Chapter 16: Oligopolies

I. Oligopoly: A market where a very few large sellers dominate an industry with few sellers and

they each know how the other will react to changes in prices and quantities. They sell a product that
is similar or identical to their competitors.
A. Characteristics are.
1. Small Number of Firms: The top few firms dominate enough to set prices such as The Atlanta Journal-Constitution, they dominant the newspaper business in the Atlanta Metro area but you
also have the Marietta Journal, The Gwinnett Post, The Dekalb Neighbor and scores of smaller newspapers in the metro area. Lockheed, Boeing Aircraft dominant but you have Piper, Cessna,
Beechcraft and Mooney Aircraft companies. Another example would be the big 3 automakers.
2. Interdependence: There are many examples of industries that react to each others
pricing, output and marketing strategies..the Tobacco companies, processed food, healthcare
products, etc. automakers, aircraft companies react to each other always. Copy-Cat Marketing.
3. Oligopolies are in-between the extremes of the no competition monopolies and the dense
perfect competition. Oligopolies are imperfect competition. Another imperfect competition can be
found with monopolistic competition in a market with many firms that sell similar products but
not identical. There are much fewer firms in a Oligopoly markets than monopolistic markets.
B. Why Oligopoly Occurs:
1. Economies of Scale: Smaller firms in this situation have a tendency to be inefficient because they do not have a high volume of production to minimize costs as production increases.
Their Average Costs continue to rise and they will eventually be bought out by a larger firm or go out
of business.
2. Barriers To Entry: These prevent more competition and help a few control an
industry. Patents, control of resources, dominant success (Coca Cola vs JLs Soda Pop)
3. Oligopoly by Merger: The merged firm almost always has a greater ability to enjoy
economies of scale, effect pricing, and increase output. Horizontal Merger: 2 steel companies, 2
shoe companies, 2 computer manufacturers.
Vertical Merger: when a manufacturer acquires a retailer..shoemaker/shoe store; Delta
buys Boeing; Publix buys Coca-Cola; Sony buys Best Buy.
4. Cartels: A group of firms acting in unison, or collusion. They are illegal in the U. S. but
not in most of the world. OPEC for example, which includes Algeria, Indonesia, Iran, Iraq, Kuwait, Libya,

Nigeria, Qatar, Saudi Arabia, United Arab Emirates, Venezuela.

C. Measuring Industry Concentration or Oligopoly: The most popular way to compute industry
concentration is to determine the percentage of total sales or production accounted for by the top
four or top eight firms in an industry.
D. SEE Table 1 This is an example of an oligopoly.
1. U.S. Concentration Ratios: This is a table that shows the percentage
oligopolys hold in major industrys.
a. Table 2 shows the four-firm domestic concentration ratios for various industries.
b. There is no definite way to determine which industries are oligopolies.
c. We arbitrarily select 75% as a cut-off for oligopolies in table 2, tobacco, cereals &
domestic vehicles would make the list.but we could just as well select 60% as the point of reference.
2. Oligopoly, Efficiency, and Resource Allocation: There is no evidence that oligopolies
create resource misallocations as monopolies do. This is where they manipulate distribution to
artificially inflate price levels. Competition both domestically & internationally limit this possibility
and a case could be made for the reverse happening due to economies of scale..which could
mean lower prices.

Table 1:
Single Industry 4
-Firm Ratio

Firm
Annual Sales ($millions)
1
150
2
100
= 400
3
80
4
70
525
50
Total Firms in
450
the Industry
400
4-Firm Concentration Ration = 450 = 88.9%

Table 2
Industry 4-Firm
Ratios

Share of Value of Total Domestic Shipments

Accounted for by the Top Four Firms (%)

Tobacco Products
Breakfast Cereals
Domestic Motor Vehicles
Soft Drinks
Primary Aluminum
Household Vacuum Cleaners
Electronic Computers
Printing and Publishing

93%
85%
84%
69%
59%
59%
45%
23%

Figure 1 The Four Types of Market Structure

Number of Firms?
Many
firms
Type of Products?

One
firm

Few
firms

Differentiated
products

Identical
products

Monopoly
(Chapter 15)

Oligopoly
(Chapter 16)

Monopolistic
Competition
(Chapter 17)

Perfect
Competition
(Chapter 14)

