OLIGOPOLY

OLIGOPOLY

OLIGOPOLY

Market demand and a firm's cost structure interact to produce unique market outcomes in reference to determining the market price and output.

oligopolistic market

It is a market dominated by a few large producers of homogenous or differentiated products. It means:

Fall between - Pure Competition and Pure Monopoly

Exhibit Imperfect Competition

Few firms have some MARKET POWER.

The determinants of market power:

Number of producers

Size of each firm

Barrier to entry

Availability of substitute goods

Measure market power by estimating market concentration ratio:

Concentration Ratio = A measure of market power that relates the size of firms to the size of the product market

“Four Firm” Concentration Ratio. The percentage of total industry sales accounted for by the four largest firms

40% or more ( Oligopolistic Market

50% of US manufacturing industries are oligopolies.

Market power measurement issues

1. Local Monopoly - Concentration Ratio pertains to a nation as whole - ignores local market power factors e.g. university bookstore

2. Inter-industry Competition - Concentration Ratio ignores inter-industry competition - e.g. copper vs. aluminum

3. Import Competition - Concentration Ratio ignores the competition from imports

4. Smaller firms can group together to generate market power - ABA, AMA and APTA

Recognizing these potential market power measurement issues, the Antitrust Division of the US Department of Justice adopted the HHI measurement in 1982.

Herfindahl - Hirshman Index = HHI = SUM of (shares of firm 1)2 + (shares of firm 2) 2 + (shares of firm n) 2

Note that HHI takes into account the market share of each firm rather than just the combined market share of the top four firms! The Department of Justice utilizes the HHI measurement to help enforce its antitrust oversight responsibilities.

Challenges any mergers that creates an HHI value over 1800

Challenges any mergers that increases an HHI value by 100 if the HHI is in between 1000 and 1800

No challenge if an HHI value is less than 1000

For over six decades, the mission of the Antitrust Division has been to promote and protect the competitive process — and the American economy — through the enforcement of the antitrust laws. The antitrust laws apply to virtually all industries and to every level of business, including manufacturing, transportation, distribution, and marketing. They prohibit a variety of practices that restrain trade, such as price-fixing conspiracies, corporate mergers likely to reduce the competitive vigor of particular markets, and predatory acts designed to achieve or maintain monopoly power.

Game Theory Model: The science of “interactive” strategy

INTITIAL EQUILIBRIUM

A balance in MARKET SHARE - the percentage of total market output produced by a single firm.

MARKET SHARE BATTLE

Interactive Game….



ABC Co. Pricing Strategy & Profit

High

Low

XYZ Co. Pricing Strategy & Profit

High

$10M $10M

$5M $15M

Low

$15M $5M

$8M $8M

If the firms COMPETE than the industry PROFIT is $16M

If the firms COLLUDE than the industry PROFIT is $20M

BUT, there is a powerful INCENTIVE to CHEAT!

RETALIATION & COUNTER-RETALITIATION

Price Reduction - Price Leader & Matching by Airlines

Quantity Discounts - Giant's Bonus Card

Service Complements - Free Oil Change

Price Differentiation - Innovations

ESTABLISH EQUILIBRIUM

But the conflict between COLLUSION vs COMPETITION

Price or Cost

MC

ATC

Pm

Monopoly D

Profit

mATCMR

Quantity

Market Q

Oligopolists want to “collude” to act like MONOPOLY to maximize the ...