OLIGOPOLY

GROUP NO. # 10
MEMBERS:
Roll Nos.
Abhishek Verma 105
Abhishek Patil 085
Gauri Patil 091
Namrata Verma 065
Ravi Prakash Singh 090
Santosh Nair 084
Vikrant Gole 075
INDEX
 Introduction
 Examples of Oligopoly

 Characteristics of Oligopoly

 Determinants of Oligopoly

 Forms of Oligopoly

 Kinked Demand Curve

 Why Oligopoly exist?

 Game Theory Approach

 Dominant Strategy

 Prisoner’s Dilemma

 Price Leadership Strategy

 Price Discrimination Strategy

 Characteristics of different types of markets

 INTRODUCTION
 The term ‘Oligopoly’ has been derived from two
Greek words:
‘Oligi’ which means few and ‘Polien’ means
sellers.
 Thus, Oligopoly is a competition among few big
sellers each of them selling either homogenous or
heterogeneous products.
 Oligopoly refers to a market situation where there
are a few sellers(2-10), selling homogenous or
differentiated products in a market.
 Oligopoly is often describes as ‘Competition
among few’.
 INTRODUCTION
 An oligopoly is a market dominated by a small number of
strategically interdependent firms.
 When just a few large firms dominate a market:

 Actions of each one have an important impact on the

others.
 In such a market, each firm recognizes its strategic
interdependence with others.
 When the products of a few sellers are homogenous, it is
known as ‘Pure Oligopoly’.
 When the products of a few sellers are differentiated, but
close substitutes of each other, it is known as
‘Differentiated Oligopoly’.
EXAMPLES OF OLIGOPOLY
Automobiles
Cereals
Steel
Soup
 CHARACTERISTICS OF OLIGOPOLY
 Few Sellers
 An oligopoly market can be characterized by a few
sellers and their number is limited. (usually not
more than 10)
 Oligopoly is a special type of imperfect market. It
has a large number of buyers but a few sellers.
 Homogenous or Differentiated Product

 The Oligopolists produce either homogenous or

differentiated products.
 Products may be differentiated by way of design ,
trademark or service
 CHARACTERISTICS OF OLIGOPOLY
 Interdependence
 The most important feature of Oligopoly is the
interdependence in decision making of the few firms
which comprise the industry.
 The reactions of the rival firms may be difficult to guess.
Hence price is indeterminate under Oligopoly.
 High Cross Elasticities

 The cross elasticity of demand for the products of

oligopoly firms is very high. Hence there is always the fear of
retaliation by rivals.
 Each firm is conscious about the possible action and
reaction of competitors while making any change in
price or output.
 CHARACTERISTICS OF OLIGOPOLY
 Competition
 Competition is unique in an oligopoly market. It
is a constant struggle against rivals.
 Uncertainty

 The interdependence of other firms for one’s own

decision creates an atmosphere of uncertainty
about price and output
 Price Rigidity

 In an oligopoly market each firm sticks to its own

price to avoid a possible price war.
 The price remains rigid because of constant
fear of retaliation from rivals.
MARKET STRUCTURE
Oligopoly:
• A Few Large Producers
• Homogeneous or
Differentiated Products
• Control Over Price, But
Mutual Interdependence
• Strategic Behavior
• Entry Barriers
Pure Monopolistic Pure
Competition Competition Oligopoly Monopoly

Market Structure Continuum

 What determines if
market is an Oligopoly?

The concentration ratio can be

used as a guide
 CONCENTRATION RATIO
 Concentration ratios are measures of the total output that is
produced in an industry by a given number of firms in the
industry.
 The most common concentration ratios are the CR4 and
the CR8, which means the 4 and the 8 largest firms.
 Two Common Ratios

 Four-Firm Concentration Ratio: It measures the total

market share of the 4 largest firms in an industry.
 Eight-Firm Concentration Ratio: It measures the total
market share of the 8 largest firms in an industry.
What concentration ratio
constitutes an Oligopoly?
There is no magic number, but if
a large percentage of the sales
are from the 4 largest firms, it’s
an Oligopoly.
 What is an example of a
high concentration ratio?

In the Mobile Phone Industry the

leading 4 constitutes 71% of
total sales.
http://www.ft.com/cms/s/0/1c7540a4-d831-11dd-bcc0-000
 What determines if
market is an Oligopoly?
Herfindahl-Hirschman Index
or HHI can also be used.
HERFINDAHL-HIRSCHMAN INDEX (HHI)
 It is a measure of the size of firms in relation
to the industry and an indicator of the amount of
competition among them.
 A measure of industry concentration, calculated
as the sum of the squares of the market
shares held by each firm in the industry.