Tap water
Cable TV

Tennis balls
Crude oil

Novels
Movies

Wheat
Milk

2007 Thomson South-Western

E. The Nash Equilibrium: When firms choose their best strategy based on the strategies of their competition. Basically, one firm copying another. Home Depot copying
Lowes, Wal-Mart copying K-Mart or Pepsi copying Coca Cola. Is this legal?
I. Strategic Behavior And Game Theory: The study of how people behave in strategic
situations. Such as, card games, board games like chess or Monopoly and betting on
sports teams. Corporate or government decisions that have significant impact, taxes,
war, mergers.
A. When there are few firms in an industry, they react to each others price,
product, quality, and distribution policies..they have an interdependence.
B. Since oligopolistic firms are interdependent, they must have strategies,
usually models to predict how prices and outputs are determined.
C. Economists have developed game theory models to describe firms rational
interactions.
II. Some Basic Notions and Characteristics About Game Theory:
A. Example of Cooperative firms: Firms that collude for results...Publix & Kroger
price fixing, Airlines price-fixing, any two firms price-fixing or engaging in turf
protection...this also called restraint of trade and is illegal.
B. Example of Non Cooperative firms: total open competition with competing firms
having the ability to change prices.due to efficient management or demand.
C. Zero sum games are when any gains by a group are exactly offset by equal
losses by the end of the game.
D. Negative sum games: when players as a group at the end of a game lose, possibly one more than another, and it is possible for one or more players to win.
E. Positive sum games are when both players end up better off, voluntary exchange
are an example.
III. Strategies in Non-Cooperative Games:
A. Decision makers have to devise a strategy, or a rule used to make a choice.
Strategies like Targeting advertising to certain age, income, ethnic, gender
group. One may have more demand for a product than another..toys for
children, jewelry for women, grits for Southerners, yachts for the rich, or
different clothes, food & music for different groups, etc.
B. The goal is to come up with successful strategies & when they come up with one
that always yields the highest benefit, it is called a dominant strategy. Whatever competitors do, a dominant strategy will yield the most benefit for the player using it.
C. Dominant strategies are rare over the long-run because of competition, Why?

IV. Public Policy Toward Oligopolies: The government recognizes that cooperation between oligopoly firms is harmful
to society and prefers that competition be the policy between firms.
a. Restraint of Trade and the Antitrust Laws:

Chapter 26: Oligopolies

I. Oligopoly: A market where a very few large sellers dominate an industry and they
each know how the other will react to changes in prices and quantities.

A.

Characteristics are.
1. Small Number of Firms: The top few firms dominate enough to set prices
such as The Atlanta Journal-Constitution, they dominant the newspaper business in the
Atlanta Metro area but you also have the Marietta Journal, The Gwinnett Post, The
Dekalb Neighbor and scores of smaller newspapers in the metro area.
2. Interdependence: There are many examples of industries that react to each
others pricing, output and marketing strategies..the Tobacco companies, processed
food, healthcare products, etc. Carmakers, aircraft companies react to each other always.

B.

Why Oligopoly Occurs:

1. Economies of Scale: Smaller firms in this situation have a tendency to be inefficient because they do not have a high volume of production to minimize costs as production increases. Their Average Costs continue to rise and they will eventually be
bought out by a larger firm or go out of business.
2. Barriers To Entry: These prevent more competition and help a few control an
industry.
3. Oligopoly by Merger: The merged firm almost always has a greater ability to
enjoy economies of scale, effect pricing, and increase output.
Horizontal Merger: 2 steel companies, 2 shoe companies, 2 computer
manufacturers.
4. Cartels: A group of firms acting in unison. They are illegal in the U. S. but not in most
of the world.

Vertical Merger: when a manufacturer acquires a retailer..shoemaker/shoe store;

Delta buys Boeing; Publix buys Coca-Cola; Sony buys Best Buy.

C. Measuring Industry Concentration or Oligopoly: The most popular way

to compute industry concentration is to determine the percentage of total sales or
production accounted for by the top four or top eight firms in an industry.

D. SEE Table 26-1 This is an example of an oligopoly.

1. U.S. Concentration Ratios: This is a table that shows the percentage
oligopolys hold in major industrys.
a. Table 26-2 shows the four-firm domestic concentration ratios for various
industries.
b. There is no definite way to determine which industries are oligopolies.
c. We arbitrarily select 75% as a cut-off for oligopolies in 26-2, tobacco, cereals,
& motor vehicles would make the list.but we could just as well select 60% as
the point of reference.
2. Oligopoly, Efficiency, and Resource Allocation: There is no evidence that
oligopolies create resource misallocations as monopolies do.
a. This is where they manipulate distribution to artificially inflate price levels.
b. Competition both domestically & internationally limit this possibility and a case
could be made for the reverse happening due to economies of scale..which
could mean lower prices.

C. Measuring Industry Concentration or Oligopoly: The most

popular way to compute industry concentration is to determine the percentage of total sales or production accounted for by the top four or top
eight firms in an industry.

D. SEE Table 26-1 This is an example of an oligopoly.

1. U.S. Concentration Ratios:
26-1 Computing 4-Firm Ration
This is a table that shows the percentage
Firm
Annual Sales ($millions)
oligopolys hold in major industrys.
150
a. Table 26-2 shows the four-firm 1
2
100
= 400
domestic concentration ratios for various
3
80
industries.
4
70
b. There is no definite way to
525
50
determine which industries are
Total Firms in
450
the Industry
oligopolies.
400
c. We arbitrarily select 75% as a
4-Firm Concentration Ration = 450 = 88.9%
cut-off for oligopolies in 26-2, tobacco,
cereals, & motor vehicles would make
the list.but we could just as well select 60% as the point of reference.

