Principles of Microeconomics: Powerpoint Presentations For

PowerPoint Presentations for
Principles of Microeconomics
Seventh Canadian Edition
by Mankiw/Kneebone/McKenzie
Adapted for the

Seventh Canadian Edition by
Marc Prud’homme
University of Ottawa
OLIGOPOLY
Chapter 17
Copyright © 2017 by Nelson Education Ltd. 17-2

OLIGOPOLY
 The essence of an oligopolistic market is that there are

only a few sellers.
 As a result, the actions of any one seller in the market
can have a large impact on the profits of all the
other sellers.
 Our goal in this chapter is to see how this interdependence shapes
firms’ behaviour and what problems it raises for public policy.

MARKETS WITH ONLY A FEW SELLERS
 Because an oligopolistic market has only a small group of

sellers, a key feature of oligopoly is the tension between
cooperation and self-interest.

A DUOPOLY EXAMPLE
 To understand the behaviour of

oligopolies, let’s consider an
oligopoly with only two members,
called a duopoly.
Dzm1try/Shutterstock
A DUOPOLY EXAMPLE (CONTINUED)
 Imagine a town where two residents (Jack and Jill) own wells
that produce safe water.
 Each Saturday, Jack and Jill decide how many litres of water
to pump, bring the water to town, and sell it for whatever price
the market will bear.
 Suppose that MC = 0.

TABLE 17.1
The Demand Schedule for Water

Active Learning
Collusion and Self-Interest
Duopoly outcome with collusion:
P Q
Each firm agrees to produce Q = 30,
$0 140 earns profit = $900.
5 130
10 120
If Telus reneges on the agreement and produces Q =
15 110
40, what happens to the market price? Telus’s
20 100 profits?
25 90 Is it in Telus’s interest to renege on the agreement?
30 80
If both firms renege and produce Q = 40, determine
35 70
each firm’s profits.
40 60
45 50
Active Learning
Answers
If both firms stick to the agreement,
P Q each firm’s profit = $900
$0 140 If Telus reneges on the agreement and
5 130 produces Q = 40:
10 120 Market quantity = 70, P = $35
15 110 Telus’s profit = 40 × ($35 – 10) = $1000
20 100
Telus’s profits are higher if it reneges.
25 90
30 80 Rogers will conclude the same, so
35 70 both firms renege, each produces Q = 40:
40 60 Market quantity = 80, P = $30
45 50 Each firm’s profit = 40 × ($30 – 10) = $800
COMPETITION, MONOPOLIES, AND CARTELS
 If the market for water were perfectly competitive, the

production decisions of each firm drive price equal to marginal
cost.
 Thus, under competition, the equilibrium price of water would
be zero, and the equilibrium quantity would be 120 L.

(CONTINUED)
 For a monopoly, total profit is maximized at a quantity of 60 L
and a price of $60 per litre.
 This result is inefficient because the quantity of water produced
and consumed is below the socially efficient level of 120 L.

(CONTINUED)
 What outcome should we expect from our duopolists?

 Collusion: An agreement among firms in a market about
quantities to produce or prices to charge.
 Cartel: A group of firms acting in unison.

(CONTINUED)
 If Jack and Jill were to collude, they would agree on the
monopoly outcome.
 Our two producers would produce a total of 60 L (30 L each),
which would be sold at a price of $60 per litre and the profit =
$1800.
 But P > MC (i.e., the outcome is socially inefficient).

THE EQUILIBRIUM FOR AN OLIGOPOLY
 Let’s consider what happens if Jack and Jill decide separately how
much water to produce.
 Is the monopoly outcome likely?
 Jack: Jack expects Jill to produce 30 L so that if he produces 30 L
as well, then a total of 60 L of water
would be sold at a price of $60 per litre.
 His profit would be $1800 (30 L × $60 per litre).
THE EQUILIBRIUM FOR AN OLIGOPOLY (CONTINUED)
 Jack could also produce 40 L.

