1、 2009 South-Western,a part of Cengage Learning,all rights reservedC H A P T E REconomicsPremium PowerPoint Slides by Ron Cronovich17What outcomes are possible under oligopoly?Why is it difficult for oligopoly firms to cooperate?How are antitrust laws used to foster competition?1OLIGOPOLY2Measuring M
2、arket ConcentrationConcentration ratio:the percentage of the markets total output supplied by its four largest firms.The higher the concentration ratio,the less competition.This chapter focuses on oligopoly,a market structure with high concentration ratios.IndustryConcentration ratioVideo game conso
3、les100%Tennis balls100%Credit cards99%Batteries94%Soft drinks93%Web search engines92%Breakfast cereal92%Cigarettes89%Greeting cards88%Beer85%Cell phone service82%Autos79%OLIGOPOLY4OligopolyOligopoly:a market structure in which only a few sellers offer similar or identical products.Strategic behavior
4、 in oligopoly:A firms decisions about P or Q can affect other firms and cause them to react.The firm will consider these reactions when making decisions.Game theory:the study of how people behave in strategic situations.OLIGOPOLY5PQ$0140513010120151102010025903080357040604550EXAMPLE:Cell Phone Duopo
5、ly in SmalltownSmalltown has 140 residentsThe“good”:cell phone service with unlimited anytime minutes and free phoneSmalltowns demand scheduleTwo firms:T-Mobile,Verizon(duopoly:an oligopoly with two firms)Each firms costs:FC=$0,MC=$10OLIGOPOLY6504560407035803090251002011015120101305140$0QP1,7501,800
6、1,7501,6001,3501,00055006501,400Profit5006007008009001,0001,1001,2001,300$1,400Cost2,2502,4002,4502,4002,2502,0001,6501,200650$0RevenueEXAMPLE:Cell Phone Duopoly in SmalltownCompetitive outcome:P=MC=$10Q=120Profit=$0Monopoly outcome:P=$40Q=60Profit=$1,800OLIGOPOLY7EXAMPLE:Cell Phone Duopoly in Small
7、townOne possible duopoly outcome:collusionCollusion:an agreement among firms in a market about quantities to produce or prices to chargeT-Mobile and Verizon could agree to each produce half of the monopoly output:For each firm:Q=30,P=$40,profits=$900Cartel:a group of firms acting in unison,e.g.,T-Mo
8、bile and Verizon in the outcome with collusion8Duopoly outcome with collusion:Each firm agrees to produce Q=30,earns profit=$900.If T-Mobile reneges on the agreement and produces Q=40,what happens to the market price?T-Mobiles profits?Is it in T-Mobiles interest to renege on the agreement?If both fi
9、rms renege and produce Q=40,determine each firms profits.PQ$0140513010120151102010025903080357040604550If both firms stick to agreement,each firms profit=$900If T-Mobile reneges on agreement and produces Q=40:Market quantity=70,P=$35T-Mobiles profit=40 x($35 10)=$1000T-Mobiles profits are higher if
10、it reneges.Verizon will conclude the same,so both firms renege,each produces Q=40:Market quantity=80,P=$30Each firms profit=40 x($30 10)=$8009PQ$0140513010120151102010025903080357040604550OLIGOPOLY10Collusion vs.Self-InterestBoth firms would be better off if both stick to the cartel agreement.But ea
11、ch firm has incentive to renege on the agreement.Lesson:It is difficult for oligopoly firms to form cartels and honor their agreements.If each firm produces Q=40,market quantity=80 P=$30 each firms profit=$800Is it in T-Mobiles interest to increase its output further,to Q=50?Is it in Verizons intere
12、st to increase its output to Q=50?11PQ$0140513010120151102010025903080357040604550If each firm produces Q=40,then each firms profit=$800.If T-Mobile increases output to Q=50:Market quantity=90,P=$25T-Mobiles profit=50 x($25 10)=$750T-Mobiles profits are higher at Q=40 than at Q=50.The same is true f
13、or Verizon.12PQ$0140513010120151102010025903080357040604550OLIGOPOLY13The Equilibrium for an OligopolyNash equilibrium:a situation in which economic participants interacting with one another each choose their best strategy given the strategies that all the others have chosen Our duopoly example has
14、a Nash equilibrium in which each firm produces Q=40.Given that Verizon produces Q=40,T-Mobiles best move is to produce Q=40.Given that T-Mobile produces Q=40,Verizons best move is to produce Q=40.OLIGOPOLY14A Comparison of Market OutcomesWhen firms in an oligopoly individually choose production to m
15、aximize profit,oligopoly Q is greater than monopoly Q but smaller than competitive Q.oligopoly P is greater than competitive P but less than monopoly P.OLIGOPOLY15The Output&Price EffectsIncreasing output has two effects on a firms profits:Output effect:If P MC,selling more output raises profits.Pri