26-2
4-Firm
Ratios

Industry
Tobacco Products
Breakfast Cereals
Domestic Motor Vehicles
Soft Drinks
Primary Aluminum
Household Vacuum Cleaners
Electronic Computers
Printing and Publishing

Share of Value of Total Domestic Shipments

Accounted for by the Top Four Firms (%)
93%
85%
84%
69%
59%
59%
45%
23%

2. Oligopoly, Efficiency, and Resource Allocation:

a. To the extent that oligopolists have market power, or the ability to effect market
price for the industrys output, they can lead to resource misallocations, just as
monopolies do. However, There is no definite evidence that oligopolies create
resource misallocations.
b. Oligopolists charge prices that exceed marginal cost, but when oligopolies occur
because of economies of scale, consumers can end up paying lower prices than if
the industry was made up of many small firms.
c. The more U. S. firms face competition from the rest of the world, the less the
current oligopoly will be able to exercise market power.

READ THE ILLEGAL PHONE CALL ON PAGE 361.

V. Public Policy Toward Oligopolies: Public policy by the government is to force firms to compete rather
than cooperate. The result is usually a better quality product and lower prices.
a. Restraint of Trade and the Antitrust Laws: Contracts are a mainstay of our market society, however, competitors in the 1800s used this freedom to form groups called trusts, agreeing to common strategies
that would benefit them and drive other competitors out of business. The result was high prices, lower quality, abuses in the workplace and social unrest tied to a decline in economic opportunities.
1. To address this, the U. S. government passed the Sherman Antitrust Act of 1890, which stated that
every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce
among several States, or with foreign nations, is declared to be illegal. The law also included a misdemeanor
fine for any person who monopolizes, or conspires to monopolize, and shall be fined not more than $50,000,
or sentenced to not more than one year. The enforcement component was lacking and the law was ineffective.
2. The Clayton Act of 1914 strengthened the antitrust laws allowing victims of antitrust violations
could sue for three times the amount of the damages.
3. The antitrust laws are designed to prevent mergers that would lead to excessive market power by
any single firm and to prevent oligopolies fro acting together that would reduce market competition.
b. Controversies over Antitrust Policy: Price-fixing is the most universally accepted illegal antitrust
practice because of the obvious benefit for a few firms and damaging to the many firms and competition.
However, other practice deemed illegal are more debatable as to the negative effects on free trade.
1. Resale Price Maintenance: This is when a manufacturer of a product forces a store to charge a
certain price for their product by way of a contractual agreement. This gives the appearance of anticompetition since the price is set by one party and not negotiable via market competition.
i. Some economists agree with this practice because they believe the retailer can influence competition
with the price imposed and it is not done to discourage competition because they would probably sell less by
limiting competition. When retailers have no competition, they often provide less service, less merchandise
quality, and have less influence over their prices. Wal-Mart arguably has very little competition for their style
of retailing and compared to a Macys or Norstroms, they provide less service, less merchandise quality, and
have less influence over their prices. If Wal-Mart raised their prices to equal mainstream retailers, they likely
would suffer a serious decline in business. This documents how difficult it can be to enforce antitrust laws
and how one judge may rule that the price violates the law and another may rule that it is within the law.
2. Predatory Pricing: Firms with market power usually use this for raising prices above the
competitive level. Other firms will lower prices artificially, not based on demand, to drive a competitor out of
business who may not be able to make a profit at the lower prices. This is against the law but some economists believe that it is a fair practice because it hurts the instigator as well as the intended victim.
i. There is a school of thought that this should be legal because both are hurt and may the best, most
competitive firm win. This is not a simple problem and it is hard to judge in many cases.
ii. On the other hand, if a Publix opens a store next to a local single-store grocery and slashes its
prices in half to attract shoppers away from the local store, it would be a blatant example of restraint of trade.
Why? Because Publix is a large chain with high volume sales and could afford to sustain the cost of unprofitable prices while the single-store grocer could not. The single-store would be at an artificially induced disadvantage and would go out of business. This would be a relatively easy judgment to make.
3. Tying is another debatable illegal antitrust strategy. This involves the manufacturer of a popular
product forcing a retailer to buy a new, or unsuccessful product, to sell along side the popular product.
i. If they do not the popular product would be denied the retailer.
ii. The Supreme Court ruled this as illegal under antitrust laws.
iii. It could force a retailer to sell a product neither it or its customer wants while it is taking up shelf
space that could be used to sell another more desirable product.
READ THE MICROSOFT CASE ON PAGE 364.

