Chapter+16+(Oligopoly)

Oligopoly
 * Chapter 16

By Rachel **.Y

First type of imperfectly competitive market is called: **Oligopoly**: "a market structure in which only a few sellers offer similar or identical products." E.g. Tennis balls, Cigarettes.

A second type of imperfectly competitive market is called: **Monopolistic competition**: "a market structure in which many firms sell products that are similar but not identical. E.g. Markets for novels, CDs."

Below is a movie about 4 Market structures: **Monopoly, Oligopoly, Monopolistic Competition, Perfect Competition.**

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 * Duopoly **

A **Duopoly**: simplest type of oligopoly that consists of two firms. For example, Jack and Jill wanted to make a decision of how many gallons of water they should pump and sell in town for any price that the market would accept.

If there was a demand schedule for water, the first column shows the Q. The second column shows the P. So as you can see, if the quantity and price were graphed, it would show a standard **downward-sloping demand curve**. The last column shows the **total revenue = Q x P**.

 


 * <span style="font-family: 바탕;">__Competition, Monopolies, and Cartels__ **

<span style="font-family: 바탕;">In a **competitive market production,** decisions of each firm make **P = MC**. <span style="font-family: 바탕;">Because marginal cost = 0, the equilibrium quantity = 120 gallons and the equilibrium price would be 0. <span style="font-family: 바탕;"> <span style="font-family: 바탕;">A **monopolist** would produce the **profit-maximizing** Q and P. P would go beyond MC. This would be inefficient because the quantity of water produced and consumed would not reach the ‘socially efficient level’ which in this example is 120 gallons. <span style="font-family: 바탕;"> <span style="font-family: 바탕;">For these **DUOPOLISTS**, Jack and Jill could make an agreement of the quantity they would produce and the price of water. <span style="font-family: 바탕;"> <span style="color: rgb(186, 21, 249);">**<span style="font-family: 바탕;">__Collusion__: Agreement made between firms about the changing of prices and the production of quantities. **

<span style="color: rgb(97, 104, 239);"><span style="color: rgb(240, 20, 106);"><span style="color: rgb(0, 0, 0);">**<span style="font-family: 바탕;">__Cartel__: a group of firms acting together. **

<span style="font-family: 바탕;">So, if Jack and Jill were to make an agreement, they would agree on the ‘//monopoly outcome//’ because this would maximize the total profit that producers can obtain from the market. So the producers would produce 60 gallons altogether sold at $60 a gallon. Jack and Jill also must split the monopoly production of 60 gallons among themselves.



<span style="font-family: 바탕;"> Sometimes cartel members may not be able to come to an agreements when they argue over how to divide the profit in the market. So, Jack and Jill must make their decisions **//separately//** of how much water to produce.
 * <span style="font-family: 바탕;">The Equilibrium for an Oligopoly **

__Without an agreement it is unlikely that there will be a monopoly outcome__. For example (from the '__Principles of Microeconomics__' by Mankiw), if Jack thinks Jill will produce only 30 gallons, Jack may think that he could produce 30 gallons as well. Then 60 gallons of water would be sold at the P of $60 a gallon. His profit would be 1,800 (30 gallons x $60 a gallon).

But, he could also produce 40 gallons. Then a total of 70 gallons of water would be sold at a price of $50 a gallon. His profit would then grow to $ 2,000 (40 gallons x $50 a gallon). His profit would ultimately be higher because he has the bigger share of the market, while the total profit in the market may fall.

Jill would also reason this way. If that happens, then they would both bring 40 gallons to town. Total sales = 80 gallons and price would fall to $40. So __if the duopolists individually look to their own self interest when deciding how to produce, they produce a total quantity GREATER than the monopoly quantity, charge a price LOWER than the monopoly price, and earn total profit LESS than the monopoly profit.__

However, Jack and Jill each producing 40 gallons could be called a Nash Equilibrium because if one of them were to increase his/her production to 50 gallons, then 90 gallons of water would be sold and price would be $30 a gallon. So the profit would be lowered to $1,500. So increasing the production only lowers the price.

<span style="color: rgb(230, 15, 72);">**__Nash Equilibrium__**__: A situation in which people interacting with one another each choose their best strategy looking at the strategies that all the others have chosen.__

So if Jill produces 40 gallons, Jack would have to produce 40 gallons as well and vice-versa. Once the Nash Equilibrium is reached, neither would want to change their decision.

Below is a must-see clip explaining the **Nash Equilibrium** from the movie "__A Beautiful Mind__" which protrays the life of John Nash, an economist theorist.

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<span style="font-family: 바탕;">This example shows that it is hard to cooperate even if it is more beneficial because of self-interest. <span style="font-family: 바탕;">

<span style="font-family: 바탕;">__* Oligopolists would be better off cooperating and reaching the monopoly outcome. But they fail to do so because of self-interest, and therefore cannot maximize their joint profit.__

__As Oligopolists try to raise production and obtain a LARGER share of the market, TOTAL PRODUCTION RISES and PRICE FALLS.__ <span style="font-family: 바탕;"> <span style="color: rgb(15, 36, 250);"><span style="color: rgb(29, 11, 11);">* When Firms in an oligopoly choose production on their own in order to choose production that would maximize profit, they produce a quantity of output > than that produced by monopoly and < than that produced by competition.