 Calculation of HHI
 HHI = s12 + s22 + …..sn
where S
i = the i th
firms market share,
n= number of firms in industry
HERFINDAHL-HIRSCHMAN INDEX(HHI)
 Examples
 1) For an industry with only 1 firm, (monopoly),
what would be the HHI?

 2) Suppose the industry has 10 equal size firms,

what is the HHI?

 3) What if the industry has 100 equal size firms?

HERFINDAHL-HIRSCHMAN INDEX(HHI)
Answers
 1) 10,000

 2) 1000

 3) 100
 FORMS OF OLIGOPOLY
 Oligopoly can be classified into several forms. Some
of the important forms of Oligopoly are as follows:
 Balanced & Unbalanced Oligopoly

 Balanced Oligopoly
An oligopoly in which the sales of the leading
firms are distributed fairly evenly among them.
 Unbalanced Oligopoly
An oligopoly in which the sales of the leading
firms are distributed unevenly among them.
 FORMS OF OLIGOPOLY
 Perfect and Imperfect Oligopolies
 If the product of the rival firm are
homogenous then it is Perfect Oligopoly, if the
product are differentiated it is Imperfect
Oligopoly.

 Open and Closed Oligopolies

 If entry is open to new firms it is termed as
Open Oligopoly, and if entry is strictly
restricted it is termed as Closed Oligopoly.
 FORMS OF OLIGOPOLY
Collusive Oligopoly/Collusion
 The practice of firms to negotiate price and
market decisions that limit competition.
 Collusion may take place in the form of a common
agreement or an understanding between the
firms.
 FORMS OF OLIGOPOLY
 Cartel
 One model of collusion that can be used is the
cartel model.
 A group of firms that collude to limit competition in
a market by negotiating and accepting agreed-upon
price and market shares.
 Internationally, some cartels like OPEC exist (public
cartel).
http://www.opec.org
 Cartel is difficult to implement because:

1) Firms want to cheat (to increase profit)

2) Firms want to enter
 FORMS OF OLIGOPOLY
 Graphs showing Cartel
A CARTEL PICKS THE MONOPOLY
PRICE

In a cartel arrangement, two

firms act as one. In this
case, they split the market
output—each serving 75
passengers per day, and
charge $400 per ticket.

• The firms also split the profit.

Each firm earns
$7,500 = [(400-300) x 150]/2.
 FORMS OF OLIGOPOLY
 Duopoly
 Specific type of oligopoly where only two producers exist
in one market.
 In reality, this definition is generally used where only two
firms have dominant control over a market.
 There are two principal duopoly models:

 Cournot Model: Two firms assume each others

output and treat this as a fixed amount, and produce in
their own firm according to this.
 Bertrand Model: Both firms assume that the other will
not change prices in response to its price cuts. When
both firms use this logic, they will reach a Nash Equilibrium.
 FORMS OF OLIGOPOLY
 Nash Equilibrium
 An equilibrium in which each player takes the best
possible action given the action of the other player.
 Set of strategies is in Nash equilibrium if,
 Holding strategies of all other players (firms) constant,
 No player (firm) can obtain a higher payoff (profit) by
choosing a different strategy.

 In Nash equilibrium, no firm changes its strategy

because each firm is using its:
 Best response.
 Strategy that maximizes its profit given its beliefs
about its rivals' strategies.
STACKELBERG’S MODEL OF
OLIGOPOLY

 Stackelberg model is an oligopoly model in which

firms choose quantities sequentially.
 One firm, a follower, takes the output of the other
firm , a leader, and adjusts its output accordingly.
COMPETING DUOPOLISTS PICK A
LOWER PRICE
When two firms compete
against one another, they
end up serving 100
passengers each, at a
price of $350.
Each firm earns a profit of
$5,000, compared to a
profit of $7,500 if they had
acted as one firm.
DUOPOLY VERSUS CARTEL PRICING

• The duopoly produces more output and charges a lower

price than the cartel.
THE KINKED DEMAND CURVE

• The kinked demand model is a model

under which firms in an oligopoly match
price reductions by other firms but do not
match price increases by other firms.
• Hence, each firm faces a “kinked”
demand curve, with 2 sections to it: more
elastic above the existing price, since
rivals won’t match a price increase, and
less elastic below the existing price,
since rivals quickly match price cuts.
THE KINKED DEMAND CURVE
The firm’s demand and
marginal revenue curves
Price