Sam

Confess
The Prisoners Dilemma
Confess

5 Years

Dont Confess

10 Years

Dont Confess

Carol

1. When two people are arrested

5 Years
for bank robbery, what
Goes Free
should they do when
2 Years
Goes Free
questioned by police?
2. The suspects, Sam & Carol,
2 Years
10 Years
are interrogated separately and
given the following options:
A. If both confess to bank robbery, they will both go to jail for 5
years.
B. If neither confesses, they will each be given a sentence of two
years on a lesser charge.
C. If one confesses and the other does not, one will go free and the
other will serve 10 years in jail.
High

Low

High

$6 million
$6 million

$8 million
$2 million

Low

Applying Game Theory to Pricing

Strategies:
$4 million
$2 million
We apply game strategy to two
firms, who must decide on their
$4 million
$8 million
pricing strategy.
A. If both choose high prices on products,
their revenue will be $6 million...
B. and if they both choose low prices their
revenue will be $4 million each.
C. If one goes low and the other high,
the high will make $2 million and the low $8 million.
D. With the absence of collusion, they will both choose low prices. Because
they know the demand will be higher and generally have a higher profit.
VI. Opportunistic Behavior: Live for today and forget tomorrow...someone who
spurns insurance and doesnt plan ahead...take a higher salary today by accepting
a job that has short-term implications versus a lower paying job for longer job security.
A. Opportunistic behavior for a firm would be to charge higher prices today
and not worry about tomorrow, they would make short-term gains but long-term
losses. This behavior could also entail cheating, or collusion.

II. Strategic Behavior And Game Theory: Card games such as poker,
board games like chess, Monopoly are examples and even betting on sports teams.
A. When there are few firms in an industry, they react to each others price,
product, quality, and distribution policies..they have an interdependence.
B. Since oligopolistic firms are interdependent, they must have strategies,
usually models to predict how prices and outputs are determined.
C. Economists have developed game theory models to describe firms rational
interactions.
III. Some Basic Notions and Characteristics About Game Theory:
A. Example of Cooperative firms: Firms that collude for results...Publix &
Kroger price fixing, Airlines price-fixing, any two firms price-fixing or engaging in turf
protection...this also called restraint of trade and is illegal.
B. Example of Non Cooperative firms: total open competition with competing
firms having the ability to change prices.due to efficient management or demand.
C. Zero sum games are when one players losses are offset by anothers gains.
D. Negative sum games are when both players in a game lose.
E. Positive sum games are when both players end up better off.
IV. Strategies in Non-Cooperative Games:
A. Decision makers have to devise a strategy, or a rule used to make a choice.
B. The goal is to come up with successful strategies & when they come up with
one that is a winner regardless of the competition does, its called a dominant strategy.
C. Dominant strategies are rare over the long-run because of competition.
V. Applying Game Theory to Pricing Strategies: We apply game strategy to two
firms, who must decide on their pricing strategy.
A. If both choose high prices on products, their revenue will be $6 million...
B. and if they both choose low prices their revenue will be $4 million each.
C. If one goes low and the other high, the high-priced firm will make $2
million and the low-priced firm will make $8 million.
D. With the absence of collusion, they will both choose low prices because they
do not know what the other chooses and a high price can hurt, a low price is safe.
VI. Opportunistic Behavior: Live for today and forget tomorrow...someone who
spurns insurance and doesnt plan ahead...take a higher salary today by accepting a
job that has short-term implications versus a lower paying job for longer job security.
A. Opportunistic behavior for a firm would be to charge higher prices today and
not worry about tomorrow, they would make short-term gains but long-term losses.
This behavior could also entail cheating, or collusion.

VI. Price Rigidity And The Kinked Demand Curve: This is when rivals all match price decreases but not
price increases to try and get a competitive edge over each other. There is no collusion and the results are rigid
prices and a kinked demand curve.

READ A. Nature of the Kinked Demand Curve (26-3)