 In this case, a total of 70 L of water would be sold at a price of
$50 per litre (Table 17.1).
 His profit would now be $2000 (40 L × $50 per litre).
 Total market profit has fallen, but Jack’s profit is now higher
because of his larger market share.

 If Jill applies the same logic as Jack, then they would each
produce 40 L.
 Total sales would be 80 L, but the price would fall to $40.
 The price is lower than the monopoly price.
 Total profit is less than the monopoly profit
($1600 vs. $1800).

 Although the logic of self-interest increases the duopoly’s

output above the monopoly level, it
does not push the duopolists to reach the competitive allocation.

 Suppose now that Jill increases her production to 50 L.

 A total of 90 L of water would be sold, and the price would be $30
per litre.
 Her profit is now $1500.
 She is better off keeping production at 40 L.

 The outcome in which Jack and Jill each produce 40 L is an

equilibrium of sorts.
 Nash equilibrium: A situation in which economic actors
interacting with one another each choose their best strategy
given the strategies that all the other actors have chosen.

 When firms in an oligopoly individually choose production to

maximize profit, they produce a quantity of output …
 … greater than the level produced by monopoly
 … less than the level produced by competition

 The oligopoly price is …

 … less than the monopoly price
 … greater than the competitive price

HOW THE SIZE OF AN OLIGOPOLY
AFFECTS THE MARKET OUTCOME
 We can use the insights from this analysis of duopoly to
discuss how the size of an oligopoly is likely to affect the
outcome in a market.
 Using data from Table 17.1, if the oligopolists do not form a
cartel, they must each decide on their own how much water to
produce.

AFFECTS THE MARKET OUTCOME (CONTINUED)
 In making this decision, the producer weighs
two effects:
1. The output effect: Because price is above marginal cost,
selling 1 more litre of water at the going price will raise profit.
2. The price effect: Raising production will increase the total
amount sold, which will lower the price of water and lower the
profit on all the other litres sold.

 If the output effect is larger than the price effect, the well owner
will increase production.
 If the price effect is larger than the output effect, the owner will
not raise production.
 Each oligopolist continues to increase production until these two
marginal effects exactly balance, taking the other firms’
production as given.
 The larger the number of sellers, the less concerned each seller
is about its own impact on the market price.
 As the number of sellers in an oligopoly grows larger, an
oligopolistic market starts to look like a competitive market
(i.e., the price approaches marginal cost, and the quantity
produced approaches the socially efficient level).

QuickQuiz
Quick
Quiz
 If the members of an oligopoly could agree on a total

quantity to produce, what quantity would they choose?
 If the oligopolists do not act together but instead make
production decisions individually, do they produce a
total quantity more or less than in your answer to the
previous question?
 Why?

THE ECONOMICS OF COOPERATION
 As we have seen, oligopolies would like to reach the

monopoly outcome, but doing so requires cooperation, which
at times is difficult to maintain.
 To analyze the economics of cooperation, we need to learn a
little about game theory.

 Prisoners’ dilemma: A particular "“game” between two

captured prisoners that illustrates why cooperation is difficult
to maintain even when it is mutually beneficial.

THE PRISONERS’ DILEMMA
 The prisoners’ dilemma is

a story about two criminals
(Bonnie and Clyde) who have been
captured by
the police.
dedMazay/Shutterstock
THE PRISONERS’ DILEMMA (CONTINUED)
 They are separately interrogated and offered the following deal:
 Both stay silent: They each get one year.
 One confesses but implicates the partner: The first person goes
free, but the partner gets 20 years.
 Both confess: They each get eight years.
 If Bonnie and Clyde only care about their own sentence, what would
you expect them to do?
 Stay silent or confess?

FIGURE 17.1
The Prisoners’ Dilemma

 Dominant strategy: A strategy that is best for a player in a

game regardless of the strategies chosen by the other players.
 Bonnie spends less time in jail if she confesses, regardless of
whether Clyde confesses or remains silent.
 Confessing is the dominant strategy for Bonnie.

