CHAPTER 12

OLIGOPOLY
By: Ceniza, Angelica Mae
Concon, Jannine
De Jesus, Rochelle
 Learning Objectives
In this chapter you’ll learn these topics:
1.Concentration Ratios.
2.The Herfindahl-Hirschman Index.
3.The competitive spectrum.
4.The kinked demand curve.
5.Administered prices.
6.Game theory.
 Oligopoly Defined
◦ Oligopoly: an industry with just a few sellers.
◦ How few? So few that at least one firm is large enough to
influence price.
◦ Product can be identical, similar, or differentiated.
◦ When we walk about big business in the U.S., we’re talking
about oligopolies. Examples are:
- GM, Ford, ExxonMobil, IBM, CBS, NBC, Kellogg, General Mills,
other industrial glants that have become household names
 Oligopoly’s Importance
◦ Oligopoly is the most prevalent type of industrial
competition in the U.S. as well as in most of the
noncommunist industrial west.

◦ The vast majority of our GDP is accounted for by firms in

oligopolistic industries.
 Oligopoly Behavior
◦ The crucial factor under oligopoly is the small number of
firms.

◦ Because there are so few firms, every competitor must think

continually about the actions of its rivals.

- What each does could make or break the other?

◦ Thus, there is a kind of interdependence among oligopolists.

 Two Measures of the Degree of
Oligopolization
1.Concentration Ratio

2.Herfindahl-Hirschman Index
 Concentration Ratios
◦ 4CR: the percentage share of industry sales of the top
4 (leading) firms in the industry.
- Industries with high concentration ratios are very
oligopolistic.
 Concentration Ratios
◦The concentration ratio: are designed to measure
industry concentration.

-the most common concentration ratio is the Four-Firm

Concentration Ratio (4CR).
Calculate the Concentration Ratio (CR)
Firm Percent of Sales
A 14 %
B 4
C 23
D 5 Concentration ratio (CR) is
E 2 23 + 17 + 15 + 14 = 69%
F 8
G 17
H 10
I 2
J 15
Total 100%
 Oligopoly in the Automobile
Market Share
Company Total Annual Sales
(%)
General Motors $600 million 30%
Ford $550 million 27.5%
Toyota $300 million 15%
Honda $190 million 9.5%
Others. --- ---
--- ---
TOTAL 4CR $1,640 million 82%

TOTAL WHOLE INDUSTRY $2000 million 100%

Annual Sales
Market Share =
Total Annual Sales
$600 𝑚
=
$2000𝑚
= 30% - Market Share (Firm A)
Concentration Ratio Levels Percentages

High 80% - 100%

Medium 50% - 80%

Low 0% - 50%
Two Key Shortcomings of Concentration
Ratios
1. Concentration ratios do not include imports.
- Ignores 1 million Japanese imports as well as hundreds of
thousands of Volkswagens, Saabs, BMWs, Audis, Jaguars, Porsches, and
Rolls Royces the U.S. imports.
2. Concentration ratios tells us nothing about the competitive structure of
the rest of the industry.
- Are all the firms relatively large or are they small?
- then the remaining firms are large, they are not as easily
dominated by the top 4 as are dozens of relatively small firms.

> CRS measured for the U.S. have become less meaningful with increased
globalization; perhaps it’s better to calculate with global markets.
Herfindahl- Hirschman Index (HHI)
◦ HHI: the sum of the squares of the market shares of
each firm in the industry.

- A monopoly has 100% of the market share

- 100² = (100 x 100) = 10,000
- You cannot get a bigger HHI number than 10,000
Herfindahl- Hirschman Index (HHI)
◦ HHI: the sum of the squares of the market shares of
each firm in the industry.

- A monopoly has 100% of the market share

- You cannot het a bigger HHI number than 10,000
- 100² = (100 x 100) = 10,000
 Calculate the HHI
HHI: the sum of the squares of the market shares of each firm in the
industry.
◦ An industry has 2 firms, each with 50% of the market.
- HHI = 50² = 2,500 + 2,500 = 5,000
◦ An industry has 4 firms, each with 25% of the market.
- HHI = 25² + 25² + 25² = 25² = 625 + 625 + 625 + 625 = 2,500

The U.S. Department of Justice uses the HHI to decide whether an

industry is highly competitive; it considers an industry with HHI <
1,800 competitive.
 HHI Levels HHI

High 1,800 - 10,000

Medium 1,000 - 1,800

Low 0 - 1,000

Note. You cannot get bigger HHI number than 10,000

Ex. The Shady Valley Soft Drink Industry
This table presents the market share of the top four soft drinks in the greater
metropolitan Shady Valley area (plus an "Other" category).

