EC120 Chapter 17-Oligopoly Week 10 Introduction -If you were to go ...
EC120
Chapter 17-Oligopoly
Week 10
Introduction -If you were to go to a store to buy hockey skates, you would likely come out with either Nike-Bauer or Reebok-CCM -These two companies make almost all of the skates sold in Canada. Together these firms determine the quantity of skates produced and, given the market demand curve, the price at which skates are sold. -This is an example of an oligopoly -Oligopoly-a market structure in which only a few sellers offer similar or identical products -The actions of any one seller in the market can have a large impact on the profits of all the other sellers -Oligopolistic firms are interdependent in a way that competitive firms are not. -Game theory-the study of how people behave in strategic situations -Strategic thinking is important in decisions -Each firm in an oligopoly should consider how its decision might affect the production decisions of all the other firms Markets with Only a Few Sellers -The group of oligopolists is best off cooperated and acting like a monopolist – producing a small quantity of output and charging a price above marginal cost A Duopoly Examples -An oligopoly with only two members -It is the simplest type of oligopoly -Imagine a town in which only two residents own wells that produce water that is safe for drinking. Each Saturday, the two decide how many litres of water to pump, bring the water to town and sell it for whatever price the market will bear
Competition, Monopolies, and Cartels -What outcome should we expect from our duopolists? -One possibility is that they will get together and agree on the quantity of water to produce and the price to charge for it. This is called a collusion -The group of firms working together is called a cartel -Once a cartel is formed, the market is in effect serves by a monopoly, and we can apply our analysis from chapter 15 -A cartel must agree not only on the total level of production but also on the amount produced by each member
EC120
Chapter 17-Oligopoly
Week 10
The Equilibrium for an Oligopoly -Oligopolists would like to form cartels and earn monopoly profits but that is not possible -The monopoly outcome is unlikely -If the duopolists individually pursue their own self interest when deciding how much 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 -They much reach a Nash Equilibrium – a situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen -Oligopolists would be better off cooperating and reaching monopoly outcome. Yet because they pursue their own self-interest, they do not end up reaching the monopoly outcome and maximizing their joint profit -Each oligopolist is tempted to raise production and capture a larger share of the market. As each of them tries to do this, total production rises, and the price falls -When firms in an oligopoly individually choose production to maximize profit, they produce a quantity of output greater than the level produced by monopoly and less than the level produced by competition. The oligopoly price is less than the monopoly price but greater than the competitive price (which equals marginal cost) How the Size of an Oligopoly Affects the Market Outcome -If two more producers join, and they form a cartel , they would once again try to maximize total profit by producing the monopoly quantity and charging the monopoly price. -As the cartel grows larger, this outcome is less likely -At any time, each well owner has the option to raise production by 1 litre. In making this decision, the well owner weights two effects: 1. The output effect: because price is above marginal cost, selling 1 more litre of water at the going price will raise profit 2. The price effect: raising production will increase the total amount sold, which will lower the price of water and lower the profit on all the other litres sold -If the output effect is larger than the price effect, the well owner will increase production. -If the price effect is larger than the output effect, the owner will not raise production -Each oligopoly continues to increase production until these two marginal effects exactly balance, taking the other firms’ production as given -As the number of sellers in an oligopoly grows larger, an oligopolistic market looks more and more like a competitive market. The price approaches marginal cost, and the quantity produced approaches the socially efficient level The Economics of Cooperation Prisoners’ Dilemma-a particular game between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial Prisoners’ Dilemma
EC120
Chapter 17-Oligopoly
Week 10
-Dominant Strategy-a strategy that is best for a player in a game regardless of the strategies chosen by the other players -In the end, they both confess, and both spend 8 years in jail. Yet, if they had both remained silent they would have only had 1 year in jail each. By each pursuing their own interests, the two prisoners together reach an outcome that is worse for each of them Oligopolies as a Prisoners’ Dilemma
Other Examples of the Prisoners’ Dilemma -Advertising-When two firms advertise to attract the same customers, they face a problem similar to the prisoner’s dilemma. -Consider Molson and Labatt. If they don’t advertise they split profit, if they do advertise they split profit and incur a loss from advertising. If one advertises and the other does not, then they take away profit from the other one
-Common Resources-Because the pool of oil is a common resource, the companies will not use it
EC120
Chapter 17-Oligopoly
Week 10
efficiently.