16、ce effect:Raising production increases market quantity,which reduces market price and reduces profit on all units sold.If output effect price effect,the firm increases production.If price effect output effect,the firm reduces production.OLIGOPOLY16The Size of the OligopolyAs the number of firms in t
17、he market increases,the price effect becomes smallerthe oligopoly looks more and more like a competitive marketP approaches MCthe market quantity approaches the socially efficient quantityOLIGOPOLY17Game TheoryGame theory helps us understand oligopoly and other situations where“players”interact and
18、behave strategically.Dominant strategy:a strategy that is best for a player in a game regardless of the strategies chosen by the other playersPrisoners dilemma:a“game”between two captured criminals that illustrates why cooperation is difficult even when it is mutually beneficial OLIGOPOLY18Prisoners
19、 Dilemma ExampleThe police have caught Bonnie and Clyde,two suspected bank robbers,but only have enough evidence to imprison each for 1 year.The police question each in separate rooms,offer each the following deal:If you confess and implicate your partner,you go free.If you do not confess but your p
20、artner implicates you,you get 20 years in prison.If you both confess,each gets 8 years in prison.OLIGOPOLY19Prisoners Dilemma ExampleConfessRemain silentConfessRemain silentBonnies decisionClydes decisionBonnie gets 8 yearsClyde gets 8 yearsBonnie gets 20 yearsBonnie gets 1 yearBonnie goes freeClyde
21、 goes freeClyde gets 1 yearClyde gets 20 yearsConfessing is the dominant strategy for both players.Nash equilibrium:both confessOLIGOPOLY20Prisoners Dilemma ExampleOutcome:Bonnie and Clyde both confess,each gets 8 years in prison.Both would have been better off if both remained silent.But even if Bo
22、nnie and Clyde had agreed before being caught to remain silent,the logic of self-interest takes over and leads them to confess.OLIGOPOLY21Oligopolies as a Prisoners DilemmaWhen oligopolies form a cartel in hopes of reaching the monopoly outcome,they become players in a prisoners dilemma.Our earlier
23、example:T-Mobile and Verizon are duopolists in Smalltown.The cartel outcome maximizes profits:Each firm agrees to serve Q=30 customers.Here is the“payoff matrix”for this exampleOLIGOPOLY22T-Mobile&Verizon in the Prisoners DilemmaQ=30Q=40Q=30Q=40T-MobileVerizonT-Mobiles profit=$900Verizons profit=$90
24、0T-Mobiles profit=$1000T-Mobiles profit=$800T-Mobiles profit=$750Verizons profit=$750Verizons profit=$800Verizons profit=$1000Each firms dominant strategy:renege on agreement,produce Q=40.The players:American Airlines and United AirlinesThe choice:cut fares by 50%or leave fares aloneIf both airlines
25、 cut fares,each airlines profit=$400 millionIf neither airline cuts fares,each airlines profit=$600 million If only one airline cuts its fares,its profit=$800 millionthe other airlines profits=$200 millionDraw the payoff matrix,find the Nash equilibrium.2324Nash equilibrium:both firms cut faresCut f
26、aresDont cut faresCut faresDont cut faresAmerican AirlinesUnited Airlines$600 million$600 million$200 million$800 million$800 million$200 million$400 million$400 millionOLIGOPOLY25Other Examples of the Prisoners DilemmaAd WarsTwo firms spend millions on TV ads to steal business from each other.Each
27、firms ad cancels out the effects of the other,and both firms profits fall by the cost of the ads.Organization of Petroleum Exporting Countries Member countries try to act like a cartel,agree to limit oil production to boost prices&profits.But agreements sometimes break down when individual countries
28、 renege.OLIGOPOLY26Other Examples of the Prisoners DilemmaArms race between military superpowers Each country would be better off if both disarm,but each has a dominant strategy of arming.Common resources All would be better off if everyone conserved common resources,but each persons dominant strate
29、gy is overusing the resources.OLIGOPOLY27Prisoners Dilemma and Societys WelfareThe noncooperative oligopoly equilibrium Bad for oligopoly firms:prevents them from achieving monopoly profitsGood for society:Q is closer to the socially efficient output P is closer to MCIn other prisoners dilemmas,the
30、inability to cooperate may reduce social welfare.e.g.,arms race,overuse of common resourcesOLIGOPOLY28Another Example:Negative Campaign AdsElection with two candidates,“R”and“D.”If R runs a negative ad attacking D,3000 fewer people will vote for D:1000 of these people vote for R,the rest abstain.If