1. We draw a kinked demand curve which assumes that the oligopoly firm matches price
decreases but not price increases.
Characs:
2. We start with a price of Po and a quantity of Qo which are stable economic levels that
*Econ/scale prompts the assumption that rivals will not react with a price change since they are already there.
*Barriers/
3. If rivals do not change their price, the firm will face demand curve d1d1 with a marginal
Entry
revenue curve of MR1.
*InterD
4. But if the assumption is they will react, it will face demand curve d2d2 and MR2 curve
*small#
because more competition lowers their demand and MR.
firms
5. If the firm lowers its price it will assume that rivals will lower prices to match them and avoid
*smaller
losing market share.
#w/higher
6. The firm that initially lowers its price will not greatly increase its quantity demanded because its
%/indus
competitor will follow suit quickly, before the market can react dramatically to the price decrease.
*similar
7. So, when it lowers its price it will expect to face demand curve d2d2
8. but if it increases prices past Po its rivals will probably not follow.
9. As a result, a higher price than Po will cause quantity demanded to decrease rapidly.
10. The demand schedule to the left of and above point E will be elastic as shown by d1d1. Remember, elastic
range is the position above equilibrium.
11. At prices above Po the relevant demand curve is d1d1, which allows for a rapid decline in QD with a price
increase, but below Po it would be d2d2, which allows for a gradual QD increase because the competition will
keep it from being rapid.
12. As a result, at point E there will be a kink in the demand curve, rotates down because the QD will be low for
an inelastic OLI because others will lower their price too. They also do not have as much leverage to differentiate their product as in monopolistic and perfect competition markets.
13. This is shown in panel B as d1d2. The marginal revenue curve is MR1MR2, shows a discontinuous portion
or gap.
14. The MR will stay the same for a while because Demand is inelastic, response is low.
15. The kinked demand curve explains why price changes are rare in oligopolies. If price goes up, demand falls,
if prices go down, competition follows and profits go down if elasticity is below 1.
16. A larger demand will increase output and production costs will go up.
17. The theoretical reason for the price inflexibility under the kinked demand curve has to do with the discontinuous portion of the MR curve in Panel B.
18. Look at 26-4, The marginal cost is represented by MC & the profit maximizing output is qo, sold at Po. If
the MC shifts up to MC, nothing will happen to the price or quantity.stays the same.
19. Remember, the profit maximizing rate is still where MC=MR. The shift in the MC to MC does not change
the profit maximizing rate of output because MC still cuts the MR curve in the discontinuous portion.
20. The result is when firms in an OLI industry have cost increase & decreases, price will not change as long as
MC=MR.
21. Prices are therefore rigid as long as OLIs react the way we assume they will.

Criticisms of the Kinked Demand Curve

1. We dont know how the Po price came to be.
2. If all Oli firms faced a kinked demand curve it would not pay to change prices.
3. The kinked demand curve does not show us how demand & supply originally determine the going price of an
Oli product.
4. Evidence is shaky, Oli prices do not appear to be as rigid as the kinked demand theory implies. During the
1970s and 1980s, when the economy prices were rising, Oli producers increased prices frequently, 1930s too.

1. We draw a kinked demand curve which assumes that the oligopoly firm matches price
decreases but not price increases.
Characs:
2. We start with a price of Po and a quantity of Qo which are stable economic levels that
*Econ/scale
prompts the assumption that rivals will not react with a price change since they are already there.
*Barriers/
3. If rivals do not change their price, the firm will face demand curve d1d1 with a marginal
Entry
revenue curve of MR1.
*InterD
4. But if the assumption is they will react, it will face demand curve d2d2 and MR2 curve
*small#
because more competition lowers their demand and MR.
firms
5. If the firm lowers its price it will assume that rivals will lower prices to match them and avoid
*smaller
losing market share.
#w/higher
6. The firm that initially lowers its price will not greatly increase its quantity demanded because its competitor
%/indus
will follow suit quickly, before the market can react dramatically to the price decrease.
*similar
7. So, when it lowers its price it will expect to face demand curve d2d2
8. but if it increases prices past Po its rivals will probably not follow.
9. As a result, a higher price than Po will cause quantity demanded to decrease rapidly.
10. The demand schedule to the left of and above point E will be elastic as shown by d1d1. Remember, elastic range is
the position above equilibrium.
11. At prices above Po the relevant demand curve is d1d1, which allows for a rapid decline in QD with a price increase, but below Po it
would be d2d2, which allows for a gradual QD increase because the competition will keep it from being rapid.
12. As a result, at point E there will be a kink in the demand curve, rotates down because the QD will be low for an inelastic OLI because others will lower their price too. They also do not have as much leverage to differentiate their product as in monopolistic and perfect competition markets.
13. This is shown in panel B as d1d2. The marginal revenue curve is MR1MR2, shows a discontinuous portion or gap.
14. The MR will stay the same for a while because Demand is inelastic, response is low.
15. The kinked demand curve explains why price changes are rare in oligopolies. If price goes up, demand falls, if prices go down,
competition follows and profits go down if elasticity is below 1.
16. A larger demand will increase output and production costs will go up.
17. The theoretical reason for the price inflexibility under the kinked demand curve has to do with the discontinuous portion of the MR
curve in Panel B.
18. Look at 26-4, The marginal cost is represented by MC & the profit maximizing output is qo, sold at Po. If the MC shifts up to
MC, nothing will happen to the price or quantity.stays the same.
19. Remember, the profit maximizing rate is still where MC=MR. The shift in the MC to MC does not change the profit maximizing
rate of output because MC still cuts the MR curve in the discontinuous portion.
20. The result is when firms in an OLI industry have cost increase & decreases, price will not change as long as MC=MR.
21. Prices are therefore rigid as long as OLIs react the way we assume they will.

