Oligopoly and Pure Monopoly

This covers terms from Chapters 14 and 15

Oligopoly

A market structure in which a small number of firms compete

Do oligopolists affect each other?

Yes, they are large enough and know their actions affect one another

Are their barriers to entry?

Yes

Can oligopolists earn long-run proft?

Yes, because of barriers to entry

Most important barrier of entry for oligopolists

Economies of scale

How do we know a market structure is an oligopoly?

The four-firm concentration

The four-firm concentration ratio

The fraction of an industry’s sales accounted for by its four largest firms

A four-firm concentration ratio larger than ____ tends to indicate an oligopoly

40%

What firms are more likely to charge inefficiently high prices?

Firms in industries with the highest four-firm concentration ration

Why do monopolies/oligopolies exist?

Barriers to entry

Examples of barriers to entry

• Control of a key input is held by one or a small number of firms

  • Examples:

    • Alcoa - bauxite for aluminum production

    • Ocean spray - cranberries

• Government imposed barriers: governments might grant exclusive rights to some industry to one or a small number of firms

  • Examples:

    • Occupational licensing (ex: dentists and doctors)

    • Patents

    • Tariffs and quotas imposed on foreign companies

Game theory

The study of how people or firms make decisions in situations in which attaining their goals depends on their interactions with others

Duopoly Game

Apple’s dominant strategy is the same as Spotify (9.99)

Nash Equilibrium

A situation in which each firm chooses the best strategy, given the strategies chosen the by the other firm

If Apple and Spotify work together to charge 14.99, that is…

Collusion

Collusion

When firms illegally cooperate to artificially raise prices to bring in more profits

Prisoner’s dilemma

A game in which pursuing dominant strategies results in noncooperating that leaves everyone worse off

5 Competitive Forces that Determine Overall Competition

1. Competition from existing firms

2. Threat from new entrants

3. Competition from substitute goods and services

4. Bargaining power of buyers

5. Bargaining power of suppliers

Most efficient market structure

Perfection competition

Least efficient market structure

Pure monopoly

Characteristics of the Monopoly Structure

1. One seller

2. No close substitutes for the good

3. Barriers to entry

4. Many buyers

5. Firms are price searchers (price makers)

Earning a positive economic profit

Is there a supply curve in monopolistic structure

No, only supply points

Why doesn’t the monopolist charge a higher price

Monopolists maximize profit, not price

Earning a negative economic profit

Are monopolies subject to the shutdown rule?

Yes

Monopolists can’t charge highest price possible because…

Profit must be maximized and demand must be acknowledged

Breaking even

Can monopolists earn profit in the long-run?

Yes

Advantages of monopolistic structures

1. Provides incentive for innovation

2. Take advantage of economies of scale and scope

   • Take advantage of being a natural monopolist with lower average costs

   • Take advantage of producing a variety of products using the same inputs

Disadvantages of monopolistic structures

1. Limits options to consumers

2. Rent-seeking (profit-seeking) behavior

   • Spending money to obtain monopoly

3. Productive inefficiency (P > min ATC)

4. Deadweight loss or welfare loss (allocative inefficiency)