Game Theory and Oligopoly Fall

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Econ 101: Principles of Microeconomics
Chapter 15 - Oligopoly

Fall 2010

Herriges (ISU)

Ch. 15 Oligopoly

Fall 2010

1 / 25

Outline

1

Understanding Oligopolies

2

Game Theory The Prisoner’s Dilemma Overcoming the Prisoner’s Dilemma

3

Antitrust Policy

Herriges (ISU)

Ch. 15 Oligopoly

Fall 2010

2 / 25

The Oligopoly
Monopolies are quiet rare, in part due to regulatory efforts to discourage them. However, there are many markets that are dominated by a relatively few firms, known as oligopolies. The term oligopoly comes from two Greek words: oligoi meaning “few” and poleein meaning “to sell”. Examples of oligopolies include: 1 2 3 4

5

6 7

Airliner Manufacturing: Boeing and Airbus Food Processing: Kraft Food, PepsiCo and Nestle US Beer Production: Anheuser-Busch and MillerCoors US Film Industry: Disney, Paramount, Warners, Columbia, 20th Century Fox and Universal US Music Industry: Universal Music Group, Sony Music Entertainment, Warner Music Group, and EMI Group Academic Publishing: Elsevier, Kluwer US Airline Industry: Delta/NWA, United, American Ch. 15 Oligopoly Fall 2010 3 / 25

Herriges (ISU)

The Problem With Oligopolies
The problem with oligopolies is much that same as with monopolies–the firms realized they have some market power because relatively few firms provide the good or service. Oligopolies still compete– it’s just that the competition is not always as rigorous. The situation in which both competition occurs and firms exercise market power is known as imperfect competition The market power of the oligopoly will typically result in higher prices and lower production levels in the market than would be efficient However, the competition among firms, and particularly their incentives to cheat on each other, will dampen this effect relative to a monopoly. Oligopolies are a very difficult type of market structure to study, relative to either perfect competition or a monopoly. Herriges (ISU) Ch. 15 Oligopoly Fall 2010 4 / 25

Determining Whether an Oligopoly Exists
An oligopoly is defined, not by the size of the firms, but by their relative market shares. Essentially, if relatively few firms control most of the market sales, then an oligopoly exists. One commonly used measure of market concentration is the Herfindahl-Hirschman Index (HHI), which is defined as: N

HHI =
i=1

Si2

(1)

where
Si denotes the percent of market controlled by the i th firm N denotes the number of firms in the market.

Herriges (ISU)

Ch. 15 Oligopoly

Fall 2010

5 / 25

More on HHI’s
The HHI ranges from zero to 10000 (i.e., 1002 in the case of a monopoly) The US Department of Justice uses the following cutoffs: HHI < 100 indicates a highly competitive market. 100 < HHI < 1, 000 indicates an unconcentrated market. 1, 000 < HHI < 1, 800 indicates a moderately concentrated market. HHI > 1, 800 indicates a highly concentrated market. PC Operating Systems: HHI=9,182 (Microsoft, Linux) Wide-Body Aircraft: HHI=5,098 (Boeing, Airbus) Diamond Mining: HHI=2,338 (De Beers, Alrosa, Rio Tinto) Movie Distributors: HHI=1,096 (roughly equivalent to 10 first each owning 10% of the market) Retail Grocers: HHI=321

HHI examples:

Herriges (ISU)

Ch. 15 Oligopoly

Fall 2010

6 / 25

An Alternative View
A less formal way of looking at market concentration is to examine the market shares held by the top few firms in an industry.

Herriges (ISU)

Ch. 15 Oligopoly

Fall 2010

7 / 25

Understanding Oligopolies

Understanding Oligopolies
The difficulty in studying oligopolies in general is that there are so many possible ways in which the firms might interact with each other. 1

They might collude; i.e., cooperate with each other so as to maximize their joint profits, dividing up the profit among the firms. Such collusion might take the form of overt collusion (such as forming a cartel) Alternatively it might be indirect, implicit collusion.

2

They might also act...
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