 In the end, both Bonnie and Clyde confess, and both spend eight
years in jail.
 This is a terrible outcome, since if they had both remained silent
both would have been better off, spending only one year in jail.

 By each pursuing his or her own interests, the two prisoners together
reach an outcome that is worse for each of them.
 Cooperation between the two prisoners is difficult to maintain
because cooperation is individually irrational.

OLIGOPOLIES AS A PRISONERS’ DILEMMA
 The game oligopolists play in trying to reach the monopoly

outcome is similar to the game that the two prisoners play in
the prisoners’ dilemma.
 Figure 17.2 shows how the profits of the two producers of
clean water (Jack and Jill) depend on the strategies they choose.

FIGURE 17.2
Jack and Jill’s Oligopoly Game

OLIGOPOLIES AS A PRISONERS’ DILEMMA
(CONTINUED)
 This example illustrates why oligopolies have trouble

maintaining monopoly profits.
 The monopoly outcome is jointly rational for the oligopoly,
but each oligopolist has an incentive to cheat.

OTHER EXAMPLES OF THE PRISONERS’ DILEMMA
 Two examples in which self-interest prevents cooperation and

leads to an inferior outcome for the parties involved:
1. Advertising
2. Common resources

FIGURE 17.3
An Advertising Game

FIGURE 17.4
A Common-Resources Game

THE PRISONERS’ DILEMMA
AND THE WELFARE OF SOCIETY
 Is lack of cooperation a problem from the standpoint of society as a
whole?
 In some cases, the noncooperative equilibrium is bad for society as
well as the players.
 The extra wells dug by Shell and Esso are pure waste.
 In the case of oligopolists trying to maintain monopoly profits, lack
of cooperation is desirable from the standpoint of society as a
whole.
WHY PEOPLE SOMETIMES COOPERATE
 Cartels sometimes do manage to maintain collusive arrangements,

despite the incentive for individual
members to defect.
 Very often, the reason that players can solve the prisoners’ dilemma
is that they play the game not once but many times.

QuickQuiz
Quick
Quiz
 Tell the story of the prisoners’ dilemma. Prepare a table

showing the prisoners’ choices and explain what
outcome is likely.
 What does the prisoners’ dilemma teach us about
oligopolies?

PUBLIC POLICY TOWARD OLIGOPOLIES
 One of the ten principles of economics in Chapter 1 is that

governments can sometimes improve market outcomes.
 To move the allocation of resources closer to the social
optimum, policymakers should try to induce firms in an
oligopoly to compete rather than cooperate.

RESTRAINT OF TRADE AND THE COMPETITION
ACT
 Canadian judges have refused to enforce agreements that restrain
trade among competitors (reducing quantities and raising prices,
or price-fixing) as being against the public interest.
 Canada’s Competition Act codifies and reinforces this policy.
 See Section 45(1) of the act.

RESTRAINT OF TRADE AND THE COMPETITION
ACT (CONTINUED)
 Other activities that are subject to criminal prosecution
include:
 Bid-rigging
 Price discrimination
 Resale price maintenance
 Predatory pricing

CONTROVERSIES OVER COMPETITION POLICY
 Over time, much controversy has centred on the question of what
kinds of behaviour the competition laws should prohibit.
 The competition laws have been used to condemn some business
practices whose effects are not obvious.
 Here we consider three examples:
 Resale price maintenance
 Predatory pricing
 Tying
QuickQuiz
Quick
Quiz
 What kind of agreement is illegal for businesses to

make?
 Why are the competition laws controversial?

