Microeconomics: OligopolyShaun Seidenberger “Shason”Jason Wilhelm1B

Characteristics and Explanation

● Few large producers of differentiated or homogenous products

o Number and type of firms can vary

o Homogenous: Standardized products (industrial)

o Differentiated: Consumer goods with non price competition and Ads

● Mutual Interdependence: Oligopolist can sets its prices but must consider

how other firms will react (Burger King learns about McDonalds)

● Entry Barriers: Economies of Scale, Control of Resources, High Cost of

Entry, Pricing/Advertising Strategies

● Mergers: Oligopolists merge and become more Monopolistic

Degree of Industry Concentration

● How much of an Oligopolistic Industry is based in the largest firms● 2 Ways: Concentration Ratios and Herfindahl Index

o Herfindahl Index: Sum of all squared percentage market shares of all firms, gives larger weight to larger firms (%S1)+(%S2)...+(%Sn)

o CR: Reveal the percent of total output produced by the largest firms, when the largest 4 firms control at least 40% the industry is oligopolistic, shows us how competitive the industry is (4 firms have 5%)

● Interindustry Competition: When 2 products compete in different industries (Aluminum and Copper)

● Import Competition: Competition from foreign inputs

Game-Theory Model and Collusion

● Analyzes the pricing behavior of oligopolists using a payoff matrix

o Payoff Matrices show the different payoffs (profits) resulting from each

combination of strategies

● Based on the behavior of other firms in strategic situations

● Collusion: Cooperation with rivals, enhances profit for firms but tempts

cheating for more profits

Noncollusive Oligopoly

Cartels and other Collusion● Cartel: group of producers

(collusion) that typically createsa written formal agreement specifying how much each member will produce and charge.

-- Overt collusion that is open to view. Illegal in the US.

-- Output must be controlled and themarket must be divided up to maintain the agreed-upon price

● Covert Collusion: Cartels areillegal, so firms secretly agree tocollude.

--Tacit Agreement: Vocal agreementsecretly and easily made for market price. Difficult to detect.

Cartels and Other Collusion● Cartels and other collusive arrangements are usually difficult to create and maintain.● Barriers to collusion include:

o Demand and Cost Differences: the variations in cost and demand curves between firms make profit maximizing prices to differ

o Number of Firms: generally, the more firms in an industry, the more difficult it is to set and keep a price

o Cheating: firms are tempted to cheat and secretly cut prices to increase sales and profits

o Recession: an economic recession leads to the increase in ATC, so firms will cut prices to increase sales at the expense of rivals

o Potential Entry: collusion can create large profits and higher prices which entice new firms to enter the market

o Legal Obstacles (Antitrust Laws): the US government has set up laws that prohibit cartels and price-fixing collusion so overt collusion is banned

Price Leadership Model

Advertising (Positive vs. Negative)

● Positive Effects: Can give consumers product characteristics and prices,

increases efficiency and competition between firms

● Negative Effects: Used to manipulate or persuade consumers, advertising

costs within an industry are so high they are a barrier to entry

● Self-Canceling Advertising: When two firms compete in advertising but it

does not change the demand for a product since it is based off of each firm

so product price just increases

Efficiency of the Oligopoly

● One view: Oligopolists always receive profit so productive (P= min ATC)

and Allocative (P=MC) Efficiency are not likely to occur

● Second View: Informal Collusion (collusion that is not regulated in any

way) may yield a situation similar to a pure monopoly but this view has 3

qualifications - Increased Foreign Competition, Limit Pricing, and

Technological Advances