So, __Competitive P (= Marginal cost) < Oligopoly P < Monopoly P__


 * The Effect of Size of an Oligopoly on the Market Outcome**

__As Cartel increases, the difficulty of reaching an agreement increases.__

Without forming a cartel, the oligopolists have to weigh the effects below:

- **the Output effect**: selling 1 more gallon of water at the going price would increase profit because P is above MC. - **the Price effect**: Increasing production would increase Total amount sold. This decreases P of water and decreases the profit on all the other gallons sold. <span style="font-family: 바탕;"> - As the size of oligopoly INCREASES, magnitude of price effect DECREASES. - When Oligopoly grows too large, NO price effect, leaving output effect. __- As # of sellers increase, oligopolistic market looks more like COMPETITIVE market. - As # of sellers increase, P approaches MC, and Q produced gets closer to the SOCIALLY EFFICIENT LEVEL__.
 * <span style="font-family: 바탕;">If Output effect > Price Effect, well owner would increase production.*
 * <span style="font-family: 바탕;">If Price effect > Output effect, well owner does not increase production.*


 * <span style="font-family: 바탕;">

Game Theory and the Economics of Cooperation **<span style="font-family: 바탕;">

'**Strategic**': we mean a situation in which each person, when making a decision of what actions they must take, must also consider how others might respond to that action.
 * Game Theory**: the study of how people behave in strategic situations

In an oligopolistic market, each firm is small, so each firm must take "strategic" actions. Each firm must know that not only their decisions but the decisions that other firm makes of how much to produce, is very important. <span style="font-family: 바탕;">__* Game theory is not used in competitve or monopoly markets__. 1) Competitive market has firms that are so small that 'strategic' with other firms is not necessary. 2) In a monopolized market, 'strategic interactions are not used because the market only has one firm. __Game theory is important in understanding the behaviors of oligopolies.__


 * Prisoner's Dilemma: a particular "game" between two captured prisoners that shows why cooperation is difficult to maintain even when it is mutually beneficial.**

This game shows how difficult it is to maintain COOPERATION. This example shows that people usually fail to cooperate with eachother when it could actually make them better off.


 * Dominant Strategy**: A strategy that is best for ONE player in a game, where the strategies chosen by the other players r <span style="font-family: 바탕;">do not matte <span style="font-family: 바탕;">r.

Look at the diagram below. If both remain silent, both only spend 1 year in jail. But they think what is best for them is confessing because that is better than spending 20 years in jail. So, both decide to confess, spending 5 years in jail.

Because of **SELF-INTEREST**, they reach a conclusion that is worse for them both. <span style="font-family: 바탕;"> <span style="font-family: 바탕;">

<span style="font-family: 바탕;">Below is another example similar to Prisoner’s Dilemma. Both countries take the dominant strategy of arming because of self-interest. But this leads <span style="font-family: 바탕;">U.S. <span style="font-family: 바탕;"> and <span style="font-family: 바탕;">USSR <span style="font-family: 바탕;"> to risks. If they were to disarm then both <span style="font-family: 바탕;">U.S. <span style="font-family: 바탕;"> and <span style="font-family: 바탕;">USSR <span style="font-family: 바탕;"> would have been safe.



//<span style="font-family: 바탕;">Why do people sometimes cooperate? //<span style="font-family: 바탕;"> The “prisoner’s dilemma” shows that cooperation can make people better off.

//How and why does the government regulate Oligopolies?// E.g. Sherman Antitrust Act, Clayton Act

These Laws tried to stop oligopolists from merging and decreasing competition.


 * Should Oligopolies cooperate or not? how does it affect the Society?**

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 * Controversies Over Antitrust Policy**

Although the actions of oligopolists may lead to less competition, they may have ‘legitimate business purposes.’ - Resale Price Maintenance - Predatory Pricing: A seller charges less than its ave. cost to make a competitor get out of business. - Tying: a seller offers to sell products only to those who also buy other products.

Questions and answers : )
Questions: Q1. What is an Oligopoly market? Q2. What is a key feature of oligopoly? Q3. What is cartel and collusion? Q4. a) John Nash proposed which theory? b) What is the theory about? Q5. Why do oligopolists fail to cooperate when it could make them better off? Q6. As the size of oligoploy ________, magnitude of price effect ________. Q7. As # of sellers increase, oligopolistic markets look more like ______ markets Q8. What is a 'dominant strategy?

Answers: A1. A market structure that has only a few sellers that produce similar products. A2. The tension between cooperation and self-interest. A3. Cartel: group of firms that work together. Collusion: Agreement made between firms about the changing of prices and the production of quantities. A4. a) Nash Equilibrium b) A situation in which people interacting with one another each choose their best strategy looking at the strategies that all the others have chosen. A5. Because of self-interest. A6. Increases, decreases A7. Competitive A8. A strategy that is best for a player in a game, where the strategies chosen by the other players do not matter.

<span style="color: rgb(183, 46, 239);">READY FOR ANOTHER QUIZ? Try: http://wps.prenhall.com/bp_case_micro_8/51/13063/3344246.cw/index.html from Pearson Education.


 * Sources:**

Books: __The Principles of Microeconomics__ by: N. Gregory Mankiw of Havard University

Sites:

Oligopoly: http://en.wikipedia.org/wiki/Oligopoly http://tutor2u.net/economics/content/topics/monopoly/oligopoly_notes.htm http://moneyterms.co.uk/oligopoly/ http://moneyterms.co.uk/duopoly/

Prisoner's dilemma: http://en.wikipedia.org/wiki/Prisoner%27s_dilemma http://pespmc1.vub.ac.be/prisdil.html http://plato.stanford.edu/entries/prisoner-dilemma/ <span style="font-family: arial,sans-serif;"><span style="color: rgb(0, 128, 0);"><span style="color: rgb(20, 5, 5);">www.britannica.com

Nash Equilibrium: http://en.wikipedia.org/wiki/Nash_equilibrium http://www.scribd.com/doc/87016/Micro-Ch16-Nash-Presentation

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