Monopolistic Competition and Oligopoly

1. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair


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Prepared by: Fernando Quijano Prepared by: Fernando Quijano
and Yvonn Quijanoand Yvonn Quijano
Monopolistic Competition and Monopolistic Competition and
OligopolyOligopoly

2. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Monopolistic CompetitionMonopolistic Competition
•A A monopolistically competitive monopolistically competitive
industryindustry has the following has the following
characteristics:characteristics:
•A large number of firmsA large number of firms
•No barriers to entryNo barriers to entry
•Product differentiationProduct differentiation

3. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Monopolistic CompetitionMonopolistic Competition
•Monopolistic competitionMonopolistic competition is a common is a common
form of industry (market) structure in the form of industry (market) structure in the
United States, characterized by a large United States, characterized by a large
number of firms, none of which can influence number of firms, none of which can influence
market price by virtue of size alone.market price by virtue of size alone.
•Some degree of market power is achieved Some degree of market power is achieved
by firms producing differentiated products.by firms producing differentiated products.
•New firms can enter and established firms New firms can enter and established firms
can exit such an industry with ease.can exit such an industry with ease.

4. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Nine Industries with Characteristics of Nine Industries with Characteristics of
Monopolistic CompetitionMonopolistic Competition
Percentage of Value of Shipments Accounted for by the Largest Firms in Percentage of Value of Shipments Accounted for by the Largest Firms in
Selected Industries, 1992Selected Industries, 1992
SIC NO.SIC NO.
INDUSTRYINDUSTRY
DESIGNATIONDESIGNATION
FOURFOUR
LARGESTLARGEST
FIRMSFIRMS
EIGHTEIGHT
LARGESTLARGEST
FIRMSFIRMS
TWENTYTWENTY
LARGESTLARGEST
FIRMSFIRMS
NUMBERNUMBER
OFOF
FIRMSFIRMS
37923792 Travel trailers and campersTravel trailers and campers 4141 5757 7272 270270
39423942 DollsDolls 3434 4747 6767 204204
25212521 Wood office furnitureWood office furniture 2626 3434 5151 611611
27312731 Book publishingBook publishing 2323 3838 6262 25042504
23912391 Curtains and draperiesCurtains and draperies 2222 3232 4848 10041004
20922092 Fresh or frozen seafoodFresh or frozen seafood 1919 2828 4747 600600
35643564 Blowers and fansBlowers and fans 1414 2222 4141 518518
23352335 Women’s dressesWomen’s dresses 1111 1717 3030 39433943
30893089 Miscellaneous plastic productsMiscellaneous plastic products 55 88 1313 76057605
Source:Source: U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Concentration Ratios in Manufacturing, Subject Series Subject Series
MC92-S-2, 1997.MC92-S-2, 1997.

5. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Product Differentiation, Advertising, Product Differentiation, Advertising,
and Social Welfareand Social Welfare
Total Advertising Expenditures in 1998Total Advertising Expenditures in 1998
DOLLARSDOLLARS
(BILLIONS)(BILLIONS)
NewspapersNewspapers 44.244.2
TelevisionTelevision 48.048.0
Direct mailDirect mail 39.539.5
OtherOther 31.731.7
Yellow pagesYellow pages 12.012.0
RadioRadio 14.514.5
MagazinesMagazines 10.410.4
TotalTotal 200.3200.3
Source:Source: McCann Erickson, Inc., Reported in U.S. Bureau of the Census, McCann Erickson, Inc., Reported in U.S. Bureau of the Census, Statistical Abstract of the United Statistical Abstract of the United
StatesStates, 1999, Table 947., 1999, Table 947.

6. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Case for Product Differentiation The Case for Product Differentiation
and Advertisingand Advertising
•The advocates of free and open The advocates of free and open
competition believe that differentiated competition believe that differentiated
products and advertising give the products and advertising give the
market system its vitality and are the market system its vitality and are the
basis of its power.basis of its power.
•Product differentiation helps to ensure Product differentiation helps to ensure
high quality and efficient production.high quality and efficient production.

7. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Case for Product Differentiation The Case for Product Differentiation
and Advertisingand Advertising
•Advertising provides consumers with Advertising provides consumers with
the valuable information on product the valuable information on product
availability, quality, and price that availability, quality, and price that
they need to make efficient choices they need to make efficient choices
in the market place.in the market place.

8. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Case Against Product The Case Against Product
Differentiation and AdvertisingDifferentiation and Advertising
•Critics of product differentiation and Critics of product differentiation and
advertising argue that they amount to advertising argue that they amount to
nothing more than waste and nothing more than waste and
inefficiency.inefficiency.
•Enormous sums are spent to create Enormous sums are spent to create
minute, meaningless, and possibly minute, meaningless, and possibly
nonexistent differences among nonexistent differences among
products.products.

9. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Case Against Product The Case Against Product
Differentiation and AdvertisingDifferentiation and Advertising
•Advertising raises the cost of products Advertising raises the cost of products
and frequently contains very little and frequently contains very little
information. Often, it is merely an information. Often, it is merely an
annoyance.annoyance.
•People exist to satisfy the needs of the People exist to satisfy the needs of the
economy, not vice versa.economy, not vice versa.
•Advertising can lead to unproductive Advertising can lead to unproductive
warfare and may serve as a barrier to warfare and may serve as a barrier to
entry, thus reducing real competition.entry, thus reducing real competition.

10. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Product Differentiation Reduces the Product Differentiation Reduces the
Elasticity of Demand Facing a FirmElasticity of Demand Facing a Firm
•Based on the availability of Based on the availability of
substitutes, the demand substitutes, the demand
curve faced by a curve faced by a
monopolistic competitor is monopolistic competitor is
likely to be likely to be less elasticless elastic
than the demand curve than the demand curve
faced by a perfectly faced by a perfectly
competitive firm, and likely competitive firm, and likely
to be to be more elasticmore elastic than the than the
demand curve faced by a demand curve faced by a
monopoly.monopoly.

11. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Monopolistic Competition in the Short RunMonopolistic Competition in the Short Run
•In the short-run, a monopolistically competitive In the short-run, a monopolistically competitive
firm will produce up to the point where firm will produce up to the point where MR = MCMR = MC. .
•This firm is This firm is
earning positive earning positive
profits in the profits in the
short-run.short-run.

12. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Monopolistic Competition in the Short-RunMonopolistic Competition in the Short-Run
•Profits are not guaranteed. Here, a firm with a Profits are not guaranteed. Here, a firm with a
similar cost structure is shown facing a weaker similar cost structure is shown facing a weaker
demand and suffering short-run losses.demand and suffering short-run losses.

13. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Monopolistic Competition in the Long-RunMonopolistic Competition in the Long-Run
•The firm’s demand The firm’s demand
curve must end up curve must end up
tangent to its average tangent to its average
total cost curve for total cost curve for
profits to equal zero. profits to equal zero.
This is the condition for This is the condition for
long-run equilibrium in long-run equilibrium in
a monopolistically a monopolistically
competitive industry.competitive industry.

14. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Economic EfficiencyEconomic Efficiency
and Resource Allocationand Resource Allocation
•In the long-run, economic profits are eliminated; thus, we In the long-run, economic profits are eliminated; thus, we
might conclude that monopolistic competition is efficient, might conclude that monopolistic competition is efficient,
however:however:
•Price is above marginal Price is above marginal
cost.cost. More output could More output could
be produced at a be produced at a
resource cost below the resource cost below the
value that consumers value that consumers
place on the product.place on the product.

15. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Economic EfficiencyEconomic Efficiency
and Resource Allocationand Resource Allocation
•In the long-run, economic profits are eliminated; thus, we In the long-run, economic profits are eliminated; thus, we
might conclude that monopolistic competition is efficient, might conclude that monopolistic competition is efficient,
however:however:
•Average total cost is not Average total cost is not
minimized.minimized. The typical The typical
firm will not realize all the firm will not realize all the
economies of scale economies of scale
available. Smaller and available. Smaller and
smaller market share smaller market share
results in excess capacity.results in excess capacity.

16. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
OligopolyOligopoly
•An An oligopolyoligopoly is a form of industry is a form of industry
(market) structure characterized by a (market) structure characterized by a
few dominant firms. Products may few dominant firms. Products may
be homogeneous or differentiated.be homogeneous or differentiated.
•The behavior of any one firm in an The behavior of any one firm in an
oligopoly depends to a great extent oligopoly depends to a great extent
on the behavior of others.on the behavior of others.

17. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Ten Highly Concentrated IndustriesTen Highly Concentrated Industries
Percentage of Value of Shipments Accounted for by the Largest Firms in High-Percentage of Value of Shipments Accounted for by the Largest Firms in High-
Concentration Industries, 1992Concentration Industries, 1992
SIC NO.SIC NO.
INDUSTRYINDUSTRY
DESIGNATIONDESIGNATION
FOURFOUR
LARGESTLARGEST
FIRMSFIRMS
EIGHTEIGHT
LARGESTLARGEST
FIRMSFIRMS
NUMBERNUMBER
OFOF
FIRMSFIRMS
28232823 Cellulosic man-made fiberCellulosic man-made fiber 9898 100100 55
33313331 Primary copperPrimary copper 9898 9999 1111
36333633 Household laundry equipmentHousehold laundry equipment 9494 9999 1010
21112111 CigarettesCigarettes 9393 100100 88
20822082 Malt beverages (beer)Malt beverages (beer) 9090 9898 160160
36413641 Electric lamp bulbsElectric lamp bulbs 8686 9494 7676
20432043 Cereal breakfast foodsCereal breakfast foods 8585 9898 4242
37113711 Motor vehiclesMotor vehicles 8484 9191 398398
34823482 Small arms ammunitionSmall arms ammunition 8484 9595 5555
36323632 Household refrigerators and freezersHousehold refrigerators and freezers 8282 9898 5252
Source:Source: U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Concentration Ratios in Manufacturing, Subject Subject
Series MC92-S-2, 1997.Series MC92-S-2, 1997.

18. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Oligopoly ModelsOligopoly Models
•All kinds of oligopoly have one All kinds of oligopoly have one
thing in common:thing in common:
•The behavior of any given The behavior of any given
oligopolistic firm depends on the oligopolistic firm depends on the
behavior of the other firms in the behavior of the other firms in the
industry comprising the oligopoly.industry comprising the oligopoly.

19. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Collusion ModelThe Collusion Model
•A group of firms that gets together A group of firms that gets together
and makes price and output and makes price and output
decisions jointly is called a decisions jointly is called a cartelcartel..
•Collusion occurs when price- and Collusion occurs when price- and
quantity-fixing agreements are quantity-fixing agreements are
explicit.explicit.
•Tacit collusionTacit collusion occurs when firms occurs when firms
end up fixing price without a specific end up fixing price without a specific
agreement, or when agreements are agreement, or when agreements are
implicit.implicit.

20. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Cournot ModelThe Cournot Model
•The The Cournot modelCournot model is a model of a is a model of a
two-firm industry (duopoly) in which a two-firm industry (duopoly) in which a
series of output-adjustment series of output-adjustment
decisions leads to a final level of decisions leads to a final level of
output between the output that would output between the output that would
prevail if the market were organized prevail if the market were organized
competitively and the output that competitively and the output that
would be set by a monopoly.would be set by a monopoly.

21. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Kinked Demand Curve ModelThe Kinked Demand Curve Model
•The The kinked demand modelkinked demand model is a is a
model of oligopoly in which the model of oligopoly in which the
demand curve facing each individual demand curve facing each individual
firm has a “kink” in it. The kink firm has a “kink” in it. The kink
follows from the assumption that follows from the assumption that
competitive firms will follow if a competitive firms will follow if a
single firm cuts price but will not single firm cuts price but will not
follow if a single firm raises price.follow if a single firm raises price.

22. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Kinked Demand Curve ModelThe Kinked Demand Curve Model
•Above P*, an increase in Above P*, an increase in
price, which is not followed price, which is not followed
by competitors, results in a by competitors, results in a
large decrease in the firm’s large decrease in the firm’s
quantity demanded quantity demanded
(demand is elastic).(demand is elastic).
•Below P*, price decreases Below P*, price decreases
are followed by are followed by
competitors so the firm competitors so the firm
does not gain as much does not gain as much
quantity demanded quantity demanded
(demand is inelastic).(demand is inelastic).

23. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Price-Leadership ModelThe Price-Leadership Model
•Price-leadershipPrice-leadership is a form of is a form of
oligopoly in which one dominant firm oligopoly in which one dominant firm
sets prices and all the smaller firms sets prices and all the smaller firms
in the industry follow its pricing in the industry follow its pricing
policy.policy.

24. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Price-Leadership ModelThe Price-Leadership Model
•Assumptions of the price-leadership model:Assumptions of the price-leadership model:
1.1.The industry is made up of one large firm and a The industry is made up of one large firm and a
number of smaller, competitive firms;number of smaller, competitive firms;
2.2.The dominant firm maximizes profit subject to The dominant firm maximizes profit subject to
the constraint of market demand the constraint of market demand andand subject to subject to
the behavior of the smaller firms;the behavior of the smaller firms;
3.3.The dominant firm allows the smaller firms to The dominant firm allows the smaller firms to
sell all they want at the price the leader has set.sell all they want at the price the leader has set.

25. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Price-Leadership ModelThe Price-Leadership Model
•Outcome of the price-leadership model:Outcome of the price-leadership model:
1.1.The quantity demanded in the industry is split The quantity demanded in the industry is split
between the dominant firm and the group of between the dominant firm and the group of
smaller firms.smaller firms.
2.2.This division of output is determined by the This division of output is determined by the
amount of market power that the dominant firm amount of market power that the dominant firm
has.has.
3.3.The dominant firm has an incentive to push The dominant firm has an incentive to push
smaller firms out of the industry in order to smaller firms out of the industry in order to
establish a monopoly.establish a monopoly.

26. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Predatory PricingPredatory Pricing
•The practice of a large, powerful firm The practice of a large, powerful firm
driving smaller firms out of the driving smaller firms out of the
market by temporarily selling at an market by temporarily selling at an
artificially low price is called artificially low price is called
predatory pricingpredatory pricing..
•Such behavior became illegal in the Such behavior became illegal in the
United States with the passage of United States with the passage of
antimonopoly legislation around the antimonopoly legislation around the
turn of the century.turn of the century.

27. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Game TheoryGame Theory
•Game theoryGame theory analyzes oligopolistic analyzes oligopolistic
behavior as a complex series of behavior as a complex series of
strategic moves and reactive strategic moves and reactive
countermoves among rival firms.countermoves among rival firms.
•In game theory, firms are assumed In game theory, firms are assumed
to anticipate rival reactions.to anticipate rival reactions.

28. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Payoff Matrix for Advertising GamePayoff Matrix for Advertising Game
B’s STRATEGYB’s STRATEGY
A’s STRATEGYA’s STRATEGY Do not advertiseDo not advertise AdvertiseAdvertise
Do not advertiseDo not advertise
A’s profit = $50,000A’s profit = $50,000
B’s profit = $50,000B’s profit = $50,000
A’s loss = $25,000A’s loss = $25,000
B’s profit = $75,000B’s profit = $75,000
AdvertiseAdvertise
A’s profit = $75,000A’s profit = $75,000
B’s loss = $25,000B’s loss = $25,000
A’s profit = $10,000A’s profit = $10,000
B’s profit = $10,000B’s profit = $10,000
•The strategy that firm A will actually choose depends on
the information available concerning B’s likely strategy.

29. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Payoff Matrix for Advertising GamePayoff Matrix for Advertising Game
B’s STRATEGYB’s STRATEGY
A’s STRATEGYA’s STRATEGY Do not advertiseDo not advertise AdvertiseAdvertise
Do not advertiseDo not advertise
A’s profit = $50,000A’s profit = $50,000
B’s profit = $50,000B’s profit = $50,000
A’s loss = $25,000A’s loss = $25,000
B’s profit = $75,000B’s profit = $75,000
AdvertiseAdvertise
A’s profit = $75,000A’s profit = $75,000
B’s loss = $25,000B’s loss = $25,000
A’s profit = $10,000A’s profit = $10,000
B’s profit = $10,000B’s profit = $10,000
•Regardless of what B does, it pays A to advertise. This is
the dominant strategy, or the strategy that is best no
matter what the opposition does.

30. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Prisoners’ DilemmaThe Prisoners’ Dilemma
ROCKYROCKY
GINGERGINGER Do not confessDo not confess ConfessConfess
Do not confessDo not confess
Ginger: 1 yearGinger: 1 year
Rocky: 1 yearRocky: 1 year
Ginger: 7 yearsGinger: 7 years
Rocky: freeRocky: free
ConfessConfess
Ginger: freeGinger: free
Rocky: 7 yearsRocky: 7 years
Ginger: 5 yearsGinger: 5 years
Rocky: 5 yearsRocky: 5 years
•Both Ginger and Rocky have dominant strategies: to
confess. Both will confess, even though they would be
better off if they both kept their mouths shut.

31. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Payoff Matrix forPayoff Matrix for
Left/Right-Top/Bottom StrategiesLeft/Right-Top/Bottom Strategies
Original GameOriginal Game
D’s STRATEGYD’s STRATEGY
C’s C’s
STRATEGYSTRATEGY
LeftLeft RightRight
TopTop
C wins $100C wins $100
D wins no $D wins no $
C wins $100C wins $100
D wins $100D wins $100
BottomBottom
C loses $100C loses $100
D wins no $D wins no $
C wins $200C wins $200
D wins $100D wins $100
•Because D’s behavior is
predictable (he will play
the right-hand strategy), C
will play bottom.
•When all players are
playing their best strategy
given what their
competitors are doing, the
result is called Nash
equilibrium.

32. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Payoff Matrix forPayoff Matrix for
Left/Right-Top/Bottom StrategiesLeft/Right-Top/Bottom Strategies
•C is likely to play top and
guarantee herself a $100
profit instead of losing
$10,000 to win $200, even if
there is just a small chance of
D’s choosing left.
•When uncertainty and risk are
introduced, the game
changes. A maximin
strategy is a strategy chosen
to maximize the minimum
gain that can be earned.
New GameNew Game
D’s STRATEGYD’s STRATEGY
C’s C’s
STRATEGYSTRATEGY
LeftLeft RightRight
TopTop
C wins $100C wins $100
D wins no $D wins no $
C wins $100C wins $100
D wins $100D wins $100
BottomBottom
C loses C loses
$10,000$10,000
D wins no $D wins no $
C wins $200C wins $200
D wins $100D wins $100

33. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Contestable MarketsContestable Markets
•A market is A market is perfectly contestableperfectly contestable if if
entry to it entry to it andand exit from it are exit from it are
costless.costless.
•In contestable markets, even large In contestable markets, even large
oligopolistic firms end up behaving oligopolistic firms end up behaving
like perfectly competitive firms. like perfectly competitive firms.
Prices are pushed to long-run Prices are pushed to long-run
average cost by competition, and average cost by competition, and
positive profits do not persist.positive profits do not persist.

34. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Oligopoly is Consistent withOligopoly is Consistent with
a Variety of Behaviorsa Variety of Behaviors
•The only necessary condition of oligopoly is The only necessary condition of oligopoly is
that firms are large enough to have some that firms are large enough to have some
control over price.control over price.
•Oligopolies are concentrated industries. At Oligopolies are concentrated industries. At
one extreme is the cartel, in essence, one extreme is the cartel, in essence,
acting as a monopolist. At the other acting as a monopolist. At the other
extreme, firms compete for small extreme, firms compete for small
contestable markets in response to contestable markets in response to
observed profits. In between are a number observed profits. In between are a number
of alternative models, all of which stress of alternative models, all of which stress
the interdependence of oligopolistic firms.the interdependence of oligopolistic firms.

35. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Oligopoly and Economic PerformanceOligopoly and Economic Performance
•Oligopolies, or concentrated industries, are Oligopolies, or concentrated industries, are
likely to be inefficient for the following reasons:likely to be inefficient for the following reasons:
•They are likely to price above marginal cost. This They are likely to price above marginal cost. This
means that there would be underproduction from means that there would be underproduction from
society’s point of view.society’s point of view.
•Strategic behavior can force firms into deadlocks Strategic behavior can force firms into deadlocks
that waste resources.that waste resources.
•Product differentiation and advertising may pose a Product differentiation and advertising may pose a
real danger of waste and inefficiency.real danger of waste and inefficiency.

36. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Role of GovernmentThe Role of Government
•The The Celler-Kefauver Act of 1950Celler-Kefauver Act of 1950
extended the government’s authority extended the government’s authority
to ban vertical and conglomerate to ban vertical and conglomerate
mergers.mergers.
•The The Herfindahl-Hirschman Index Herfindahl-Hirschman Index
(HHI)(HHI) is a mathematical calculation is a mathematical calculation
that uses market share figures to that uses market share figures to
determine whether or not a proposed determine whether or not a proposed
merger will be challenged by the merger will be challenged by the
government.government.

37. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Regulation of MergersRegulation of Mergers
Calculation of a Simple Herfindahl-Hirschman Index for Four Hypothetical Calculation of a Simple Herfindahl-Hirschman Index for Four Hypothetical
Industries, Each With No More Than Four FirmsIndustries, Each With No More Than Four Firms
PERCENTAGE SHARE OF:PERCENTAGE SHARE OF: HERFINDAHL-HERFINDAHL-
HIRSCHMANHIRSCHMAN
INDEXINDEXFIRM 1FIRM 1FIRM 2FIRM 2FIRM 3FIRM 3FIRM 4FIRM 4
Industry AIndustry A5050 5050 -- -- 5050
22
+ 50 + 50
22
= 5,000 = 5,000
Industry BIndustry B8080 1010 1010 -- 8080
22
+ 10 + 10
22
+ 10 + 10
22
= 6,600 = 6,600
Industry CIndustry C2525 2525 2525 2525 2525
22
+ 25 + 25
22
+ 25 + 25
22
+ 25 + 25
22
= 2,500 = 2,500
Industry DIndustry D4040 2020 2020 2020 4040
22
+ 20 + 20
22
+ 20 + 20
22
+ 20 + 20
22
= 2,800 = 2,800

38. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Department of Justice Merger Department of Justice Merger
Guidelines (revised 1984)Guidelines (revised 1984)
ANTITRUST DIVISION ACTIONANTITRUST DIVISION ACTION
HHIHHI
1,8001,800
1,0001,000
00
ConcentratedConcentrated
Challenge if Index is Challenge if Index is
raised by more than 50 raised by more than 50
points by the mergerpoints by the merger
Moderate Moderate
ConcentrationConcentration
Challenge if Index is Challenge if Index is
raised by more than 100 raised by more than 100
points by the mergerpoints by the merger
UnconcentratedUnconcentrated
No challengeNo challenge