AP Microeconomics

Oligopoly

Warm Up: Who is the main competitor for each of the pictured firms? How are all of these firms both powerful and weak?

Oligopoly Characteristics

An industry with a small number of firms selling a standardized or differentiated product; these few firms control at least 2/3’s (67%) of the industry collectively.

Significant pricing power (Lerner Index)Significant barriers to entry; sheer size of

the few firms prevents others firms from entering the market (Herfindahl Index)

Oligopoly Characteristics• Examples include:

– Airlines– Soft drinks

– Car Manufacturers– Car tires

– Beer– Cereal makers

• Unlike Perfect Competition that are so small that they have no effect on each other and monopolies that face an entire market alone, oligopolistic firms must consider the reactions of their rivals to marketing decisions.

Oligopoly Models:

• There are four different models that all represent oligopolies (a few firms dominating the industry).

1. Collusion Model

2. Kinked Demand Curve Model

3. Duopoly

4. Price Leadership

1. Collusion Model

a) The small group of controlling firms conspire on price and output and the result is exactly the same as it would be if a monopoly controlled the entire industry

{ P (MR = MC) }

b) Ex) Cartels like OPEC Output

Price & Cost

Demand

MR

MC

QX

PX ATC

Profit

2. Kinked Demand Curve Model

a. The demand curve facing each individual firm has a “kink” in it.

b. Firms will follow each other if they cut prices but not if they raise prices

c. The demand above P is elastic and raising prices will decrease total revenue

d. The demand below P is inelastic and changing price will see little change in demand for products

Output

Price & Cost

Demand

MR

MC

QX

PX

ATC

Profit

More Oligopoly Models

(3) Duopoly (Cournet Model)a. Two firms

controlling market

b. Was once a monopoly but another firm was able to grasp some of the market

(4) Price Leadershipa. There is a dominant

firm and this firm will change price and the others will be forced to follow

Strategy!!!

Because oligopolies follow one another, they must strategize as to what the competition is always doing!!

• Game Theory:• Considers the strategic decisions of

“players” in anticipation of their rival’s reaction.

• Often illustrated in a payoff matrix. Let’s Play:

John Nash“A Beautiful Mind”

Raise Lower

Raise 400, 300 -800, 500

Lower 600, -800 -500, -500

LIZ

BOB

What would you do?

Dominant Strategy:Bob = Lower: chance to make most or lose least

the strategy that is the best regardless of what the opponent does.

Player 2chooses Left

Player 2chooses Right

Player 1chooses Up

4, 3 –1, –1

Player 1chooses Down

0, 0 3, 4

#1: Earn the Most Points

#2: Do Not Let your Opponent Win!!

Cooperate

Defect

Cooperate

2, 2 0, 3

Defect 3, 0 1, 1Do you cooperate with police or lie (defect)

The numbers represent extra years in prison you get for attempting an escape; so you want the least amount of years!!!

As times get more complicated:

ROCK~PAPER~SCISSORS!!!

Is there a dominant strategy?