D1
Quantity MR1
THE KINKED DEMAND CURVE

The rival’s demand and

marginal revenue curves
Price

D2

MR2
D1
Quantity MR1
THE KINKED DEMAND CURVE
Rivals tend to
follow a price cut
Price

D2

MR2
D1
Quantity MR1
THE KINKED DEMAND CURVE
Rivals tend to
follow a price cut
or ignore a
price increase
Price

D2

MR2
D1
Quantity MR1
THE KINKED DEMAND CURVE

Effectively creating
a kinked demand curve
Price

D2

MR2
D1
Quantity MR1
THE KINKED DEMAND CURVE

Effectively creating
a kinked demand curve
Price

D
Quantity
THE KINKED DEMAND CURVE

Effectively creating
a kinked demand curve

MC1
MR2
Price

MC2

D
Quantity MR1
THE KINKED DEMAND CURVE
Profit maximization
MR = MC occurs
at the kink.
MC1
MR2
Price

MC2

D
Quantity MR1
THE KINKED DEMAND CURVE
(EXAMPLE)
After the initial price of $6, the
firm has two options:
Increase price: the other
firms will not change their
prices and quantity will
decrease by a large amount
(elastic)
Decrease price: the other
firms will decrease their
prices, so quantity will
increase only by a small
amount (inelastic)
THE KINKED DEMAND CURVE
(EXAMPLE)
 The demand curve of the
typical firm has a kink at the
prevailing price. It is
relatively flat for higher
prices, and relatively
steep for lower prices.
 There is little evidence,
however, that oligopolistic
firms really act this way—
that firms will not go along
with a higher price but
only match a lower price.
THE KINKED DEMAND CURVE
(EXAMPLE)
•The demand curve of the
typical firm has a kink at the
prevailing price. It is
relatively flat for higher
prices, and relatively steep for
lower prices.

•There is little evidence,

however, that oligopolistic firms
really act this way—that firms
will not go along with a
higher price but only match a
lower price.
Why do Oligopolies exist?
Mergers
Economies of Scale
Reputation
Strategic Barriers
Government Barriers
 WHY DO OLIGOPOLY EXIST?
Mergers
 Oligopolistic firms perpetually balance
competition against cooperation. One way to
pursue cooperation is through merger--legally
combining two separate firms into a single
firm.
 Merger gives the resulting firm greater market
control-by giving the emerging oligopolists
more monopoly power.
 They result in more economies of scale and
thereby increase that barrier to new entry.
 WHY DO OLIGOPOLY EXIST?
Economies of Scale
 Cost advantages that a business obtains due to
expansion.
 They are factors that cause a producer’s
average cost per unit to fall as scale is
increased.
 This makes it virtually impossible for new
firms to enter the industry.
 A small firm could not produce at minimum
cost and would soon be competed out of the
business.
 WHY DO OLIGOPOLY EXIST?
 Reputation
 Established oligopolists are likely to have favorable
reputations.
 Investors decision: enter or not?
 Critical
thing: is it worthy to take the risk of being a
new firm in such market?
 Ifexpected profit is greater than the initial loss,
enter
 If initial loss is too great, stay out.
 WHY DO OLIGOPOLY EXIST?
Strategic Barriers
 Strategies designed to keep out potential
competitors, for example:

 Maintain excess production capacity as a signal.

 Make special deals with distributors to receive
best shelf space in retail stores.
 Spend large amounts on advertising to make it
difficult for a new entrant to differentiate its
product.
 WHY DO OLIGOPOLY EXIST?
Government Barriers:
 The need for government authorization is one
entry barrier that can create oligopoly, especially if
entry is limited to only a few firms.

 It can also create monopolistic competition if

a larger number are allowed entry.
 THE GAME THEORY APPROACH
 Game Theory Approach
 An approach to modeling strategic interaction of
oligopolists in terms of moves and countermoves
 Elements
 Players
 Strategies
 Payoffs
 Game tree
 Payoff Matrix
THE GAME THEORY APPROACH

Game Tree

• A game tree is a graphical

representation of the
consequences of alternative
strategies. Firms can use it to
develop pricing strategies.
CARTEL AND DUOPOLY
OUTCOMES IN THE GAME TREE

Two firms
coordinating price
decisions choose
the high price.

Two firms acting

rationally and
interdependently
choose the low
price.
THE OUTCOME OF THE PRICE-FIXING
GAME

Jack captures large

share of market
Jill captures large
share of market

Jill: Low Price Jack: High Price

Price $350 $400
Quantity 170 10
Average cost $300 $300
Profit per passenger $50 $100
Total profit $8,500 $1,000
 THE DOMINANT STRATEGY

Irrational for Jack to

choose high price

• Jack chooses the

low price when Jill
chooses the high
price.