Classroom Activity
Market Structure Article
1. Find an article in a recent newspaper or magazine
that illustrates a market structure other than
perfect competition.
2. Is it an example of monopoly, monopolistic
competition, or oligopoly?
3. Do you think the firms in the industry are earning
an economic profit? Are new firms likely to enter
this market?
Classroom Activity
Market Structure Article (continued)
4. Use the analysis developed in class and the text to
explain the situation. Use economic reasoning and
show your analysis using a graph or other model,
as appropriate.
5. Turn in a copy of the article along with your
explanation.

THE END
Chapter 17

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Adapted for the

Copyright © 2017 by Nelson Education Ltd. 17-2

 The essence of an oligopolistic market is that there are

Copyright © 2017 by Nelson Education Ltd. 17-3

 Because an oligopolistic market has only a small group of

Copyright © 2017 by Nelson Education Ltd. 17-4

 To understand the behaviour of

Copyright © 2017 by Nelson Education Ltd. 17-6

Copyright © 2017 by Nelson Education Ltd. 17-7

 If the market for water were perfectly competitive, the

Copyright © 2017 by Nelson Education Ltd. 17-10

Copyright © 2017 by Nelson Education Ltd. 17-11

 What outcome should we expect from our duopolists?

Copyright © 2017 by Nelson Education Ltd. 17-12

Copyright © 2017 by Nelson Education Ltd. 17-13

 Jack could also produce 40 L.

Copyright © 2017 by Nelson Education Ltd. 17-15

Copyright © 2017 by Nelson Education Ltd. 17-16

 Although the logic of self-interest increases the duopoly’s

Copyright © 2017 by Nelson Education Ltd. 17-17

 Suppose now that Jill increases her production to 50 L.

Copyright © 2017 by Nelson Education Ltd. 17-18

 The outcome in which Jack and Jill each produce 40 L is an

Copyright © 2017 by Nelson Education Ltd. 17-19

 When firms in an oligopoly individually choose production to

Copyright © 2017 by Nelson Education Ltd. 17-20

 The oligopoly price is …

Copyright © 2017 by Nelson Education Ltd. 17-21

Copyright © 2017 by Nelson Education Ltd. 17-22

Copyright © 2017 by Nelson Education Ltd. 17-23

Copyright © 2017 by Nelson Education Ltd. 17-25

 If the members of an oligopoly could agree on a total

Copyright © 2017 by Nelson Education Ltd. 17-26

 As we have seen, oligopolies would like to reach the

Copyright © 2017 by Nelson Education Ltd. 17-27

 Prisoners’ dilemma: A particular "“game” between two

Copyright © 2017 by Nelson Education Ltd. 17-28

 The prisoners’ dilemma is

Copyright © 2017 by Nelson Education Ltd. 17-30

Copyright © 2017 by Nelson Education Ltd. 17-31

 Dominant strategy: A strategy that is best for a player in a

Copyright © 2017 by Nelson Education Ltd. 17-32

Copyright © 2017 by Nelson Education Ltd. 17-33

Copyright © 2017 by Nelson Education Ltd. 17-34

 The game oligopolists play in trying to reach the monopoly

Copyright © 2017 by Nelson Education Ltd. 17-35

Copyright © 2017 by Nelson Education Ltd. 17-36

 This example illustrates why oligopolies have trouble

Copyright © 2017 by Nelson Education Ltd. 17-37

 Two examples in which self-interest prevents cooperation and

Copyright © 2017 by Nelson Education Ltd. 17-38

Copyright © 2017 by Nelson Education Ltd. 17-39

Copyright © 2017 by Nelson Education Ltd. 17-40

 Cartels sometimes do manage to maintain collusive arrangements,

Copyright © 2017 by Nelson Education Ltd. 17-42

 Tell the story of the prisoners’ dilemma. Prepare a table

Copyright © 2017 by Nelson Education Ltd. 17-43

 One of the ten principles of economics in Chapter 1 is that

Copyright © 2017 by Nelson Education Ltd. 17-44

Copyright © 2017 by Nelson Education Ltd. 17-45

Copyright © 2017 by Nelson Education Ltd. 17-46

 What kind of agreement is illegal for businesses to