ECO 202 Chapter 14: Oligopoly

oligopoly

market structure in which a small number of interdependent firms compete

oligopolists are large and know that thei actions affect one another

barriers to entry exist, preventing firms from competing away profits

four-firm concentration ratio

the fraction of an industry’s sales accounted for by its four biggest firms. if this number is larger than 40%, that indicates an oligopoly

BUT:

• this number doesn’t include goods and services foreign firms export to the US

• it is calculated for national markets, even if the market is local

• definition of a market is tricky

economies of scale - barrier to entry

situation in which a firm’s long-runa verage cost falls as it increases the quantity of output it produces

• new firms have to start small and will therefore have substantially higher average costs than established firms

ownership of a key input - barrier to entry

if control of a key input is hekd by one or a small number of firms, it will be difficult for additional firms to enter

game theory

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

business strategy

a set of actions that a firm takes to achieve a goal, such as maximizing profits

dominant strategy

the best strategy for a firm, no matter what strategies other firms use

Nash equilibrium

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

the best response to one another’s strategies

noncooperative equilibrium

an equilibirium in a game in which players do not cooperate but pursue their own self-interest

cooperative equilibrium

equilibrium in a game in which players cooperate to increase their mutual payoff, results from collusion

prisoners dilemma

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

enforcement mechanism

price match guarantee, ensures punishment to a competing firm for charging a lower price

price leadership

a form of implicit collusion in which one firm in an oligopoly announces a price change, and other firms in the industry match the change

• results in higher prices and decreased qualitity due to lack of competition

cartel

group of firms that collude by agreeding to restrict output to increase prices and profits

sequential games

one firm makes a decision and the other makes its decision having observed the first firm’s decision

analyzed using a decision tree

bargaining

one party can make a threat - say they will or won’t accept a certain deal, other party needs to analyze if threat is credible

subgame-perfect equilibrium

Nash equilibrium in which the player can make themself better off by changing their decision at any decision node

five competitive forces model

model used to determine the level of competition in an industry

1. competition from existing firms

2. threat from potential entrants

3. competition from substitute goods or services

4. bargaining power of buyers

5. bargaining power of suppliers

competition from existing firms

competition among firms in an industry can lower prices and profits

threat from potential entrants

actions to deter entry can reduce profits

competition from substitute goods or services

a firm is always vulnerable to a competitor introducing a product that fills a consumer need better than the current product does

bargaining power of buyers

buyers with enough bargaining power can insist on lower prices, higher-quality products, or additional services

bargaining power of suppliers

specialized input and few firms = bargaining power + higher prices; many firms and unspecialized input = no bargaining power