 Dominant strategy: An action that is the best

choice under all circumstances.
 THE DOMINANT STRATEGY

• Jack chooses the

low price when Jill
chooses the low
price.
Irrational for Jack to
choose high price

• Dominant Strategy: Jack chooses the low price

regardless of Jill’s choice.
A GAME-THEORY OVERVIEW USING
PAYOFF MATRIX
SantoshFreight’s Price Strategy

High Low

A $12 B $15
VickyFreight’s Price Strategy

High

$12 $6

C $6 D $8
Low

$15 $8
A GAME-THEORY OVERVIEW USING
PAYOFF MATRIX
SantoshFreight’s Price Strategy

High Low

A $12 B $15 Greatest

VickyFreight’s Price Strategy

Combined
High Profit

$12 $6

C $6 D $8
Low

$15 $8
A GAME-THEORY OVERVIEW USING
PAYOFF MATRIX
SantoshFreight’s Price Strategy

High Low

A $12 B $15 Independent

VickyFreight’s Price Strategy

Actions
High Stimulate
$12 $6 Response

C $6 D $8
Low

$15 $8
A GAME-THEORY OVERVIEW USING
PAYOFF MATRIX
SantoshFreight’s Price Strategy

High Low

A $12 B $15 Independent

VickyFreight’s Price Strategy

Actions
High Stimulate
$12 $6 Response

Gravitating
C $6 D $8 to the
Low Worst Case

$15 $8
A GAME-THEORY OVERVIEW USING
PAYOFF MATRIX
SantoshFreight’s Price Strategy

High Low

Collusion
A $12 B $15 Invites a
VickyFreight’s Price Strategy

Different
High Solution.

$12 $6

C $6 D $8
Low

$15 $8
A GAME-THEORY OVERVIEW USING
PAYOFF MATRIX
SantoshFreight’s Price Strategy

High Low

Collusion
A $12 B $15 Invites a
VickyFreight’s Price Strategy

Different
High Solution.

$12 $6

C $6 D $8
Low

$15 $8
A GAME-THEORY OVERVIEW USING
PAYOFF MATRIX
SantoshFreight’s Price Strategy

High Low

Collusion
A $12 B $15 Invites a
VickyFreight’s Price Strategy

Different
High Solution.

$12 $6
But, the
incentive

C $6 D $8
to cheat
is very real.
Low

$15 $8
THE DUOPOLISTS’ DILEMMA

• The duopolists’ dilemma is a

situation in which both firms in a
market would be better off if they
chose the high price but each
chooses the low price.
 THE PRISONERS’ DILEMMA
 The prisoners’ dilemma is a well-known game that
demonstrates the difficulty of cooperative
behavior in certain circumstances.
 In the prisoner’s dilemma, mutual trust gets each
one out of the dilemma, confessing is the
rational choice.
 The prisoners dilemma has its simplest
application when the oligopoly consists of only
two firms—a duopoly.
 THE PRISONERS’ DILEMMA

 The prisoners’ dilemma is the duopolists’

dilemma. Although both criminals would be better
off if they both kept quiet, they implicate each other
because the police reward them for doing so.
THE PRISONERS’ DILEMMA
PRICE LEADERSHIP IN OLIGOPOLY

 Price leadership is an
implicit agreement under
which firms in a market
choose a price leader,
observe that firm’s price,
and match it.
 PRICE LEADERSHIP IN OLIGOPOLY
 The problem with an implicit pricing agreement
is that price signals sent by the leader may be
misinterpreted.
 Firms could interpret a price cut in two ways:

 A change in market conditions, in which

case firms just match the lower price and
price fixing continues.
 Under pricing, in which case a price war
may be triggered, destroying the price-
fixing agreement.
What is Price
Discrimination?
The practice of offering a
specific good or service
at different prices to
different segments of
the market
 Why would a firm want
to price discriminate?

Greater profits
possible!!
 TYPES OF PRICE DISCRIMINATION
 Perfect Price Discrimination
 Charge each buyer the highest price they are
willing to pay.
 Groups

 Separate buyers into groups (based on age, sex,

region of country, etc).
 Groups should have different elasticities of
demand.
 Higher price to more inelastic group, lower to more
elastic.
 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.
CHARACTERISTICS OF
DIFFERENT TYPES OF MARKETS
 REFERENCES
 http://www.wikipedia.com
 http://www.ft.com

 http://www.census.gov

 http://www.antitrust.org

 http://www.opec.org

 Economics Principles & Tools(Prentice Hall

Publication)