Chapter+16+Oligopoly+KC

Chapter 16 Oligopoly





How do oligopolies interact with each other in making decisions?

In previous chapters we have discussed competitive markets and monopolies. These models of market structures are highly theoretical since most market structures are neither completely monopolies nor perfectly competitive. Most markets in our economy include characteristics of both models, otherwise known as imperfectly competitive markets. There are two types of an imperfectly competitive market: oligopoly and monopolistic competition. In this chapter we will be examining and analyzing the behaviors of oligopolies.

An oligopoly  has only a few sellers producing similar or identical products. Therefore each firm in the market has a substantial influence on the market as a whole. Economists often use the concentration ratio to determine market domination. The concentration ratio  measures the percentage of products produced by the four largest firms in the market. Some companies such as cereal companies have a few brands such as Kellogg’s and Post producing a large percentage of the goods in the market. According to the Principles of Microeconomics textbook, breakfast cereal has a concentration ratio of 83 percent!

Because oligopolies have a small number of sellers, these groups must learn how to work in collusion with each other. Collusion  refers to the agreements made by the sellers. These groups of firms are called cartels , and cartels make decisions similar to monopolistic firms. Oligopolies earn the most profit by acting like a monopoly, but this is often times interrupted by the firms’ self-interest. However, when the firms act accordingly to their own self-interest they will end up producing a quantity greater than the monopolistic quantity, and end up placing lower prices on their products. Thus, the market will end up earning less profit than a monopoly would have earned.


 * Nash Equilibrium**

Since the firms in an oligopoly are all interdependent on each other, it is possible for individual firms to make their decisions based on the strategies of others. This creates an outcome closest to what we would call an equilibrium. Nash equilibrium  explains this property of oligopolistic firms. Nash equilibrium offers a satisfying outcome for every firm, while suppressing the incentives to produce extra profit. This is because often times when the firms make decisions to increase its profits, other firms would do the same, quantity would go up making the prices drop, and they would end up losing potential profit.

It is not always so difficult to come to a decision on the quantity of a product in oligopolies. Like monopolies, the prices of a product goes down if the quantity increases. Therefore oligopolists must be aware of their own quantity as well as others’ to make sure that they are producing at the point where price equals marginal cost (profit maximizing point as we have discussed in the previous chapter).


 * Market Outcomes**

When oligopolists fail to work in cartels, they must make individual decisions. When a firm decides to raise their production by one unit, there are two possible outcomes. - The first is called the output effect. In the output effect, the price is above the marginal cost so an increase in production will lead to profit. - The second is called the price effect. In the price effect, the increase in production leads to a decrease in price, and lowers the profit of a good.

The place where oligopolists make their decisions is right in between these two cases where the marginal cost and marginal revenue intersect.


 * Size of an Oligopoly**

As the oligopoly grows and more and more sellers enter in the market, the price effect starts to happen less frequently until it completely disappears. Then, only output effect remains which allows firms to increase production where price is above marginal cost. Then the larger oligopolies start acting more and more like a competitive market, and this allows the market to produce at the socially efficient scale.

Label if the following is a property of an oligopoly of not a property of an oligopoly P = MC NO  P > MR <span style="color: #ffffff; font-family: Verdana,Geneva,sans-serif; font-size: 120%;">YES <span style="font-family: Verdana,Geneva,sans-serif; font-size: 120%;"> Few Firms <span style="color: #ffffff; font-family: Verdana,Geneva,sans-serif; font-size: 120%;">YES <span style="font-family: Verdana,Geneva,sans-serif; font-size: 120%;"> Price taker <span style="color: #ffffff; font-family: Verdana,Geneva,sans-serif; font-size: 120%;">NO <span style="font-family: Verdana,Geneva,sans-serif; font-size: 120%;"> Price maker <span style="color: #ffffff; font-family: Verdana,Geneva,sans-serif; font-size: 120%;">YES <span style="font-family: Verdana,Geneva,sans-serif; font-size: 120%;"> strong barriers to entry <span style="color: #ffffff; font-family: Verdana,Geneva,sans-serif; font-size: 120%;">YES (highlight the above to see answers)

<span style="display: block; font-family: Verdana,Geneva,sans-serif; font-size: 110%; text-align: left;">**Oligopoly**- a market structure with only a few sellers producing the same/similar products
 * concentration ratio**- the percentage of total output in the market produced by the largest four firms in the market
 * monopolistic competition**- a market structure with many firms selling similar products
 * duopoly**- simplest form of oligopoly (with only two firms in the market)
 * collusion**- agreement made between firms about the quantity or price of a good in the market
 * cartel**- a unit of firms cooperating with each other
 * Nash equilibrium**- when people decide on their best strategy based on the strategies of others