Chapter 13 Oligopoly Firms in Less Competitive Markets

Chapter 13 Oligopoly: Firms in Less Competitive Markets Prepared by: Fernando & Yvonn Quijano © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION.

Competing with Wal-Mart Learning Objectives 13. 1 Show barriers to entry explain the existence of oligopolies. 13. 2 Use game theory to analyze the strategies of oligopolistic firms. 13. 3 Use sequential games to analyze business strategies. 13. 4 Use the five competitive forces model to analyze competition in an industry. In an oligopoly, a firm’s profitability depends on its interactions with other firms. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 2 of 29

Chapter 13: Oligopoly: Firms in Less Competitive Markets Oligopoly A market structure in which a small number of interdependent firms compete. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 3 of 29

Learning Objective 13. 1 Chapter 13: Oligopoly: Firms in Less Competitive Markets Oligopoly and Barriers to Entry Table 13 -1 Examples of Oligopolies in Retail Trade and Manufacturing RETAIL TRADE INDUSTRY MANUFACTURING FOUR-FIRM CONCENTRATION RATIO INDUSTRY FOUR-FIRM CONCENTRATION RATIO Discount Department Stores 95% Cigarettes 95% Warehouse Clubs and Supercenters 92% Beer 91% Hobby, Toy, and Game Stores 72% Aircraft 81% Athletic Footwear Stores 71% Breakfast Cereal 78% College Bookstores 70% Automobiles 76% Radio, Television, and Other Electronic Stores 69% Computers 76% Pharmacies and Drugstores 53% Dog and Cat Food 64% © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 4 of 29

Learning Objective 13. 1 Chapter 13: Oligopoly: Firms in Less Competitive Markets Oligopoly and Barriers to Entry Barrier to entry Anything that keeps new firms from entering an industry in which firms are earning economic profits. Economies of Scale Economies of scale The situation when a firm’s long-run average costs fall as it increases output. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 5 of 29

Learning Objective 13. 1 Chapter 13: Oligopoly: Firms in Less Competitive Markets Oligopoly and Barriers to Entry Economies of Scale FIGURE 13 -1 Economies of Scale Help Determine the Extent of Competition in an Industry © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 6 of 29

Learning Objective 13. 1 Chapter 13: Oligopoly: Firms in Less Competitive Markets Oligopoly and Barriers to Entry Ownership of a Key Input If production of a good requires a particular input, then control of that input can be a barrier to entry. Government-Imposed Barriers Patent The exclusive right to a product for a period of 20 years from the date the product is invented. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 7 of 29

Learning Objective 13. 2 Chapter 13: Oligopoly: Firms in Less Competitive Markets Using Game Theory to Analyze Oligopoly Game theory The study of how people make decisions in situations in which attaining their goals depends on their interactions with others; in economics, the study of the decisions of firms in industries where the profits of each firm depend on its interactions with other firms. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 8 of 29

Learning Objective 13. 2 Chapter 13: Oligopoly: Firms in Less Competitive Markets Using Game Theory to Analyze Oligopoly All games share three key characteristics: 1 Rules that determine what actions are allowable 2 Strategies that players employ to attain their objectives in the game 3 Payoffs that are the results of the interaction among the players’ strategies Business strategy Actions taken by a firm to achieve a goal, such as maximizing profits. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 9 of 29

Learning Objective 13. 2 Chapter 13: Oligopoly: Firms in Less Competitive Markets Using Game Theory to Analyze Oligopoly A Duopoly Game: Price Competition between Two Firms FIGURE 13 -2 A Duopoly Game © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 10 of 29

Learning Objective 13. 2 Chapter 13: Oligopoly: Firms in Less Competitive Markets Using Game Theory to Analyze Oligopoly A Duopoly Game: Price Competition between Two Firms Payoff matrix A table that shows the payoffs that each firm earns from every combination of strategies by the firms. Collusion An agreement among firms to charge the same price or otherwise not to compete. Dominant strategy A strategy that is the best for a firm, no matter what strategies other firms use. Nash equilibrium A situation in which each firm chooses the best strategy, given the strategies chosen by other firms. Don’t Let This Happen to YOU! Don’t Misunderstand Why Each Manager Ends Up Charging a Price of $400 © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 11 of 29

Learning Objective 13. 2 Making Chapter 13: Oligopoly: Firms in Less Competitive Markets the Connection A Beautiful Mind: Game Theory Goes to the Movies In the film A Beautiful Mind, Russell Crowe played John Nash, winner of the Nobel Prize in Economics. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 12 of 29

Learning Objective 13. 2 Chapter 13: Oligopoly: Firms in Less Competitive Markets Using Game Theory to Analyze Oligopoly Firm Behavior and the Prisoners’ Dilemma Cooperative equilibrium An equilibrium in a game in which players cooperate to increase their mutual payoff. Noncooperative equilibrium An equilibrium in a game in which players do not cooperate but pursue their own self-interest. Prisoners’ dilemma A game in which pursuing dominant strategies results in noncooperation that leaves everyone worse off. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 13 of 29