31、D runs a negative ad attacking R,R loses 3000 votes,D gains 1000,2000 abstain.R and D agree to refrain from running attack ads.Will each one stick to the agreement?OLIGOPOLY29Another Example:Negative Campaign AdsDo not run attack ads(cooperate)Run attack ads(defect)Do not run attack ads(cooperate)Ru
32、n attack ads(defect)OLIGOPOLY30Another Example:Negative Campaign AdsNash eqm:both candidates run attack ads.Effects on election outcome:NONE.Each sides ads cancel out the effects of the other sides ads.Effects on society:NEGATIVE.Lower voter turnout,higher apathy about politics,less voter scrutiny o
33、f elected officials actions.OLIGOPOLY31Why People Sometimes CooperateWhen the game is repeated many times,cooperation may be possible.These strategies may lead to cooperation:If your rival reneges in one round,you renege in all subsequent rounds.“Tit-for-tat”Whatever your rival does in one round(whe
34、ther renege or cooperate),you do in the following round.OLIGOPOLY32Public Policy Toward OligopoliesRecall one of the Ten Principles from Chap.1:Governments can sometimes improve market outcomes.In oligopolies,production is too low and prices are too high,relative to the social optimum.Role for polic
35、ymakers:Promote competition,prevent cooperation to move the oligopoly outcome closer to the efficient outcome.OLIGOPOLY33Restraint of Trade and Antitrust LawsSherman Antitrust Act(1890):Forbids collusion between competitorsClayton Antitrust Act(1914):Strengthened rights of individuals damaged by ant
36、icompetitive arrangements between firmsOLIGOPOLY34Controversies Over Antitrust PolicyMost people agree that price-fixing agreements among competitors should be illegal.Some economists are concerned that policymakers go too far when using antitrust laws to stifle business practices that are not neces
37、sarily harmful,and may have legitimate objectives.We consider three such practicesOLIGOPOLY351.Resale Price Maintenance(“Fair Trade”)Occurs when a manufacturer imposes lower limits on the prices retailers can charge.Is often opposed because it appears to reduce competition at the retail level.Yet,an
38、y market power the manufacturer has is at the wholesale level;manufacturers do not gain from restricting competition at the retail level.The practice has a legitimate objective:preventing discount retailers from free-riding on the services provided by full-service retailers.OLIGOPOLY362.Predatory Pr
39、icingOccurs when a firm cuts prices to prevent entry or drive a competitor out of the market,so that it can charge monopoly prices later.Illegal under antitrust laws,but hard for the courts to determine when a price cut is predatory and when it is competitive&beneficial to consumers.Many economists
40、doubt that predatory pricing is a rational strategy:It involves selling at a loss,which is extremely costly for the firm.It can backfire.OLIGOPOLY373.TyingOccurs when a manufacturer bundles two products together and sells them for one price(e.g.,Microsoft including a browser with its operating syste
41、m)Critics argue that tying gives firms more market power by connecting weak products to strong ones.Others counter that tying cannot change market power:Buyers are not willing to pay more for two goods together than for the goods separately.Firms may use tying for price discrimination,which is not i
42、llegal,and which sometimes increases economic efficiency.OLIGOPOLY38CONCLUSIONOligopolies can end up looking like monopolies or like competitive markets,depending on the number of firms and how cooperative they are.The prisoners dilemma shows how difficult it is for firms to maintain cooperation,eve
43、n when doing so is in their best interest.Policymakers use the antitrust laws to regulate oligopolists behavior.The proper scope of these laws is the subject of ongoing controversy.Oligopolists can maximize profits if they form a cartel and act like a monopolist.Yet,self-interest leads each oligopol
44、ist to a higher quantity and lower price than under the monopoly outcome.The larger the number of firms,the closer will be the quantity and price to the levels that would prevail under competition.39The prisoners dilemma shows that self-interest can prevent people from cooperating,even when cooperation is in their mutual interest.The logic of the prisoners dilemma applies in many situations.Policymakers use the antitrust laws to prevent oligopolies from engaging in anticompetitive behavior such as price-fixing.But the application of these laws is sometimes controversial.40
