oligopoly and monopolistic competition Why do competing firms sometimes fix prices Why do other competitors spend so much effort trying to convince consumers that their highly similar products are fundamentally different ID: 1027571
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2. The answer is has to do with incentives faced by firms in the two most common types of markets: oligopoly and monopolistic competition. Why do competing firms sometimes fix prices? Why do other competitors spend so much effort trying to convince consumers that their highly similar products are fundamentally different?Discussion Starter: Price-Fixing and Product Differentiation
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8. Understanding OligopolyFirms are interdependent when the outcome (profit) of each firm depends on the actions of the other firms in the market. An oligopoly consisting of only two firms is a duopoly. Each firm is known as a duopolist. Few producers offering differentiated products, with high barriers to enter the market
9. Game TheoryGame theory is the study of how firms behave in strategic situations.When setting price and quantity, oligopolies are constantly playing a “game” with their competitors….
10. Game TheoryLet’s play a game
11. The GameTake a sheet of paper (You will only need a ¼ so shareYou will write an “x” or “o” in the middle which will count as your voteYou will then fold the paper (2 times)Write your name on the outside of the paper
12. The GameSo why do this?The class will have the possibility of earning bonus points on the past quiz depending on how you vote
13. The Game# of “X” votesReward110 points26 points33 points4+NO ONE GETS pointsEntire class votes “O”Everyone gets 1 point
14. The GameTake a sheet of paper (You will only need a ¼ so shareYou will write an “x” or “o” in the middle which will count as your voteYou will then fold the paper (2 times)Write your name on the outside of the paper
15. The GameIt is best is oligopoly firms work together and don’t “cheat” but…. There is a large incentive to cheat (the firm could benefit more then their comptition)
16. Collusion and CompetitionOPEC, the organization of petroleum-exporting countries, meets regularly to discuss the cartel’s policies of cooperation. Firms engage in collusion when they cooperate to raise their joint profits. A cartel is a group of firms that agree to restrict output in order to increase prices and their joint profits.
17. Collusion and CompetitionWhen firms act in their own self-interest, ignoring the effects of their actions on each other’s profits, they engage in noncooperative behavior.This noncooperative behavior tends to reduce the efficacy and endurance of a cartel that seeks to restrict quantity or keep prices above marginal cost.
18. Collusion and CompetitionA contract among firms to keep prices high would be unenforceable in a court of law, and could be a one-way ticket to jail. Although illegal in the U.S., collusion is legal in some parts of the world.
19. In the absence of collusion, price competition among oligopolists can be intense, as with the price wars between airlines that led to $99 airfares from New York to Paris in 2018. Collusion and Competition
20. Lets preview some game theory with a short videoGame Theory
21. Game’s Oligopolists PlayGame theory is the study of behavior in situations of interdependence.A player’s reward in a game, such as an oligopolist’s profit, is that player’s payoff A payoff matrix shows how the payoff to each participant in a two-player game depends on the actions of both. Such a matrix helps us analyze situations of interdependence.
22. The Prisoners’ DilemmaThe profits of the two firms are interdependent: each firm’s profit depends not only on its own decision but also on the other’s decision. Each row represents an action by Firm 1; each column represents an action by Firm 2.
23. The Prisoners’ DilemmaThe prisoners’ dilemma is a game based on two premises:Each player has an incentive to choose an action that benefits themselves at the other player’s expense.When both players follow that incentive, both are worse off than if they had acted cooperatively. An action is a dominant strategy when it is a player’s best action regardless of the action taken by the other player.
24. The Prisoner’s Dilemma
25. The Prisoners’ DilemmaThe Nash equilibrium, or a noncooperative equilibrium, occurs when each player in a game chooses the action that maximizes their payoff given the other players’ actions. Nobel Laureate mathematician John Forbes Nash, Jr. proposed a key idea in game theory.
26. More Game theory Coke’s DecisionHigh ProductionHigh Production: 40 Gal.Coke gets $1,600 profitPepsi gets $1,600 profitCoke gets $1,500 profitPepsi gets $2,000 profitCoke gets $2,000 profitPepsi gets $1,500 profitCoke gets $1,800 profitPepsi gets $1,800 profitLow Production: 30 gal.LowProductionPepsi’sDecision40 gal.30 gal.
