Oligopoly
CHAPTER
13B
After studying this chapter you will be able to
Define and identify oligopoly
Explain two traditional oligopoly models
Use game theory to explain how price and output are determined in oligopoly
Use game theory to explain other strategic decisions
PC War Games
In some markets there are only two firms. Computer chips are an example.
The chips that drive most PCs are made by Intel and Advanced Micro Devices.
How does competition between just two chip makers work?
Do they operate in the social interest, like the firms in perfect competition?
Or do they restrict output to increase profit, like a monopoly?
What Is Oligopoly?
The distinguishing features of oligopoly are
Natural or legal barriers that prevent entry of new firms
A small number of firms compete
What is Oligopoly?
Barriers to Entry Either natural or legal barriers to entry can create oligopoly.
Figure 13.9 shows two
What is Oligopoly?
In part (b), there is a natural oligopoly market with three firms.
A legal oligopoly might arise even where the demand and costs leave room for a larger number of firms.
What is Oligopoly?
Small Number of Firms
Because an oligopoly market has a small number of firms, the firms are interdependent and face a temptation to cooperate.
Interdependence: With a small number of firms, each firm’s profit depends on every firm’s actions.
Cartel: A carteland is an illegal group of firms acting together to limit output, raise price, and increase profit.
Firms in oligopoly face the temptation to form a cartel, but aside from being illegal, cartels often break down.
What is Oligopoly?
Examples of Oligopoly Figure 13.10 shows some examples of oligopoly.
Four largest firms
Next four largest firms
Next 12 largest firms An HHI that exceeds 1,000 is usually an oligopoly.
An HHI below 1,000 is usually monopolistic competition.
Two Traditional Oligopoly Models
The Kinked Demand Curve Model
In the kinked demand curve model of oligopoly, each firm believes that if it raises its price, its competitors will not follow, but if it lowers its price all of its competitors will follow.
Figure 13.11 shows the kinked demand curve model.
The firm believes that the demand for its product has a kink at the current price and quantity.
Two Traditional Oligopoly Models
Two Traditional Oligopoly Models
Above the kink, demand is relatively elastic because all other firm’s prices remain unchanged.
Below the kink, demand is relatively inelastic because all other firm’s prices change in line with the price of the firm shown in the figure.
Two Traditional Oligopoly Models
The kink in the demand curve means that the MR curve is discontinuous at the current quantity—shown by that gap ABin the figure.
Two Traditional Oligopoly Models
This slide helps to envisage why the kink in the demand
Two Traditional Oligopoly Models
Fluctuations in MCthat remain within the
discontinuous portion of the MRcurve leave the profit- maximizing quantity and price unchanged.
For example, if costs increased so that the MC curve shifted upward from MC0to MC1, the profit- maximizing price and quantity would not change.
Two Traditional Oligopoly Models
The beliefs that generate the kinked demand curve are not always correct and firms can figure out this fact.
If MCincreases enough, all firms raise their prices and the kink vanishes.
A firm that bases its actions on wrong beliefs doesn’t maximize profit.
Two Traditional Oligopoly Models
Dominant Firm Oligopoly
In a dominant firm oligopoly, there is one large firm that has a significant cost advantage over many other, smaller competing firms.
The large firm operates as a monopoly, setting its price and output to maximize its profit.
The small firms act as perfect competitors, taking as given the market price set by the dominant firm.
Figure 13.12 shows10 small firms in part (a). The demand curve, D, is the market demand and the supply curve S10is the supply of the 10 small firms.
Two Traditional Oligopoly Models
Two Traditional Oligopoly Models
At a price of $1.50, the 10 small firms produce the quantity demanded. At this price, the large firm would sell nothing.
Two Traditional Oligopoly Models
But if the price was $1.00, the 10 small firms would supply only half the market, leaving the rest to the large firm.
Two Traditional Oligopoly Models
The demand curve for the large firm’s output is the curve XDon the right.
Two Traditional Oligopoly Models
The large firm can set the price and receives a marginal revenue that is less than price along the curve MR.
Two Traditional Oligopoly Models
The large firm maximizes profit by setting MR= MC. Let’s suppose that the marginal cost curve is MCin the figure.
Two Traditional Oligopoly Models
The profit-maximizing quantity for the large firm is 10 units.
The price charged is $1.00.
Two Traditional Oligopoly Models
The small firms take this price and supply the rest of the quantity demanded.
Two Traditional Oligopoly Models
In the long run, such an industry might become a monopoly as the large firm buys up the small firms and cuts costs.
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