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Course informa-on
• Final exam: Tuesday, 12/11 4 -‐6 in Machmer W 15
• If you have a conflict, go the the Registrar’s office and they will give you a form saying which exam can be changed.
• Final exam will cover the chapters on perfect compe--on, monopoly, monopolis-c compe--on up to page 329 only and oligopoly up to page 350 (‘Other Oligopoly Games’).
To do today
• One last look at monopolis-c compe--on
• What does the US economy look like? Indicators of compe--on
• What is oligopoly and how is it related to related to
• è
– Four-‐Firm Concentra/on Ra/o – The percentage of the value of sales accounted for by the four largest firms in the industry.
– Herfindahl-‐ Hirschman Index • A ra-o that exceeds 60 percent is an indica-on of oligopoly. • A ra-o of less than 40 percent is an indica-on of a compe--ve market—monopolis-c compe--on.
• Range goes down to almost zero – close to perfect compe--on – for a few sectors
How do we know the market structure?
– The square of the percentage market share of each firm summed over the largest 50 firms in a market.
– A market with an HHI less than 1,000 is regarded as compe--ve and between 1,000 and 1,800 is moderately compe--ve.
Herfindahl-‐Hirschman Index (HHI)
Concentra-on ra-os and H-‐H Index, 2002
Sector # Companies % of All Herfindahl-‐ Shipments Hirschman
Food 23334 100 4 largest 16.8 8 largest 25.4 20 largest 39.8 50 largest 53.1 118.7
Chocolate 138 100 4 largest 69 8 largest 87.9 20 largest 96.7 50 largest 98.8 1793.1
Petroleum manufacturing 43 100 4 largest 84.7 8 largest 93.9 20 largest 99.7 50 largest 100 2651.6
Computer equipment 4 largest 1517 8 largest 49.5 20 largest 65.2 50 largest 80
88.3 1183.3 Apparel cut and sew 7170 4 largest 5.3 8 largest 8.3 20 largest 13.9 50 largest 22.6 15.5
Adver-sing costs and total costs
Adver-sing expenditures increase the costs of a monopolis-cally compe--ve firm above those of a perfectly compe--ve firm or a monopoly. Adver-sing costs are fixed costs. Adver-sing costs per unit decrease as produc-on increases.
1. When adver-sing costs are added to
2. The average total cost of produc-on,
3. Average total cost increases by a greater amount at small outputs than at large outputs.
Effect of adver-sing cost on total cost
– Adver-sing and other selling efforts change the demand for a firm’s product.
– The effects are complex: • A firm’s own adver-sing increases the demand for its product.
• Adver-sing by all firms might decrease the demand for any one firm’s product and might make demand more elas-c.
– The price and markup might fall.
Adver-sing (selling) costs and demand
No adver-sing graphically
Effects of adver-sing graphically
Why adver-se? Signaling quality
– Some adver-sing is very costly and has almost no informa-on content about the item being adver-sed.
– Such adver-sing is used to signal high quality.
– Signaling works because it is profitable to signal high quality and deliver it but unprofitable to signal a high quality product and not deliver it.
Efficiency of adver-sing and brand names
Adver-sing and brand name can be efficient if the marginal cost of the informa-on equals its marginal benefit. The final verdict on the efficiency of monopolis-c compe--on is ambiguous: there are benefits (consumer choice of differen-ated products) and costs (deadweight loss and higher than minimum ATC)
1. The efficient scale is 100 pairs of Tommy jeans a day.
2. The firm produces less than the efficient scale and has excess capacity.
3. Price exceeds 4. marginal cost by the amount of 5. the markup.
6. Deadweight loss arise.
Monopolis-c compe--on: long run
Important note on efficiency • More than one defini-ons is used
• MC = MB (and P in perfect compe--on but not otherwise
• This gives deadweight loss (i.e., less than maximum consumer and surplus)
• Also though: point of lowest ATC -‐ used just now in the discussion of monopolis-c compe--on
Introduc-on to oligopoly • Core concept -‐ interdependence of firm decisions
• Structure – only a few firms
• Interdependence – if one firm lowers its price, others must do the same to keep its customers
• Asymmetry – but if one firm raises price, others won’t and that firm loses customers
– Temptation to Collude – When a small number of firms share a market,
they can increase their profit by forming a cartel and acting like a monopoly.
– Cartel is a group of firms acting together to limit output, raise price, and increase economic profit.
– Illegal but they do operate in some markets – Tend to collapse
Collusion and Cartels
Interdependence
• Firms are involved in a game with each other
• The game is to set a price taking into account all the moves by the other players
• You know that other firms will respond to you moves on price
Interdependence and the Kinked Demand Curve
Interdependence and uncertainty
• In oligopoly, the equilibrium may not be unique and may not even exist
• Far from the neat intersec-on of the S and D curves defining a unique and stable equilibrium
Barriers to Entry
– Natural or legal barriers to entry can create an oligopoly.
– Natural: arise from the combination of the demand for a product and economies of scale in producing it.
Game Theory
• What Is a Game? – All games involve three features:
• Rules • Strategies • Payoffs
– Prisoners’ dilemma is a game between two prisoners that shows why it is hard to cooperate, even when it would be beneficial to both players to do so.
The ‘Beau-ful Mind’ game
• If all players go for the blonde, only one will get a date with her
• The others will find that the neglected women won’t want to be the second to be asked for a date and will refuse
• Therefore it is bemer not to go for the blonde knowing what happens when they all do
The Prisoner’s Dilemma game
– Art and Bob been caught stealing a car: sentence is 2 years in jail.
– DA wants to convict them of a big bank robbery: sentence is 10 years in jail.
