Oligopoly

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OLIGOPOLY

INTRODUCTION

Oligopolists maximize their total profits by forming a cartel and acting like a monopolist. Yet, if oligopolists make decisions about production levels individually, the result is a greater quantity and a lower price than under the monopoly outcome. The larger the number of firms in the oligopoly, the closer the quantity and price will be to the levels that would prevail under competition.

The prisoners’ dilemma shows that self-interest can prevent people from maintaining cooperation, even when cooperation is in their mutual interest. The logic of the prisoners’ dilemma applies in many situations including arms races, advertising, common-resource problems, and oligopolies.

Policymakers use the antitrust laws to prevent oligopolies from engaging in behavior that reduces competition. The application of these laws can be controversial, because some behavior that may seem to reduce competition may in fact have legitimate business purposes. Between Monopoly and Perfect Competition

A.The typical firm has some market power, but its market power is not as great as that described by monopoly.

B.Firms in imperfect competition lie somewhere between the competitive model and the monopoly model.

C.Definition of oligopoly: a market structure in which only a few sellers offer similar or identical products.

1.Economists measure a market’s domination by a small number of firms with a statistic called a concentration ratio.

2.The concentration ratio is the percentage of total output in the market supplied by the four largest firms.

3.In the U.S. economy, most industries have a four-firm concentration ratio under 50%.

D.Definition of monopolistic competition: a market structure in which many firms sell products that are similar but not identical.

E.Figure 1 summarizes the four types of market structure. Note that it is the number of firms and the type of product sold that distinguishes one market structure from another.

F.In the News: The Growth of Oligopoly

1.Many industries in the United States, especially those in the world of technology, media, and communications, are becoming more oligopolistic.

2.This is an article from The Wall Street Journal describing this trend and discussing its negative effects.

Markets with Only a Few Sellers

A.A key feature of oligopoly is the tension between cooperation and self-interest.

1.The group of oligopolists is better off cooperating and acting like a monopolist, producing a small quantity of output and charging a price above marginal cost.

2.Yet, because the oligopolist cares about his own profit, there is an incentive to act on his own. This will limit the ability of the group to act as a monopoly.

B.A Duopoly Example

1.A duopoly is an oligopoly with only two members.

2.Example: Jack and Jill own the only water wells in town. They have to decide how much water to bring to town to sell. (Assume that the marginal cost of each gallon of water is zero.)

3.The demand for the water is as follows:

|Quantity (gallons) |Price |Total Revenue | |0 | $120 |$0 | |10 |110 |1,100 | |20 |100 |2,000 | |30 |90 |2,700 | |40 |80...
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