14 Oligopoly and Strategic Behavior McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved Oligopoly • A few large producers • Homogeneous or differentiated products • Limited control over price • Mutual interdependence • Strategic behavior • Entry barriers • Mergers LO3 Oligopolistic Industries • Four-firm concentration ratio • 40% or more to be oligopoly • Shortcomings • Localized markets • Inter-industry competition • World price • Dominant firms – Herfindahl Index LO3 High Concentration Industries (3) (1) (3) Herfindahl (1) 4-Firm Concentration Ratio Index Industry Household laundry equipment 100 ND Household refrigerators and freezers 93 ND Cigarettes 88 Beer Industry (2) (2) Herfindahl 4-Firm Concentration Ratio Index Primary aluminum 74 2089 Tires 73 1531 2897 Bottled water 71 1564 88 3561 Gasoline pumps 70 1611 Glass containers 86 ND Bar soaps 70 2250 Phosphate fertilizers 85 3152 Burial caskets 69 1699 Small-arms ammunition 84 2848 Printer toner cartridges 67 1449 Electric light bulbs 84 3395 Alcohol distilleries 65 1394 Aircraf 80 3287 Turbines and generators 61 1263 Breakfast cereals 79 2333 Motor vehicles 60 1178 Aerosol cans 75 1667 Primary copper 50 879 LO1 Oligopoly Behavior • Game theory • Profit matrix – Shows the profits for each firm based on the firm’s actions and his rivals actions • Collusion – Incentive to cheat – Prisoner’s dilemma LO3 Game Theory RareAir’s price strategy High Low A B Uptown’s price strategy $12 $15 High $12 C $6 $6 D $8 Low $15 LO1 $8 Oligopoly Models • Kinked Demand Curve • Collusive Pricing • Price Leadership • Reasons for models • Diversity of oligopolies • Complications of interdependence LO5 Kinked Demand Curve • Criticisms • Explains inflexibility, not price • Prices are not that rigid • Price wars LO6 Overt Collusion • Collusion reduces uncertainty, improves control of price, profits rise, and prevents entry of firms • Cartels - a group of firms or nations that collude • Formally written agreement • Sets output levels and price for members • OPEC LO6 Covert Collusion • Gentleman’s agreements • Informal understandings often in social settings between firms about price and output LO6 Positive Effects of Advertising • Low cost way of providing information to customers • Enhances competition • Speeds up technological progress • Helps firms attain economies of scale LO7 Negative Effects of Advertising • Can be manipulative • Contains misleading claims that confuse consumers • Consumers may pay high prices for a good while forgoing a better, lower priced, unadvertised good LO7 Oligopoly and Efficiency • Oligopolies are inefficient • Productively inefficient P > minATC • Allocatively inefficient P > MC • Qualifications • Increased foreign competition • Limit pricing • Technological advance LO7 One-Time Game: Strategy • One-time game • Simultaneous game • Positive sum game LO7 One-Time Game: Strategy • One-time game • Simultaneous game • Positive sum game LO7 One-Time Game Dramco’s price strategy International A B $5 $11 C $5 LO7 National $11 National Chipco’s price strategy International $20 $20 D $17 $17 A One-Time Game: Equilibrium • Nash Equilibrium • • • LO7 Outcome from which neither firm wants to deviate Current strategy viewed as optimal Stable and persistent outcome Credible and Empty Threats • Credible threats • • • • • Threat is believable Can be used for collusion A strong enforcer can prevent cheating Can generate higher profits May be countered by rival firm • Empty threats • LO7 Threat is not believable Repeated Games • Game recurs • May cooperate and choose not to compete strongly • Rival reciprocates LO7 Repeated Game with Reciprocity LO7 ThirstQ’s advertising strategy Promo budget Normal budget Promo budget Normal budget A B A B $10 C $8 $16 $16 D $12 $12 $11 Promo budget $8 Normal budget $10 2Cool’s advertising strategy Promo budget Normal budget 2Cool’s advertising strategy ThirstQ’s advertising strategy $10 $11 C $10 $14 $15 D $13 $13 Sequential Game • Firms move sequentially • Final outcome is dependent on who moves first • First Mover Advantage • • • LO7 Advantages for the firm that is first May be better prepared May preempt entry of rival First-Mover Advantages Big Box strategies Don’t build Build A B Build C $0 LO7 $0 -$5 Don’t build Huge Box strategies -$5 $12 $12 D $0 $0 First-Mover Advantages Extensive Form LO7 Extensive Form • Subgame • Subgame perfect Nash Equilibrium • Stackelberg Duopoly • LO7 Leader-follower game Extensive Form LO7 ... B $10 C $8 $16 $16 D $12 $12 $11 Promo budget $8 Normal budget $10 2Cool’s advertising strategy Promo budget Normal budget 2Cool’s advertising strategy ThirstQ’s advertising strategy $10 $11 C... aluminum 74 2089 Tires 73 15 31 2897 Bottled water 71 1564 88 35 61 Gasoline pumps 70 16 11 Glass containers 86 ND Bar soaps 70 2250 Phosphate fertilizers 85 315 2 Burial caskets 69 16 99 Small-arms ammunition... cartridges 67 14 4 9 Electric light bulbs 84 3395 Alcohol distilleries 65 13 94 Aircraf 80 3287 Turbines and generators 61 1263 Breakfast cereals 79 2333 Motor vehicles 60 11 78 Aerosol cans 75 16 67 Primary