Learning Objective 13. 2 Solved Problem 13 -2 Chapter 13: Oligopoly: Firms in Less Competitive Markets Is Advertising a Prisoners’ Dilemma for Coca-Cola and Pepsi? © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 14 of 29

Learning Objective 13. 2 Making Chapter 13: Oligopoly: Firms in Less Competitive Markets the Connection Is There a Dominant Strategy for Bidding on e. Bay? On e. Bay, bidding the maximum value you place on an item is a dominant strategy. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 15 of 29

Learning Objective 13. 2 Chapter 13: Oligopoly: Firms in Less Competitive Markets Using Game Theory to Analyze Oligopoly Can Firms Escape the Prisoners’ Dilemma? FIGURE 13 -3 Changing the Payoff Matrix in a Repeated Game © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 16 of 29

Learning Objective 13. 2 Chapter 13: Oligopoly: Firms in Less Competitive Markets Using Game Theory to Analyze Oligopoly Can Firms Escape the Prisoners’ Dilemma? Price leadership A form of implicit collusion where one firm in an oligopoly announces a price change, which is matched by the other firms in the industry. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 17 of 29

Learning Objective 13. 2 Making American Airlines and Northwest Airlines Fail to Cooperate on a Connection Price Increase Chapter 13: Oligopoly: Firms in Less Competitive Markets the The airlines have trouble raising the price this business traveler pays for a ticket. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 18 of 29

Learning Objective 13. 2 Chapter 13: Oligopoly: Firms in Less Competitive Markets Using Game Theory to Analyze Oligopoly Cartels: The Case of OPEC Cartel A group of firms that collude by agreeing to restrict output to increase prices and profits. FIGURE 13 -4 Oil Prices, 1972–to mid 2008 © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 19 of 29

Learning Objective 13. 2 Chapter 13: Oligopoly: Firms in Less Competitive Markets Using Game Theory to Analyze Oligopoly Cartels: The Case of OPEC FIGURE 13 -5 The OPEC Cartel with Unequal Members © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 20 of 29

Learning Objective 13. 3 Chapter 13: Oligopoly: Firms in Less Competitive Markets Sequential Games and Business Strategy Deterring Entry FIGURE 13 -6 The Decision Tree for an Entry Game © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 21 of 29

Learning Objective 13. 3 Solved Problem 13 -3 Chapter 13: Oligopoly: Firms in Less Competitive Markets Is Deterring Entry Always a Good Idea? © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 22 of 29

Learning Objective 13. 3 Chapter 13: Oligopoly: Firms in Less Competitive Markets Sequential Games and Business Strategy Bargaining FIGURE 13 -7 The Decision Tree for a Bargaining Game © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 23 of 29

Learning Objective 13. 4 Chapter 13: Oligopoly: Firms in Less Competitive Markets The Five Competitive Forces Model FIGURE 13 -8 The Five Competitive Forces Model © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 24 of 29

Learning Objective 13. 4 Chapter 13: Oligopoly: Firms in Less Competitive Markets The Five Competitive Forces Model Competition from Existing Firms Competition among firms in an industry can lower prices and profits. Competition in the form of advertising, better customer service, or longer warranties can also reduce profits by raising costs. The Threat from Potential Entrants Firms face competition from companies that currently are not in the market but might enter. We have already seen how actions taken to deter entry can reduce profits. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 25 of 29

Learning Objective 13. 4 Chapter 13: Oligopoly: Firms in Less Competitive Markets The Five Competitive Forces Model Competition from Substitute Goods or Services Firms are always vulnerable to competitors introducing a new product that fills a consumer need better than their current product does. The Bargaining Power of Buyers If buyers have enough bargaining power, they can insist on lower prices, higher-quality products, or additional services. The Bargaining Power of Suppliers If many firms can supply an input and the input is not specialized, the suppliers are unlikely to have the bargaining power to limit a firm’s profits. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 26 of 29

Learning Objective 13. 4 Making Is Southwest’s Business Strategy More Important Than the Structure Connection of the Airline Industry? Chapter 13: Oligopoly: Firms in Less Competitive Markets the Southwest’s business strategy allowed it to remain profitable when many other airlines faced heavy losses. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 27 of 29

Chapter 13: Oligopoly: Firms in Less Competitive Markets An Inside LOOK Can Target Compete with Wal-Mart in the Market for Generic Drugs? Target Says It Will Match Wal-Mart’s $4 Generic Drug Price © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 28 of 29

Chapter 13: Oligopoly: Firms in Less Competitive Markets Key Terms Barrier to entry Business strategy Cartel Collusion Cooperative equilibrium Dominant strategy Economies of scale Game theory Nash equilibrium Noncooperative equilibrium Oligopoly Patent Payoff matrix Price leadership Prisoners’ dilemma © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 29 of 29