D2
D1

D1
Po

D1

Po

MC1

MR1

MC
MR1
MC2
D2

D2

MR2
Qo

MR2
Qo

VI. Price Rigidity And The Kinked Demand Curve: This is when rivals all match price decreases but not price
increases to try and get a competitive edge over each other. There is no collusion and the results are rigid prices
and a kinked demand curve.
NON Collusive Oligopoly
Imagine an oligopolistic industry made up of three firms A, B, & C each having 1/3 of the total market of a differentiated product.
Assume the firms are independent, meaning they do not engage in price fixing.
Suppose the price is at Po and sales are at Qo. What does the firms demand curve look like? This depends on how
its rivals will react to a price change by firm E
There are two plausible assumptions about the reaction of Es rivals.
1. Match price changes: One possibility is firms B & C will exactly match any price change initiated by A.
A. In this case As demand curve will look like the straight line D1 & MR1. Why are they so steep? Because if
price A cuts its price, its sales will increase only modestly because its two rivals will also cut their prices to prevent A from gaining an advantage over them.
B. The small increase in sales that A, B, & C will realize is at the expense of other industries.
C. A will gain no sales from B & C.
D. If A raises its price its sales will fall only modestly because B & C will match its price increase. The industry
will lose sales to other industries but A will lose no customers to B & C.
2. Ignore price changes: The other possibility is that firms B & C will ignore any price change by A.
A. In this case, the demand and marginal-revenue curves faced by A will resemble the straight lines D2 and MR2
in figure A.
B. Demand in this case is considerably more elastic than under the previous assumption.
C. The reasons are clear: if A lowers its price and its rivals do not, A will gain sales significantly at the expense of
its two rivals because it will be underselling them.
D. Conversely, if A raises its price and its rivals do not, A will lose many customers to B & C, which will be underselling it..
E. Because of product differentiation, however, As sales will not fall to zero when it raises its price; some of As
customers will pay the higher price because they have strong preferences for As product.
3. A Combined Strategy: Now what is the most logical assumption for A to make about its rivals reaction to any
price change it has? Some of each.
A. Common sense suggests that price declines below Po will be matched as a firms rivals act to prevent the price
cutter from taking their customers.
B. But price increases above Po will be ignored because rivals of the price-increasing firm stand to gain the business lost by the price booster. In other words, D2 seems relevant for price increases and D1 seems relevant for
price cuts.
C. It is logical, or a reasonable assumption, to that the noncollusive oligopolist faces the kinked demand curve
D2eD1, as in panel B.
D. Demand is very elastic above price Po but less elastic below that price.
E. Note also that if it is correct to suppose that rivals will follow a price cut but ignore an increase, the MR curve
will also have an odd shape. It will have two segments.
F. Because of the difference in elasticity of demand above & below the going price, there is a gap in the curve.
4. On the demand side: The kinked demand curve gives the oligopolist reason to believe that any change in price
will be for the worse.
A. If is raises prices customers leave. If it lowers price sales will rise slightly because rivals match price.
B. Even if a price-cut increases the oligopolists TR, its costs will increase by a greater amount.
C. And if demand is inelastic, to the right of Qo, the firms profit will fall.
D. A price decrease in the inelastic region, lowers the firms TR & more production increases TC.
5. On the Cost Side
A. The broken MR curve suggests that even if an oligopolists cost changesa lot, the firm may have no reason to
change its price.
B. In partcular, all positions of the MC Curve between MC1 & MC2 in 4-B will result in the firm deciding on the
same price & output. At all positions, MC = Qo and Po is charged.

VII. Price Rigidity: The kinked demand curve analysis may help explain why price changes might be
infrequent in an oligopolistic industry without collusion..Each oligopolist can only see harm in a price
change.
1. If price is increased, the Oli. Firm will lose many of its customers to rivals who do not raise prices.
2. This is shown in panel B, figure 25-5, where the Oli. firm move up from point E along d1.
3. If the Oli. Firm lowers price, the rivals will lower prices too and sales will not increase much.
4. Moving down along d2 from E in panel B we see that the price is inelastic and if it is less than one,
total revenues will fall rather than increase with a price decrease.
5. Given that the production of more output will increase total costs, the Oli. Firm profits will fall.
6. A possible outcome of a price decrease by an Oli. Firm is a price war.

VIII. Changes in Cost

Figure 25-6

1. The theory for the price inflexibility shown in the kinked demand curves in 25-5 & 25-6 has to do
with the discontinuous portion of the MR curve.
2. Assume the marginal cost is represented by MC.
3. The profit-maximizing rate of output is qo, which can be sold at price Po.
4. Also assume that that marginal cost curve rises to MC where the quantity & price will remain the
same.
5. The MC curve and MR curve is still profit-maximization output.
6. The shift in the marginal cost curve to MC does not change that because MC still cuts the marginal
revenue curve in the discontinuous portion.
7. As a result, the equality between marginal revenue and marginal cost still holds at output rate qo
even when the marginal cost curve shifts upward.
8. When the marginal costs fall to MC the Oli. Firm will still produce at a rate of output of Po.
9. Whenever the marginal cost curve cuts the discontinuous portion of the marginal revenue curve,
fluctuations in marginal cost generally will not affect output or price because the profit-maximization
condition MR=MC will hold.
10. The result is that when Oli. Firms experience increases or decreases in costs, their prices do not
change as long as MC cuts MR at the discontinuous portion. This is why prices are seen as rigid in
Oligopolistic firms.

