Microeconomics chapter 14 highlights PDF

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Oligopoly is a market dominated by a few large producers of a homogenous or differentiated product. In terms of degrees of competition, oligopoly market structure is placed right after pure monopoly. Monopolistic competition and pure competition come third and last, respectively. Oligopolistic industries are characterized by a few dominant firms and substantial entry barriers. Economies of scale enable a large firm to produce at a lower unit cost than can a small firm. Mutual interdependence is a unique feature of oligopoly. Oligopoly is characterized by strategic behavior and mutual interdependence. Strategic behavior means self-interested behavior that takes into account the reactions of others (rivals). But b/c rivals are few, there is mutual interdependence: a situation in which each firm’s profit depend not just on its own price and sales strategies but also on those of the other firms in its highly concentrated industry. Thus, oligopolistic firms base their decisions on how they think their rivals will react. So game theory is utilized in oligopolistic market structure. Game theory is used for analyzing the pricing behavior of oligopolists. Game theory reveals that rivals in an oligopolistic market may increase profits through collusion. See Figure 14.1. It is very important to understand Figure 14.1 If an oligopolistic producer assumes that its rivals will ignore a price increase but match a price cut then the firm perceives its demand curve as kinked, being steeper below the going price than above.

Thus, the kinked-demand curve of an oligopolist is based on the assumption that competitors will ignore price increases but match price cuts. See Figure 14.2 The kinked-demand curve model helps explain price rigidity, or stability, b/c there is a gap in the marginal revenue curve within which changes in marginal cost will not affect output or prices. Therefore, oligopolistic prices might change infrequently. When marginal cost shifts in the kinked-demand model, the price and quantity will remain the same. See Figure 14.2 Oligopolistic firms engage in collusion to earn more profits. Figure 14.3 Conditions that would encourage firms to collude in oligopolistic market are (i) similar cost and demand curves of participant, (ii) small number of firms producing a homogenous product, (iii) easy to detect cheating and punishing, (iv) booming economic environment, (v) blocked entry for potential firms, and (vi) no legal obstacles. Cartel is a group of producers that typically create a formal written agreement specifying how much each member will produce and charge. The most significant cartel is the Organization of Petroleum Exporting Countries (OPEC). The three major means of collusion are cartels, price leadership, and informal understandings.

Obstacles to collusion include (i) demand and cost differences, (ii) large number of firms, (iii) potential for cheating, (iv) economic slowdown, (v) potential entry of new firms, (vi) legal obstacles such as antitrust laws. A breakdown in price leadership leading to successive rounds of price cuts is known as price wars. Most price wars eventually run their course. After a period of low or negative profits, they again yield price leadership to one of the industry’s leading firms. That firm then begins to raise prices, and the other firms willingly follow suit. Advertising can enhance economic efficiency when it increases consumer awareness of substitute products. However, it could impede economic efficiency when it leads to greater monopoly power....