Oligopoly

chapter
thirteen
Oligopoly: Firms in Less Competitive Markets
Prepared by: Fernando & Yvonn Quijano
2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1 st ed.
After studying this

chapter, you should be
able to:
In an oligopoly, a firms
profitability depends
crucially on its interactions
with other firms.
LEARNING OBJECTIVES
CHAPTER 13: Oligopoly: Firms in Less

Competitive Markets
Competing with Wal-Mart
Show how barriers to

entry explain the
existence of oligopolies.
Use game theory to
analyze the actions of
oligopolistic firms.
Use a sequential games
to analyze business
strategies.
Use the five competitive
forces model to analyze
competition in an industry.
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Competitive Markets
Oligopoly
Oligopoly A market structure in

which a small number of
interdependent firms compete.
The approach we use to analyze
competition among oligopolists
is called game theory.
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Competitive Markets
Sources of Oligopoly power
Government Barriers
Ownership of Key resources
Patenting
Huge economies of scale
Brand power
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Competitive Markets
Measuring Oligopoly
Four firm concentration ratio
Sum of market share of top four
firms in the industry
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Competitive Markets
Types of Oligopoly
Homogenous Oligopoly (pure
oligopoly)
Differentiated Oligopoly
Collusive oligopoly (cartels)
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1 LEARNING OBJECTIVE
Oligopoly and Barriers to Entry

Competitive Markets
Barriers to Entry
13 - 1
Examples of Oligopolies in
Retail Trade and Manufacturing
Barrier to entry Anything that keeps

new firms from entering an industry in
which firms are earning economic profits.
RETAIL TRADE
INDUSTRY
MANUFACTURING
INDUSTRY
FOUR-FIRM
CONCENTRATION
RATIO
FOUR-FIRM
CONCENTRATION
RATIO
Warehouse Clubs and

Superstores
90%
Cigarettes
99%
Discount Department Stores
88%
Beer
90%
Hobby, Toy, and Game

Stores
70%
Aircraft
85%
Radio, Television, and Other

Electronic Stores
62%
Breakfast Cereal
83%
Athletic Footwear Stores
62%
Automobiles
80%
College Bookstores
58%
Dog and Cat Food
58%
Pharmacies and Drugstores
47%
Computers
45%
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Competitive Markets
Only a few firms account for most or

all of total production.
In oligopolistic markets some or all
firms earn substantial profits over the
long run because barriers to entry
make it difficult or impossible for new
firms to enter.
Managing an oligopolistic firm is
complicated because pricing, output,
advertising and investment decisions
involve important strategic
considerations.
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Competitive Markets
While making decisions each firm

must weigh its competitors
reactions.
There could be sequence of actions
and reactions.
When the managers of firms
evaluate the potential
consequences of the decisions they
must assume that their competitors
are as rational as they are.
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Oligopoly and Barriers to Entry

Competitive Markets
Barriers to Entry
13 - 1
Economies of Scale Help
Determine the Extent of
Competition in an Industry
Economies of scale Economies of

scale exist when a firms long-run
average costs fall as it increases
output.
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Competitive Markets
Rivalry
Through:
Price wars
Product innovations leading to low cost
products or new product features.
Advertising
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Competitive Markets
Why do firms prefer non price competition

If firm A increases the price others would not follow suit making the demand curve elastic
If it decreases the price, others would follow suit . Making the demand curve inelastic
This is explained with the help of kinked demand curve.
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Competitive Markets
Equilibrium in Oligopolistic market

In monopoly and perfect markets we
derived equilibrum of the firm with the
revenue and cost curves where MR =
MC.
In these markets each firm could take
price or market demand as given and
can afford to ignore the competitors.
But there is no given demand curve
in Oligopoly markets.
When the market is in equilibrium
firms are doing their best they can
and have no reason to change the
price.
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Competitive Markets
Kinked demand curve
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Competitive Markets
Popular price wars

Airline industry
Entry of vistara- sharp price cuts by
airindia and jet airways
Air asias entry- price cut by spice jet
and indigo
Surf and Tide
Discounts offered by online retailers
Discounts offered by cell phone
service providers
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Competitive Markets
Advertising wars
BMW Audi billboard fight.
Samsung and Apple
Apples new add of Iphone 6
Mercedes V/s Jaguar
The add
What do chickens and Mercedes
have in commonstability at all
times
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Competitive Markets
Why is rivalry too crucial in Oligopoly than in

monopolistic
Monopolistic firms operate more or
less in a competitive environment.
Market share of a monopolistic firm
is not as high as in oligopoly. Threat
from rivals is minimum.
It can be devastating for oligopoly
firms not to react to rivals actions
which can lead to heavy loss of
market share and revenues.
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Competitive Markets
Using Game Theory to Analyze Oligopoly

Game theory The study of how people make decisions in
situations where attaining their goals depends on their
interactions with others; in economics, the study of the
decisions of firms in industries where the profits of
each firm depend on its interactions with other firms.
Key characteristics of all games:
1. Rules that determine what actions are allowable.
2. Strategies that players employ to attain their
objectives in the game.
3. Payoffs that are the results of the interaction among
the players strategies.
Business strategy Actions taken by a business firm to
achieve a goal, such as maximizing profits.
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Competitive Markets
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Competitive Markets

A Duopoly Game: Price Competition between Two Firms
13 - 2
Payoff matrix A table that

shows the payoffs that each
firm earns from every
combination of strategies by
the firms.
A Duopoly Game
Collusion An agreement
among firms to charge the
same price, or to otherwise
not compete.
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Competitive Markets

A Duopoly Game: Price Competition between Two Firms
Dominant Strategy A strategy that
is the best for a firm, no matter what
strategies other firms use.
Nash equilibrium A situation
where each firm chooses the best
strategy, given the strategies chosen
by other firms.
13 - 1
A Beautiful Mind: Game Theory Goes to the Movies
In the film, A Beautiful Mind,

