OLIGOPOLY

Market in which there are few firms, so individual firms

can affect market price.
Interdependence of firms is an important characteristic.
The demand curves for the individual firms are
dependent on the pricing and marketing decisions of
competitors.
Strategy becomes important to firms in oligopoly.

Oligopoly slide 1
Barriers to entry are an especially important part of
oligopoly behavior:

1) Xerox and patents

2) Aluminum and control of bauxite deposits
3) Breakfast cereals ,beer, and economies of scale in
advertising
4) Daily newspapers

Oligopoly slide 2
Of the many different models of oligopoly, we will
examine only two in class:

1) The collusion or cartel model.

2) Cooperation games based on the Prisoners'

Dilemma.

Oligopoly slide 3
 CARTELS

Cartels are usually illegal in the U.S. because of

antitrust laws, but some industries and kinds of
firms are exempt. In addition, some instances of
cartel-like behavior may simply not have been
prosecuted.

Cartel is a form of collusion in which the member

firms in an industry try to agree on all aspects of
pricing and output for the individual firms.

Oligopoly slide 4
 EXAMPLES OF CARTELS OR
COLLUSIVE BEHAVIOR
OPEC
DeBeers
Some professional sports, including the NCAA.
Labor unions (legal in the U.S.).
Agricultural cooperatives (legal in the U.S.).

Oligopoly slide 5
A cartel that wants to maximize the collective profits
of the members should operate just like a
monopolist with more than one plant.

Marginal cost (for each cartel member) must equal

marginal revenue in the market.

Oligopoly slide 6
 A coffee cartel would set price and quantity
at P* and Q*. Quotas would be ideally
allocated to the members by having them
produce at the same level of marginal cost.
$/Q
 MC

P* This is the sum

of the MC
curves of the
members.

D
Q
Q*
MR
COFFEE MARKET
Oligopoly slide 7
Cartels are not without their problems. The most
important problem is keeping members from
striking out on their own, that is, cheating on the
cartel agreement.

Examples:

Oligopoly slide 8
 Prisoners' Dilemma

A crime is committed, and two suspects are arrested.

The police separate the suspects, John and Alice,
into separate interrogation rooms.
The cops give John and Alice the following "deal":

Oligopoly slide 9
"If you both remain silent, we can only get you on
the lesser charge of trespassing, and you get 3
months in jail each."
"If you remain silent, and your partner confesses and
implicates you, you'll get 5 years in jail. Your
partner will go free."
"if you both confess, you'll each get 2 years in jail."

Oligopoly slide 10
 Here's a summary of the outcomes:

John
Confess Don't confess

2 years 5 years
Confess
2 years go free
Alice
go free 3 months
Don't confess
5 years 3 months

Oligopoly slide 11
The Dominant Strategy for both people is to confess.

But they both could be better off not confessing.

Cooperation (agreeing between themselves not to

confess) is very difficult because there is an
incentive for each to cheat.

Oligopoly slide 12
 Here's a real world pricing problem that can be
studied using the Prisoners' Dilemma.

P&G and Unilever are pricing a uniform product

(like bleach).

The "payoff matrix" is given on the next slide.

What should P&G's pricing policy be?

Oligopoly slide 13
 The payoffs are dollars of profit per month. Unilever's
payoffs are at the top right of each cell.

Unilever
P=$1.40 P=$1.50

12,000 11,000
P=$1.40
12,000 29,000
P&G
21,000 20,000
P=$1.50
3,000 20,000

Oligopoly slide 14
Note that cooperation leads to the most profits, but
the dominant strategy may well be chosen.

Should P&G just charge $1.50 and hope for the best?

What if they are entering a new market with these

payoffs?

Oligopoly slide 15