The Prisoners’ Dilemma and the Welfare of Society The dilemma describes many of life’s situations, and it shows that cooperation can be difficult to maintain, even when cooperation would make both players in the game better off -In the case of oligopolists trying to maintain monopoly profits, lack of cooperation is desirable from the standpoint of society as a whole Why People Sometimes Cooperate -The cooperative outcome may easily be reached Public Policy Toward Oligopolies -Policymakers should try to induce firms in an oligopoly to compete rather than cooperate Restraint of Trade and the Competition Act -Section 45(1) of Canada’s Competition Act Controversies over Competition Policy -Most commentators agree that price-fixing agreements among competing firms should be illegal. Here we consider 3 examples: 1. Resale Price Maintenance -Also referred to as fair trade -Business practices that appear to reduce competition may in fact have legitimate purposes 2. Predatory Pricing -Price cuts that occur to drive other businesses out of business -Suppose two movies come out – Spiderman and Hamlet. They offer the two movies together at the same price because one is ‘worthless’
Chapter 17-Oligopoly
Week 10
Introduction -If you were to go to a store to buy hockey skates, you would likely come out with either Nike-Bauer or Reebok-CCM -These two companies make almost all of the skates sold in Canada. Together these firms determine the quantity of skates produced and, given the market demand curve, the price at which skates are sold. -This is an example of an oligopoly -Oligopoly-a market structure in which only a few sellers offer similar or identical products -The actions of any one seller in the market can have a large impact on the profits of all the other sellers -Oligopolistic firms are interdependent in a way that competitive firms are not. -Game theory-the study of how people behave in strategic situations -Strategic thinking is important in decisions -Each firm in an oligopoly should consider how its decision might affect the production decisions of all the other firms Markets with Only a Few Sellers -The group of oligopolists is best off cooperated and acting like a monopolist – producing a small quantity of output and charging a price above marginal cost A Duopoly Examples -An oligopoly with only two members -It is the simplest type of oligopoly -Imagine a town in which only two residents own wells that produce water that is safe for drinking. Each Saturday, the two decide how many litres of water to pump, bring the water to town and sell it for whatever price the market will bear
Competition, Monopolies, and Cartels -What outcome should we expect from our duopolists? -One possibility is that they will get together and agree on the quantity of water to produce and the price to charge for it. This is called a collusion -The group of firms working together is called a cartel -Once a cartel is formed, the market is in effect serves by a monopoly, and we can apply our analysis from chapter 15 -A cartel must agree not only on the total level of production but also on the amount produced by each member
EC120
Chapter 17-Oligopoly
Week 10
The Equilibrium for an Oligopoly -Oligopolists would like to form cartels and earn monopoly profits but that is not possible -The monopoly outcome is unlikely -If the duopolists individually pursue their own self interest when deciding how much 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 -They much reach a Nash Equilibrium – a situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen -Oligopolists would be better off cooperating and reaching monopoly outcome. Yet because they pursue their own self-interest, they do not end up reaching the monopoly outcome and maximizing their joint profit -Each oligopolist is tempted to raise production and capture a larger share of the market. As each of them tries to do this, total production rises, and the price falls -When firms in an oligopoly individually choose production to maximize profit, they produce a quantity of output greater than the level produced by monopoly and less than the level produced by competition. The oligopoly price is less than the monopoly price but greater than the competitive price (which equals marginal cost) How the Size of an Oligopoly Affects the Market Outcome -If two more producers join, and they form a cartel , they would once again try to maximize total profit by producing the monopoly quantity and charging the monopoly price. -As the cartel grows larger, this outcome is less likely -At any time, each well owner has the option to raise production by 1 litre. In making this decision, the well owner weights two effects: 1. The output effect: because price is above marginal cost, selling 1 more litre of water at the going price will raise profit 2. The price effect: raising production will increase the total amount sold, which will lower the price of water and lower the profit on all the other litres sold -If the output effect is larger than the price effect, the well owner will increase production. -If the price effect is larger than the output effect, the owner will not raise production -Each oligopoly continues to increase production until these two marginal effects exactly balance, taking the other firms’ production as given -As the number of sellers in an oligopoly grows larger, an oligopolistic market looks more and more like a competitive market. The price approaches marginal cost, and the quantity produced approaches the socially efficient level The Economics of Cooperation Prisoners’ Dilemma-a particular game between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial Prisoners’ Dilemma
EC120
Chapter 17-Oligopoly
Week 10
-Dominant Strategy-a strategy that is best for a player in a game regardless of the strategies chosen by the other players -In the end, they both confess, and both spend 8 years in jail. Yet, if they had both remained silent they would have only had 1 year in jail each. By each pursuing their own interests, the two prisoners together reach an outcome that is worse for each of them Oligopolies as a Prisoners’ Dilemma
Other Examples of the Prisoners’ Dilemma -Advertising-When two firms advertise to attract the same customers, they face a problem similar to the prisoner’s dilemma. -Consider Molson and Labatt. If they don’t advertise they split profit, if they do advertise they split profit and incur a loss from advertising. If one advertises and the other does not, then they take away profit from the other one
-Common Resources-Because the pool of oil is a common resource, the companies will not use it
EC120
Chapter 17-Oligopoly
Week 10
efficiently.
The Prisoners’ Dilemma and the Welfare of Society The dilemma describes many of life’s situations, and it shows that cooperation can be difficult to maintain, even when cooperation would make both players in the game better off -In the case of oligopolists trying to maintain monopoly profits, lack of cooperation is desirable from the standpoint of society as a whole Why People Sometimes Cooperate -The cooperative outcome may easily be reached Public Policy Toward Oligopolies -Policymakers should try to induce firms in an oligopoly to compete rather than cooperate Restraint of Trade and the Competition Act -Section 45(1) of Canada’s Competition Act Controversies over Competition Policy -Most commentators agree that price-fixing agreements among competing firms should be illegal. Here we consider 3 examples: 1. Resale Price Maintenance -Also referred to as fair trade -Business practices that appear to reduce competition may in fact have legitimate purposes 2. Predatory Pricing -Price cuts that occur to drive other businesses out of business -Suppose two movies come out – Spiderman and Hamlet. They offer the two movies together at the same price because one is ‘worthless’