27. More Game theory Decision of the United States (U.S.)ArmArmU.S. at riskUSSR at riskU.S. at risk and weakUSSR safe and powerfulU.S. safe and powerfulUSSR at risk and weakU.S. safeUSSR safeDisarmDisarmDecision of the Soviet Union (USSR)
28. The Legal FrameworkAntitrust policy involves efforts by the government to prevent oligopolistic industries from becoming or behaving like monopolies. In a trust, shareholders of all the companies in one industry place shares in the hands of trustees who control the companies. This effectively merges the companies into one firm capable of monopoly pricing.
29. The Legal FrameworkCarnegie, Morgan, and Rockefeller established trusts in the steel, electricity, and oil markets, among others, in the late 19th and early 20th centuries. These were later broken up by antitrust policy.Among advanced countries, the United States is unique in its long tradition of antitrust policy.
30. Constraints on CollusionAlthough tacit collusion is common, four factors make it more difficult:1) Large numbers: the more firms in the industry, the harder it is to ensure cooperation among them all. 2) Complex products and pricing schemes: the more complex products and pricing, the harder to determine if a firm is cheating or cooperating.
31. Constraints on Collusion3) Differences in interests: firms can have different interests or face different costs, making a “fair” cooperative agreement hard to reach.4) Bargaining power of buyers: the more power buyers have, cheating becomes more likely as firms try to win buyers over with lower prices.
32. Price WarsWhen buyer bargaining power is high, competition among firms can lead to a price war, as periodically happens in the burger, airline, and grocery industries. A price war occurs when tacit collusion breaks down and aggressive price competition causes prices to collapse.Competition can be so fierce, prices can even fall below noncooperative levels.
33. How Important Is Oligopoly?Here, cars line up for gasoline after the U.S. government imposed price controls on the oligopolistic oil industry in in 1973. In many cases, the limitations on collusion keep prices close to those of perfect competition.Oligopoly is more common than perfect competition or monopoly.
34. Summary and ReviewAntitrust policy.1) What is government policy designed to prevent oligopolistic industries from becoming or behaving like monopolies called?Repeated interaction and tacit collusion.2) For oligopolistic firms that want to collude, what two things can help overcome the prisoners’ dilemma?strategic behavior3) A firm engages in _____ when it attempts to influence the future actions of other firms.
35. Summary and Review5) When firms limit production and raise prices in a way that raises each other’s profits, even though they have not made any formal agreement, they are engaged in _____.tit for tat4) A strategy of _____ involves playing cooperatively at first, then doing whatever the other player did in the previous period.tacit collusion
36. Summary and Review6) What four factors make tacit collusion difficult?Large numbers of firmsComplexity of products or pricing schemesDifferences in interestsBargaining power of buyers7) What is it called when tacit collusion breaks down and aggressive price competition causes prices to collapse?A price war.
37. Summary and Review8) What occurs when firms convince buyers that their products differ from products of other firms in the industry?Price differentiation.9) What is it called when one firm sets its price first, then other firms follow?Price leadership.10) What is it called when firms that have a tacit understanding not to compete on price using advertising and other means to try to increase sales? Nonprice competition.
38. Walkthrough: Free-Response Question 11 point: Factors that work against tacit collusion in the market for higher education include the large number of universities and the bargaining power of the better applicants.1. Like other firms, universities face temptations to collude in order to limit the effects of competition and avoid price wars. (In fact, the U.S. Department of Justice formally accused a group of universities of price-fixing in 1991.) Answer the following questions about behavior in the market for higher education. a. Describe one factor of the market for higher education that invites tacit collusion. b. Describe one factor of the market for higher education that works against tacit collusion. c. Explain one way in which universities could engage in illegal collusion. d. What are three ways in which universities engage in product differentiation? e. Explain how price leadership might work in the university setting. f. What forms of nonprice competition do you see universities engaged in? (6 points)1 point: The fact that universities offer a small number of products—a small number of programs with a small number of tuition levels—invites tacit collusion. They may also have similar perceptions of the tuition level that families can afford.1 point: Universities could engage in illegal collusion by holding meetings to establish uniform tuition rates, divvying up applicants so that each is accepted by a limited number of schools (to avoid competition), or sharing information on scholarship offerings so that applicants will receive similar offers from the competing schools.