Start on Page 637 with Criticisms of Kinked Demand Curve.

AP Economics: Chapter 16: Oligopoly Classwork

Name:

Date:

Period:

1. Is price leadership legal and why?

2. Explain a situation that would set off a price war.

3. Why would oligopolists invest in excess capacity?

4. How might an oligopolist protect itself from increased foreign competition?

5. What is the limit-pricing strategy and what is its significance?

6. Provide an example of how switching costs can be a deterrent to entry.

7. Some say the best advertising is word-of-mouth. Explain a similar concept that can help a firm prosper.

8. Explain how and why the telecommunications industry has suffered financial losses in recent years.

9. Explain the network effect and how does it work?

10. Name and explain the characteristics of the industry structure my company is in if I have a lot of
competition producing a similar product?

AP Economics: Chapter 16: Oligopoly Classwork

Name:

Date:

Period:

1. Is price leadership legal and why?

Yes, it comes close to breaking the law, but since there is no contact between companies, It is legal.
2. Explain a situation that would set off a price war.
When a price leader has a rate that is not working for smaller competitors, they may lower prices to compete.
3. Why would oligopolists invest in excess capacity?
To deter potential competitors from entering the industry and to scare competitors from lowering prices.
4. How might an oligopolist protect itself from increased foreign competition?
Try to get the government to pass new health, safety or environmental standards passed costing importers.
5. What is the limit-pricing strategy and what is its significance?
Threaten to lower prices below profit level to deter potential competitors from entering the industry.
6. Provide an example of how switching costs can be a deterrent to entry.
By making products non-compatible with other similar products driving up the cost to switch products.
7. Some say the best advertising is word-of-mouth. Explain a similar concept that can help a firm prosper.
Positive Market Feedback. The product becomes popular and is talked about in the market.
8. Explain how and why the telecommunications industry has suffered financial losses in recent years.
Victims of negative market feedback. Consumers quit buying and let their friends know about it.
9. Explain the network effect and how does it work?
A small number receive the bulk of industry sales due to positive feedback.
10. Name and explain the characteristics of the industry structure my company is in if I have a lot of
competition producing a similar product?
Monopolistic: many sellers, unrestricted entry, no LR economic profits, a lot of differentiation, examples are
toiletries, retail trade are examples.

Chapter 26 Test: Oligopoly

Name:

Date:

Period:

1. An implication of the kinked demand curve is that oligopolies..

A. are more profitable than other economic markets.
B. prices are more rigid than
C. can replicate monopolies by cooperating.
other market structures.
D. advertise more than other economic markets.
2. A market in which a few firms realize their interdependence is
A. monopolistic competition .
C. monopoly.
B. oligopoly.
D. regulated monopoly.
3. Which of the following statements about oligopoly is false?
A. They can break up easy and become perfect competitors.
C. Can generate lower prices for consumers.
B. May generate more resource allocation by having P>MC.
D. Market power limited by foreign competition.
4. Concentration ratio measures
A. the average size of firms.
C. the share of industry sales by the largest firms in the industry.
B. the sales of the top four firms divided by the sales of the bottom four.
5. If Ford believes other automakers will match any price decrease but not price increase, the result is.
A. more sales for Ford.
C. a unitary-elastic demand curve.
B. a demand curve that is kinked at the current price.
D. a cooperative game.
6. A dominant strategy is one that.
A. provides for a firm to become a monopoly.
C. turns a negative-sum game into a positive sum-game.
B. every participant will follow.
D. always yield the highest profit regardless of what others do.
7. An oligopoly situation is described in game-theory terms as a
A. zero-sum game B. cooperative game
C. non-cooperative game

D. tit-for-tat game

8. Managers in oligopolistic firms that make decisions on price and output usually.
A. erect barriers to entry to protect their turf.
C. consult the antitrust division of the Justice Department.
B. anticipate the reaction of competitors.
D. inform regulators of their plans.
9. Which of the following is not a reason why some industries are oligopolies?
A. economies if scale.
B. barriers to entry
C. regulation

D. mergers

10. When General Motors purchased Fisher Body & Auto Repair Company, it was an example of a
A. horizontal merger.
B. vertical merger.
C. monopoly.
D. excess capacity.
11. Oligopoly is a situation when there
A. is one firm in an industry that is large
C. are too many firms in an industry and there is excess capacity
B. are a few large firms in the industry
D. is one giant firm and many small ones.
12. An example of a cooperative game would be
A. oligopoly
B. monopolistic competition

C. a cartel

D. perfect competition

13. Horizontal merger occurs when.

A. two firms merge one sold its output to another as input.
B. the merger moves the combined firm onto the horizontal long-run.
C. two firms merge where each is about the same size.
D. two firms producing a similar product merge.
14. On a kinked demand curve the upward portion is
A. inelastic and the lower is elastic. C. horizontal and the lower is sloping down.
B. elastic and the lower is inelastic. D. sloping down and the lower is vertical.