Russell Crowe played John Nash,
winner of the Nobel Prize in
Economics.
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Competitive Markets

Firm Behavior and the Prisoners Dilemma
Cooperative equilibrium An
equilibrium in a game in which
players cooperate to increase their
mutual payoff.
Noncooperative equilibrium
An equilibrium in a game in which
players do not cooperate but pursue
their own self-interest.
Prisoners dilemma A game
where pursuing dominant strategies
results in noncooperation that leaves
everyone worse off.
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13 - 1
Competitive Markets
Is Advertising a Prisoners Dilemma for Coca-Cola and Pepsi?
Advertising is the
optimal decision
for both firms,
given the decision
by the other firm.
13 - 2
Is There a Dominant Strategy for Bidding on eBay?
On eBay, bidding the maximum

value you place on an item is a
dominant strategy.
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Competitive Markets
Using Game Theory to

Analyze Oligopoly
Can Firms Escape the Prisoners
Dilemma?
13 - 3
Changing the Payoff Matrix in a
Repeated Game
13 - 3
American Airlines and Northwest Airlines

Fail to Cooperate on a Price Increase
The airlines have trouble raising

the price this business traveler
pays for a ticket.
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Competitive Markets

Cartels: The Case of OPEC
13 - 4
World Oil Prices
Cartel A group of firms that

colludes by agreeing to restrict
output to increase prices and
profits.
Sustaining high prices has been difficult because

members often exceed their output quotas.
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Competitive Markets

Cartels: The Case of OPEC
13 - 5
The OPEC Cartel with Unequal
Members
The equilibrium of this game will occur

with Saudi Arabia producing a low output
and Nigeria producing a high output.
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Competitive Markets
Sequential Games
Deterring Entry
13 - 6
The Decision Tree for an Entry

Game
The best decision for

Wal-Mart is to build a
large store to deter
Targets entry.
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13 - 1
Competitive Markets
Is Deterring Entry Always a Good Idea?
In this case, Wal-Mart will build a small store and Target will enter.
Deterrence is only worth pursuing if its costs are not too high.
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Competitive Markets
Sequential Games
Bargaining
13 - 7
The Decision Tree for a
Bargaining Game
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Competitive Markets
The Five Competitive Forces Model

13 - 7
The Five Competitive Forces

Model
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Competitive Markets
13 - 4
Is Business Strategy More Important Than
the Structure of the Airline Industry?
Southwests business strategy

allowed it to remain
profitable when many other
airlines faced heavy losses.
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Competitive Markets
32 of 21

Competitive Markets
Barrier to entry
Business strategy
Cartel
Collusion
Cooperative equilibrium
Dominant strategy
Economies of scale
Game theory
Nash equilibrium
Noncooperative equilibrium
Oligopoly
Patent
Payoff matrix
Prisoners dilemma
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Oligopoly

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chapter

Oligopoly: Firms in Less Competitive Markets

Prepared by: Fernando & Yvonn Quijano

After studying this

CHAPTER 13: Oligopoly: Firms in Less

Competing with Wal-Mart

Show how barriers to

CHAPTER 13: Oligopoly: Firms in Less

Oligopoly A market structure in

CHAPTER 13: Oligopoly: Firms in Less

Sources of Oligopoly power

CHAPTER 13: Oligopoly: Firms in Less

CHAPTER 13: Oligopoly: Firms in Less

Oligopoly and Barriers to Entry

Barrier to entry Anything that keeps

Warehouse Clubs and

Discount Department Stores

Hobby, Toy, and Game

Radio, Television, and Other

Athletic Footwear Stores

Dog and Cat Food

Pharmacies and Drugstores

CHAPTER 13: Oligopoly: Firms in Less

Only a few firms account for most or

CHAPTER 13: Oligopoly: Firms in Less

While making decisions each firm

Oligopoly and Barriers to Entry

Economies of scale Economies of

CHAPTER 13: Oligopoly: Firms in Less

CHAPTER 13: Oligopoly: Firms in Less

Why do firms prefer non price competition

CHAPTER 13: Oligopoly: Firms in Less

Equilibrium in Oligopolistic market

CHAPTER 13: Oligopoly: Firms in Less

Kinked demand curve

CHAPTER 13: Oligopoly: Firms in Less

Popular price wars

CHAPTER 13: Oligopoly: Firms in Less

CHAPTER 13: Oligopoly: Firms in Less

Why is rivalry too crucial in Oligopoly than in

CHAPTER 13: Oligopoly: Firms in Less

Using Game Theory to Analyze Oligopoly

CHAPTER 13: Oligopoly: Firms in Less

CHAPTER 13: Oligopoly: Firms in Less

Using Game Theory to Analyze Oligopoly

Payoff matrix A table that

CHAPTER 13: Oligopoly: Firms in Less

Using Game Theory to Analyze Oligopoly

A Beautiful Mind: Game Theory Goes to the Movies

In the film, A Beautiful Mind,

CHAPTER 13: Oligopoly: Firms in Less

Using Game Theory to Analyze Oligopoly

Is Advertising a Prisoners Dilemma for Coca-Cola and Pepsi?

Is There a Dominant Strategy for Bidding on eBay?

On eBay, bidding the maximum

CHAPTER 13: Oligopoly: Firms in Less

Using Game Theory to

American Airlines and Northwest Airlines

The airlines have trouble raising

CHAPTER 13: Oligopoly: Firms in Less

Using Game Theory to Analyze Oligopoly

Cartel A group of firms that

Sustaining high prices has been difficult because

CHAPTER 13: Oligopoly: Firms in Less