S&N, Ch.

10
Mw, Ch. 16

OLIGOPOLY
Reasons for imperfect competition
 Costs
Minimum economic size relatively large
Only a few firms can be profitable
 Barriers to competition
Government restrictions
Intellectual Property Rights
 Interdependence
 Concentration in US industries (1997)
4 largest Next 4 largest

Machine shops 21

Women's clothes 6 4

Iron and Steel Mills 33 20

Computers 45 23

Breakfast cereals 83 11

Refrigerators 83 15

Automobiles 88 10

Cigarettes 99 1
Oligopoly
 A market dominated by a small number
of firms
 Imperfect competition is expected to
lead to:
Higher prices (supernormal profits)
Lower quality
 Two options are:
Collusive oligopoly
Strategic interaction
Oligopoly
 A market with a few firms each large
enough to have an effect on the price
 Interdependence among firms
 Each firm would try to guess its
competitor’s reaction to its pricing strategy
 Relative price stability
 Different Oligopoly models
○ The Kinked Demand Curve Model
○ The Game Theory
Collusive Oligopoly
• Oligopolists cooperate (collude) to
reduce competition
– Agree on prices
– Restrict output
– Geographic differentiation
• Want to divide the monopolist’s output
and profit between them
• In most free-market economies collusion
is illegal
OPEC
• OPEC – Organisation of Petroleum
Exporting Countries
• “The OPEC MCs coordinate their oil
production policies in order to help
stabilise the oil market and to help oil
producers achieve a reasonable rate of
return on their investments. This policy is
also designed to ensure that oil consumers
continue to receive stable supplies of oil.”
(www.opec.org)
OPEC (2)
 OPEC is a cartel
 Cartels need effective collaboration to
work
 OPEC sets production quotas – not
prices
 Member countries can cheat and
produce more (or may not produce their
quota)
Strategic Interaction
 With just a few companies in the market
each can second guess the competition.
 Company A wants to lower prices to
increase sales at the expense of
Company B
 But if Company B also cuts prices (a
price war) both lose.
Jack and Jill’s Water
 Jack and Jill form a duopoly on the
supply of water.
 Each collects water from their own well
(marginal cost = 0) and sells it at the
market price.
 In perfect competition the price will be
the marginal cost, which is zero.
 A monopoly maximises profit, 60 L at Rs
60/L
Demand schedule for water
Quantity Price Total Revenue
(L) (Rs) (Rs)
10 110 1,100
20 100 2,000
30 90 2,700
40 80 3,200
50 70 3,500
60 60 3,600
70 50 3,500
80 40 3,200
90 30 2,700
100 20 2,000
110 10 1,100
120 0 0
Jack and Jill - the duopoly
 Jack and Jill form a cartel
 Maximum total profit is from 60L sold at
Rs 60/L
 Need to decide how to share the
production
 Jack expects Jill to produce 30 L
Jack produces 40L
Price falls to Rs 50 (70 L in total are produced)
Jack makes Rs 2,000 (instead of Rs 1,800)
Jack and Jill - the duopoly
 But Jill think the same, so she produces 40
L
Total produced is now 80L
Price is Rs 40 / L
Each makes Rs 1,600
 Jack now wants to produce 50 L (total of 90
L)
Price falls to Rs 30 / L
Jack’s revenue is RS 1,500
Less profit, so Jack and Jill each produce 40 L
Game Theory
 Strategic interaction is dealt with by
Game Theory.
S&N, Ch 11
Mw, pp. 353-360