(market power based on product differentiation and/or the firm’s dominance

8/14/2019 (Market Power Based on Product Differentiation and/or the Firm’s Dominance

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OLIGOPOLYOLIGOPOLY

(market power based on product (market power based on product

differentiation and/or the firm’sdifferentiation and/or the firm’s

dominance of the market)dominance of the market)



FEATURESFEATURES

Few sellers of a productFew sellers of a product Unspecified number of buyersUnspecified number of buyers

Interdependence among firmsInterdependence among firms

Market entry and exit difficultMarket entry and exit difficult

Pure oligopoly - Homogeneous productPure oligopoly - Homogeneous product Differentiated oligopoly - DifferentiatedDifferentiated oligopoly - Differentiated

productproduct

Non-price competition very important amongNon-price competition very important among

firms selling differentiated productsfirms selling differentiated products Duopoly - Two sellersDuopoly - Two sellers



SOURCES OF OLIGOPOLY SOURCES OF OLIGOPOLY

Economies of scaleEconomies of scale

Large capital investment requiredLarge capital investment required

Patented production processesPatented production processes

Brand loyaltyBrand loyalty Control of a raw material or resourceControl of a raw material or resource

Government franchiseGovernment franchise



COLLUSIVE OLIGOPOLYCOLLUSIVE OLIGOPOLY



COLLUSIVE OLIGOPOLYCOLLUSIVE OLIGOPOLY

Cooperation among firms to restrictCooperation among firms to restrict

competition in order to increase profitscompetition in order to increase profits

Firms cooperate with each other in takingFirms cooperate with each other in taking

joint decisions to keep their bargaining joint decisions to keep their bargaining

position stronger against the consumersposition stronger against the consumers



CARTELSCARTELS

Cartel: explicit agreement among firms (onCartel: explicit agreement among firms (onprice, O/P, market sharing etc)price, O/P, market sharing etc)

2 types of cartels:2 types of cartels:

(a) Centralized Cartel(a) Centralized Cartel All decisions (price, O/P, sales, distribution of All decisions (price, O/P, sales, distribution of

profits) taken by central association of allprofits) taken by central association of all

firmsfirms

(b) Market-Sharing Cartel(b) Market-Sharing Cartel Firms agree on market shares (geographicalFirms agree on market shares (geographical

area), with or without any understanding onarea), with or without any understanding on

pricesprices



CENTRALIZED CARTELCENTRALIZED CARTEL



WEAKNESSWEAKNESS

Firms can ask for an equitable distribution of Firms can ask for an equitable distribution of profits.profits.

Firm may withdraw from the cartelFirm may withdraw from the cartel

Cartel members have a strong incentive to cheatCartel members have a strong incentive to cheat

by selling more.by selling more.

Monopoly profits may attract other firms.Monopoly profits may attract other firms.



EXCERCISEEXCERCISE

If 2 firms constitute duopoly industry & theirIf 2 firms constitute duopoly industry & their

profit function are:profit function are:

∏∏ 11 = 12 X= 12 X11 – X– X1122 – 2X– 2X22

22 – 10– 10

∏∏ 22 = 16 X= 16 X22 – 2X– 2X2222 – 4X– 4X11 – 2– 2

What will be firm’s profits & O/P if they set O/PWhat will be firm’s profits & O/P if they set O/P

level by collusion i.e. to maximize their jointlevel by collusion i.e. to maximize their joint

profits?profits?



ANSWERANSWER

XX11 = 4= 4

XX22 = 2= 2

∏∏11 = 14= 14 ∏∏22 = 6= 6

∏∏= 20= 20



NON COLLUSIVE OLIGOPOLYNON COLLUSIVE OLIGOPOLY



NON COLLUSIVE OLIGOPOLYNON COLLUSIVE OLIGOPOLY

Firms act independently & each firm is closelyFirms act independently & each firm is closely

watched by otherwatched by other

Price & O/P decisions are taken keeping in viewPrice & O/P decisions are taken keeping in view

the reaction of other firms in industrythe reaction of other firms in industry

3 models:3 models:

Sweezy kinked demand modelSweezy kinked demand model

Price leadershipPrice leadership

Prisoners’ dilemmaPrisoners’ dilemma



KINKED DEMAND CURVE MODELKINKED DEMAND CURVE MODEL

Proposed by Paul SweezyProposed by Paul Sweezy If an oligopolist raises price, other firms willIf an oligopolist raises price, other firms will

not follow, so demand will be elasticnot follow, so demand will be elastic

If an oligopolist lowers price, other firms willIf an oligopolist lowers price, other firms will

follow, so demand will be inelasticfollow, so demand will be inelastic Implication is that demand curve will beImplication is that demand curve will be

kinked, MR will have a discontinuity, andkinked, MR will have a discontinuity, and

oligopolists will not change price whenoligopolists will not change price when

marginal cost changesmarginal cost changes




Original price and quantityOriginal price and quantity

at point Aat point A

If reduce price &If reduce price &

competitors matchcompetitors match

price cut then moveprice cut then move

along more inelasticalong more inelastic

demand segmentdemand segment

If increase price &If increase price &

competitors do notcompetitors do not

follow then move alongfollow then move along

the more elasticthe more elastic

segmentsegment

It leads to kinked demandIt leads to kinked demand

curvecurve

Competitors do notmatch price increases

Competitors

match

price cuts




In order to maximizeIn order to maximizeprofits, apply MR=MCprofits, apply MR=MC

rule.rule.

The MR curve for the The MR curve for the

kinked demand curvekinked demand curveis discontinuous atis discontinuous at

the kink.the kink.

This leads the firm to This leads the firm to

charge the same pricecharge the same price

even if costs changeeven if costs change



CRITICISMCRITICISM

No evidence that price increase is not matchedNo evidence that price increase is not matched

Unable to tell the price at which the kink willUnable to tell the price at which the kink will

occuroccur



PRICE LEADERSHIPPRICE LEADERSHIP

Price LeaderPrice Leader

Largest, dominant, or lowest cost firmLargest, dominant, or lowest cost firm

in the industryin the industry

Demand curve is defined as theDemand curve is defined as the

market demand curve less supply bymarket demand curve less supply bythe followersthe followers

FollowersFollowers

Take market price as given and Take market price as given and

behave as perfect competitorsbehave as perfect competitors



PRICE LEADERSHIPPRICE LEADERSHIP

MC leader

MC f

Total Demand

Demand Leader MR leader

Q leader Q total

P leader

P

0 Quantity

Price



PRISONERS’ DILEMMAPRISONERS’ DILEMMA

Two suspects are arrested for armed robbery. They areimmediately separated. If convicted, they will get a term

of 10 years in prison. However, the evidence is not

sufficient to convict them of more than the crime of

possessing stolen goods, which carries a sentence of only 1 year.

The suspects are told the following: If you confess and

your accomplice does not, you will go free. If you do not

confess and your accomplice does, you will get 10years in prison. If you both confess, you will both get 5

years in prison.

What will each suspect do?What will each suspect do?




Confess Don't Confess

Confess (5, 5) (0, 10)Don't Confess (10, 0) (1, 1)

Individual B

Individual A

Payoff Matrix



Low Price High Price

Low Price (2, 2) (5, 1)High Price (1, 5) (3, 3)

Firm B

Firm A


Application: Price Competition



Low Price High Price

Low Price (2, 2) (5, 1)High Price (1, 5) (3, 3)

Firm B

Firm A


Application: Price Competition

Dominant Strategy: Low Price

(market power based on product differentiation and/or the firm’s dominance

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