– DA has no evidence and to get the conviction, he makes the prisoners play a game.
Rules of the game and payoffs
– Players cannot communicate with one another before decide whether to confess to robbery
• Both confess: both get 3 years • One confesses: confessor gets 1 year but
accomplice gets 10 years • Neither confesses: both get a 2-year sentence
Equilibrium
– When each player takes the best possible action given the action of the other player.
– Nash equilibrium: each player takes the best possible action given the action of the other player.
– The Nash equilibrium for Art and Bob is to confess.
– The equilibrium of the prisoners’ dilemma is not the best outcome for the players.
The payoff matrix
Collusion is Difficult – The duopolists’ dilemma explains why it is
difficult for firms to collude and achieve the maximum monopoly profit.
– Individually rational for each firm to cheat on a collusive agreement and increase output.
– Collectively irrational to cheat – lowers profit for both.
– How does OPEC succeed? A leading member – Saudi Arabia
– Coke and Pepsi have two strategies: advertise or not advertise.
Table shows the payoff matrix as the economic profits for each firm in each possible outcome.
Advertising Game
– The Nash equilibrium for this game is for both firms advertise.
But they could earn a larger joint profit if they could collude and not adver/se.
Nash Equilibrium
The Duopolists’ Dilemma
– The dilemma of Boeing and Airbus is similar to that of Art and Bob.
– Each firm has two strategies. It can produce airplanes at the rate of:
• 3 a week • 4 a week
The Duopoly Dilemma
– Because each firm has two strategies, there are four possible combinations of actions:
• Both firms produce 3 a week (monopoly outcome). • Both firms produce 4 a week. • Airbus produces 3 a week and Boeing produces 4
a week. • Boeing produces 3 a week and Airbus produces 4
a week.
– The Payoff Matrix: profits for each firm in each possible outcome.
– Better for both to choose 4 per week
The Payoff Matrix
– Airbus gets $36m – Boeing gets $36m – (Lower right cell) But given that the other is likely to go for 4 per week -‐
Airbus at 4/week gets $32m and Boeing $32m
(upper leo cell)
What if cooperated at 3 a week each?
Again: Collusion is Difficult
– The duopolists’ dilemma explains why it is difficult for firms to collude and achieve the maximum monopoly profit.
– Individually rational for each firm to cheat on a collusive agreement and increase output.
– Collectively irrational to cheat – lowers profit for both.
Advertising and Research Games in Oligopoly
– Advertising campaigns by Coke and Pepsi, and research and development (R&D) competition between Procter & Gamble and Kimberly-Clark are like the prisoners’ dilemma game.
– P&G and Kimberly-Clark have two strategies: spend on R&D or do no R&D. – Table shows the payoff matrix as the economic profits for each firm in each possible outcome.
Research and Development Game
The Nash equilibrium for this game is for both firms to undertake R&D.
But they could earn a larger joint profit if they could collude and not do R&D.
Nash Equilibrium
Repeated Games
– Most real-world games get played repeatedly. – Repeated games have a larger number of
strategies because a player can be punished for not cooperating.
– This suggests that real-world duopolists might find a way of learning to cooperate so they can enjoy monopoly profit.
– The next slide shows the payoffs with a “tit-for-tat” response.
– Week 1: Suppose Boeing contemplates producing 4 planes instead of the agreed 3 planes.
– Boeing’s profit will increase from $36 million to $40 million, and Airbus’s profit will decrease from $36 million to $30 million.
A Repeated Boeing/Airbus Game
– Week 2: Airbus punishes Boeing and produces 4 planes.
– But Boeing must go back to producing 3 planes to induce Airbus to cooperate in week 3.
– In week 2, Boeing’s profit falls to $30 million and Airbus’s profit increases to $40 million.
Second Round of the Game
– Over the two-week period,
– Boeing’s profit would have been $72 million if it had cooperated, but it was only $70 million with Airbus’s tit-for-tat response.
Effect of Tit-for-Tat
Can there be a monopoly outcome?
– In reality, whether a duopoly works like a one-play game or a repeated game depends on the number of players and the ease of detecting and punishing overproduction.
– The larger the number of players, the harder it is to maintain the monopoly outcome.
Is oligopoly efficient?
• Is Oligopoly Efficient? – In oligopoly, price usually exceeds marginal cost. – So the quantity produced is less than the efficient
quantity. – Oligopoly suffers from the same source and type
of inefficiency as monopoly. – Because oligopoly is inefficient, antitrust laws and
regulations are used to try to reduce market power and move the outcome closer to that of competition and efficiency.
The CPU chip in your computer or game box is made by either Intel Corporation or Advanced Micro Devices (AMD). Does competition between these duopolists achieve an efficient outcome—a win for consumers—or just a win for one or both of the producers?
Is Two Too Few?
EYE on the CHIPS DUOPOLY
The figure shows that Intel is the big winner. Intel dominates the market. Intel’s prices are generally higher than AMD’s.
Is Two Too Few?
EYE on the CHIPS DUOPOLY
In the game that Intel and AMD play, the outcome is closer to monopoly than perfect competition.
Producer surplus is maximized.
Consumer surplus is less than it would be in a competitive market.
There is underproduction and a deadweight loss.
Is Two Too Few?
EYE on the CHIPS DUOPOLY
What’s a government to do?
– Antitrust law is the body of law that regulates and prohibits certain kinds of market behavior, such as monopoly and monopolistic practices.
• Antitrust Laws – The first antitrust law, the Sherman Act,
passed in 1890. – The Clayton Act of 1914 supplemented the
Sherman Act.
Anti-trust law
Anti-trust law