39. Walkthrough: Free-Response Question 11 point: Universities seek product differentiation in regard to athletic programs, facilities, academic standards, location, overseas programs, faculty, graduation requirements, and class size, among other areas.1 point: Price leadership could be achieved in the university setting if one school, perhaps a large or prestigious university, announced its tuition early and then other schools based their tuition on that announcement.1 point: Universities can engage in nonprice competition by offering better food, bigger dorm rooms, more accomplished faculty members, plush student centers, and similar amenities.1. Like other firms, universities face temptations to collude in order to limit the effects of competition and avoid price wars. (In fact, the U.S. Department of Justice formally accused a group of universities of price-fixing in 1991.) Answer the following questions about behavior in the market for higher education. a. Describe one factor of the market for higher education that invites tacit collusion. b. Describe one factor of the market for higher education that works against tacit collusion. c. Explain one way in which universities could engage in illegal collusion. d. What are three ways in which universities engage in product differentiation? e. Explain how price leadership might work in the university setting. f. What forms of nonprice competition do you see universities engaged in? (6 points)
40. Summary and ReviewGame theory.1) What is the is the study of behavior in situations of interdependence called?Payoff.2) In game theory, what is player’s reward called?Payoff matrix.3) In game theory, what are the rows and columns that show each player’s payoffs, given their actions and the actions of other players?
41. Summary and ReviewWhen a player has a best action regardless of the actions of the other player.5) When does a player have a dominant strategy?4) What are the two premises of the game known as the prisoner’s dilemma?Each player has an incentive to choose an action that benefits themselves at the other player’s expense.When both players follow that incentive, both are worse off than if they had acted cooperatively.
42. Summary and ReviewThe Nash equilibrium occurs when each player chooses the action that maximizes their payoff given the other players’ actions.6) In game theory, what is the the Nash equilibrium (i.e., the noncooperative equilibrium)?
43. Walkthrough: Free-Response Question 11. Refer to the payoff matrix provided, which indicates the profits earned by two producers in various scenarios. You and your competitor must decide whether or not to market a new product. a. If you market the new product and your competitor does not, how much profit will you earn? b. If you market the new product, what should your competitor do? c. Do you have a dominant strategy? Explain. d. Does this situation have a Nash equilibrium? Explain. (6 points)1 point: $4001 point: Market the new product1 point: Yes, I have a dominant strategy.1 point: Profits are greater (either $100 or $400 versus $0) if I market the new product, regardless of what my competitor does.1 point: Yes, there is a Nash equilibrium.1 point: Both players marketing the product is a Nash equilibrium because neither side wants to change to not marketing, given what the other side is doing. (In fact, in this case both sides want to market the product regardless of what the other side is doing, so it is a dominant strategy equilibrium as well as a Nash equilibrium.)
44. Summary and ReviewWhen the outcome (profit) of each firm depends on the actions of the other firms in the market.1) When are firms considered to be interdependent?Duopoly.2) An oligopoly consisting of only two firms is known as a _____.Collusion.3) When firms cooperate to raise their joint profits, they engage in _____.
45. Summary and ReviewCartel.4) A group of firms that agree to restrict output in order to increase prices and their joint profits is called a _____.Noncooperative behavior.5) When firms act in their own self-interest, ignoring the effects of their actions on each other’s profits, they engage in _____.
46. Walkthrough: Free-Response Question 11. Refer to the table provided to answer the following questions. Assume that marginal cost is zero. a. If the market is perfectly competitive, what will the market equilibrium price and quantity be in the long run? Explain. b. If the market is a duopoly and the firms collude to maximize joint profits, what will market price and quantity be? Explain. c. If the market is a duopoly and the firms collude to maximize joint profits, what is each firm’s total revenue if the firms split the market equally? (7 points)1 point: If the market is perfectly competitive, price will be zero. 1 point: If the market is perfectly competitive, quantity will be 12.1 point: Price equals marginal cost in the long-run equilibrium of a perfectly competitive market, so price will be zero, at which price the quantity is 12.1 point: If the market is a duopoly, price will be $12.1 point: If the market is a duopoly, quantity will be 6.1 point: To maximize joint profits, the two firms act as a monopoly, setting marginal revenue equal to marginal cost and finding price on the demand curve above the profit-maximizing quantity. MR passes through zero (going from 2 to 22) after the 6th unit, making 6 the profit-maximizing quantity. The most consumers would pay for 6 units is $12, so that is the profit-maximizing price. 1 point: Total revenue is $12 × 6 = $72. By dividing this equally, each firm receives $36.