– The dilemma of Boeing and Airbus is similar

to that of Jerry and Ben.– Each firm has two strategies. It can produce

airplanes at the rate of:3 a week

4 a week

Vocab: A duopoly is a market with two firms.

Game Theory: Market Example

– Because each firm has two strategies, there are four possible combinations of actions:

Both firms produce 3 a week (monopoly outcome).

Both firms produce 4 a week.

Airbus produces 3 a week and Boeing produces 4 a week.

Boeing produces 3 a week and Airbus produces 4 a week.

Game Theory: Market Example

The Payoff Matrix–This table shows the payoff matrix as the economic profits for each firm in each possible outcome.

Game Theory: Market Example

Equilibrium of the Duopolists’ Dilemma:

Both firms produce 4 a week.

Like the prisoners, the duopolists fail to cooperate and get a worse outcome than the one that cooperation would deliver.

The two firms may choose to collude.

Remember that cartel formation & collusion is ILLEGAL.

Game Theory: Market Example

P&G and Kimberly-Clark have two strategies: spend on R&D or do no R&D.

The table shows the payoff matrix as the economic profits for each firm in each possible outcome.

Another Example: Research and Development Game

Game Theory: Market Example

Research and Development Game

The Nash equilibrium for this game is for both firms to undertake R&D.

But they could earn a larger joint profit if they could collude and not do R&D.

Kinked Demand

Kinked Demand

Sometimes price in the oligopoly become “stuck”

Not because of collusion, but due to the elastic and inelastic nature of the demand curve.

I will lower if you will?

Uhhh….No!

Kinked Demand: Homogenous OligopolySometimes price in the oligopoly becomes “stuck”

Note: If price does drop then a temporary price wars may occur if other firms don’t follow price increases of the one dominant firm.

$

QO

P1

Q1

D = AR

Inelastic range

Stuck priceBasically, NO firm will want to lower its price into the inelastic range.

Elastic range

Graphing a Oligopoly: Price LeadershipExample: Temporary price wars may occur if other firms don’t follow price increases of dominant firm.