Market Power and Oligopolies

Market Power and Oligopolies

MARKET POWER AND OLIGOPOLIES

Review of Slide 17 –Short run loss Minimization under a Monopoly

  1. MR crosses SMC at a point a point below ACV and ATC so we are losing money.
  2. We still produce because between points D, C, E marginal revenue is greater the marginal costs.
  3. We are trying to offset fixed costs. When all variable costs are covered we continue to produce because the marginal revenue offset sets the fixed costs.
  4. At point B the price is above demand so we stop at C.
  5. Again in the short run we continue to produce until the cost of an additional unit is greater than the revenue of an additional unit.

Slide 18

Long term Equilibrium

  1. Choose to produce the level of output where marginal revenue = long term marginal costs. (MR = LMC) unless the than price is less than long term average costs (P<LAC) in which case the firm exits the market.
  2. The key is to adjust plant size and mix of inputs to reduce costs per unit.

Monopolistic Competition

  1. Monopolistic Competition also has a degree of market power
  2. Firms with downward sloping demand curves make maximum profit when MR = MC.
  3. Monopolistic Competition has (a) a large number of relatively small firms, (b) products that are similar but somewhat different, and (c) unrestricted entry and exit
  4. The difference between pure competition is that the products are different. The difference can be a real difference or a perceived difference.
  5. The difference with a monopoly is ease of entry and exit from the market.

Slide 24, 25

Explanation of Slide 26

Short Term Equilibrium

  1. With given demand, marginal revenue and costs curves a monopolistic competitor maximizes profits OR minimizes losses when MR = MC.
  2. In our example, Profit is maximized at producing Q and selling at P.
  3. In the area between PABC we have economic profit.
  4. In the short run we produce Q and sell at P.
  5. We have market power between C and P.
  6. Short run in Monopolistic Competition is similar to Monopolies

STRATEGIC DECISION MAKING IN OLIGOPOLY MARKETS

Oligopoly

  1. Few firms in the market.
  2. So decisions made by one firm affect the MR and MC of the entire market
  3. My decision affects yours.
  4. Taco Bell again

Strategic Behavior

  1. Action taken/decisions made based on how your competition will respond to your decision.
  2. As a group you are price setters but individually you are price takers.
  3. So, every decision you make about pricing and output depends what your competitors do.

Pricing through Price Theory

  1. Reference Value
  2. Plus or minus differences
  3. That is the marking function.
  4. The economic function is game theory

PPT 2, 3, 4,5

Game Theory

1. You compete with your competitors trying to make the best decision knowing your outcome depends on their decisions.

2. Prisoners Dilemma (slide 6,7)

a) If Jane and Bill do NOT confess they each get 2 years in prison

b) If Jane and Bill DO confess they each get 6 years in prision

c) If Jane confesses and Bill does not then Jane gets 1 year in prison and Bill 12

d) If Bill confesses and Jane does not then Bill gets one year in prison and Jane 12.

3. These possible outcomes are called a “pay-off” table.

4. If all parties know the “pay-off” table it is called common knowledge.

5. If Bill confesses he will get 1 or 6 years depending on if Jane confesses AND if he does not confess he gets 2 or 12 years depending on what Jane does.

Dominant Strategy

1. An action that is the best result for you no matter what other game players do.

2. Bill confesses and Jane doesn’t he gets 1 year as opposed to 2 years if she doesn’t – a win

3. Bill confesses and Jane does and he gets 6 years instead of 12 if he did not confess.

4. No matter what Jane does Bill is better off by confessing so “confessing is THE DOMINANT strategy as opposed to not confessing.

5. However the dominant strategy for Jane is also confess!

6. If both confess they get 6 yeas each instead of 1 or 2 – bad.

7. This is called “Dominate Strategy Equilibrium” where each player has a dominant strategy and “play them”.

8. Odds are both play their dominant “hands” and serve 2 years each

Decisions with one Dominate Strategy

1. In Prisoner’s dilemma each person had a dominate strategy and they play them even if the result in less favorable than if they co-operated.

2. If one firm has a dominant strategy it will play it.

3. The other firms know this and will play there best strategy based on the dominant company.

4. Predict what your best reaction is to the dominate strategy.

Slide 11, 24, 25

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