Firm

Annual Sales Firm

Annual Sales

A
B
C
D
E
F

$1000
800
220
75
50
40

$800
$1500
$1050
$ 90
$ 75
$ 300

G
H
I
J
K
L

15. Refer to the table above. The four-firm concentration is.

a. 85.1%
b. 75%
c. 72.5%
d. 59.2%

Graph E
MC

D
C
B
A

ATC

MR

18. Refer to Graph E. What is the average

cost?
a. A b. B c. C d. D

16. Refer to the table above. The eight-firm concentration ratio is

a. 100%
b. 96%
c. 94.5%
d. 87.2%
19. Refer to Graph E. What is the marginal
cost at the this level of output?
17. Refer to Graph E. What is the price of the product?
a. A b. B c. C d. D
A. A
b. B
c. C
d. D
20. In which of the following will the players sum of benefits be positive?
A. Negative-sum game
B. Zero-sum game C. positive-sum game

D. prisoners dilemma

21. If oligopolist Bs rivals ignore its price increases but match price decreases, then Bs demand will be
A. Discontinuous
B. kinked at the going price C. below MR curve D. equal to the industry demand
22. In long-run equilibrium for the oligopolist,
A. MR=MC
B. P>MR
C. economic profits are zero D. all of the above
23. The kinked demand curve theory.
A. is supported by research
B. Requires that rivals match prices

C. Predicts price rigidity

D. requires collusion

24. The best explanation for the existence of oligopolies is..

A. no economies of scale
B. large economies of scale
T
T
T
T
T
T
T

F
F
F
F
F
F
F

25.
26.
27.
28.
29.
30.
31.

C. advertising

D. competition

Price wars result because all players are in a positive sum game.
Concentration ratios provide an accurate measure of monopoly power in an industry.
If an oligopolists rivals match its price changes, the demand curve will kink.
The limit-pricing model suggests oligopolists set price at the highest priced they can.
A dominant strategy is always favored by a player, regardless of what others do.
A main characteristic oligopolies is an oligopolist must consider the reaction of rivals.
Interdependence results in oligopoly firms copying each others strategies.

32. Which of the following is most likely not a price leader?

A. A firm that is the first in an industry to make pricing decisions.
B. A firm that is the largest firm in an industry.
C. A firm that has an ATC above the price line.
D. A bold, risk-taking firm.
33. Which of the following best describes the network effect?
A. A firm prospers due to positive feedback.
C. A new firm earns a profit its first month in business.
B. A firm loses 15% in the second quarter.
D. A firm diversifies into another field.
34. Which would not involve a switching cost?
A. A consumer has $500 in cassette tapes when she buys a CD player.
B. A traveler changes planes in Atlanta paying $110 more for the second leg of the flight than she did the first.
C. Sony invents a new hypersonic speaker sound system but its unique plug only fits Sony Hypersonic players.
D. An electric car runs for 400 mile on one battery charge, but you must get the charge from the dealer for $300.
35. This is a situation when one players losses are offset by another.
A. Negative-sum game
B. positive-sum game
C. Zero-sum game

D. Cooperative games

36. Which is an example of a firm that is likely violating a law?

A. Cooperative firm
B. Non-cooperative firm
C. Positive-sum investor
37. When both players are better off at the end of the game, it is called a..
A. Negative-sum game
B. positive-sum game
C. Zero-sum game

D. a negative-sum firm

D. Cooperative games

38. Which option most closely represents the characteristic of an oligopoly?

A. Barriers to entry B. Economies of scale
c. merger
d. All of these
39. Which of the following would be a horizontal merger?
A. Coca Cola buys Pepsi B. Publix buys Kraft Cheese C. Wal-Mart buys Lionel
D. Ford Motor Company buys Exxon Oil Company
40. An oligopolist can never raise its prices Is this a true statement?
A. Yes
B. No
C. Sometimes she can
D. none of these
41. Why would an oligopolist not want to have excess capacity?
A. There is a minimal competitive threat.
C. It can produce more than rivals.
B. The cost of resources fell.
D. It would receive a tax break.
See the Prisoners Dilemma Game for the next 3 questions

44. If neither confesses, what will be their penalty?

A. Free &10 years B. 5 & 5 years C. 2 & 5 years
D. 2 & 2 years

Confess

Confess

Dont Confess

43. If only one confesses, what will be their penalty?

A. Free &10 years B. 5 & 5 years C. 2 & 5 years
D. 2 & 2 years

CAROL

42. If both confess to bank robbery, what will be their penalty?

A. 2 years
B. 5 years
C. 10 years D. None

SAM

Dont Confess

5 years
5 years

10 years
Goes Free

Goes Free
10 years

2 years
2 years