COMPANY MARKET SHARE

Omni Cola 62.85 %

Juice-Up
13.05%

Super Soda
10.69%

King Caffeine
4.83%

Other Companies* 8.58%

SOLUTIONs:

4CR= 𝑀𝑆1 + 𝑀𝑆2 + 𝑀𝑆3 + 𝑀𝑆4

=62.85 %+13.05%+10.69%+4.83%
=91.43%

HHI=𝑀𝑆12 + 𝑀𝑆22 +𝑀𝑆32 +𝑀𝑆42

=(62.85)2 +(13.05)2 +(10.69)2 + (4.83)2
=4276.9862
 Concentration
Concentration
Ratio HHI
Ratio/HHI Levels
%

High 80% - 100% 1,800 - 10,000

Medium 50% - 80% 1,000 - 1,800

Low 0% - 50% 0 - 1,000

 The Competitive Spectrum
The Degrees of Competition in Oligopoly
 Cartels
◦ Cartel: a combination of firms that acts as if it were a
monopoly.
◦ The leading firms in an industry band together to restrict
output and, consequently, increase prices and profits.
◦ If the demand is there, oligopolistic firms can openly
collude to control supply and, to a large degree, market
price.
◦ Example: OPEC and the price of oil.

◦ A cartel is the most extreme case of oligopoly

Withholding Supply to Raise Price

When supply is lowered

from S1 to S2, prices rises
from P1 to P2
Daily Output and Capacity of 13
Members of OPEC
 Open Collusion
◦ Slightly less extreme than a cartel

◦ Operates like the alleged Mafia

- Some type of territorial division of the market among the firms in
the industry
- This type of arrangement gives each firm in the market a regional
monopoly.
- The firm may have only 15 or 20 percent of the market, but under this type
of arrangement, its pricing behavior Is that of the monopolist.
The Colluding Oligopolist

This graph could also

belong to the monopolist or
the monopolistic
competitor in the short run
 Covert Collision
◦ Usually involves price-fixing
- In the late 1950s, General Electric, Westinghouse, Allis-Chalmers and other
leading electrical firms conspired to fix the price of electrical transformers,
turbines, and other electrical equipment.
- They rigged government bids by taking turns making (high) low bids, bilking
the public of hundreds of millions of dollars.
- In 1961, the U.S. Supreme court found 7 high ranking corporate officials guilty of
illegal price-fixing and market sharing agreements
- Their employers paid their fines
- They got short jail sentences
- Their employers paid their salaries while in jail, and they got their old job back after
they got out
Examples of Other cases of Collusion
◦ In 1996, Archer Daniels Midland Company pleaded guilty and
paid a $100 million criminal fine for its role in two international
price fixing- conspiracies.

◦ In 1999, an arrangement was uncovered that fixed worldwide

vitamin prices as much as 25% above the market level.

◦ In 2004, Schering-Pough paid $350 Million in fines for

overchanging Medicaid
 Price Leadership
◦ Playing follow the leader
- One company raises prices and shortly after, the other companies in the
same market do the same.

◦ Examples: the prime rate set by the big banks, prices hikes by
Delta Airlines.

◦ Collusion is most likely to succeed when there are few firms and
high barriers to entry
 Cutthroat Competition
◦ An extreme case, but common in the U.S.
◦ The cutthroat competitor’s actions are based on assumptions about their
rivals’ behavior
Assumption #1: “If I raise my price, my competitors won’t raise their price.”
Assumption #2: “If I lower my price, my competitors will also lower their price.”
◦ Therefore, the cutthroat competitor keeps the price just where it is – “sticky
prices”
◦ Example:
◦ McDonald’s and Burger King
◦ Costco and Sam’s club
◦ Club and Pepsi
The Kinked Demand Curve of the
Cutthroat Oligopolist
 Full Graph of the Oligopoly
(Cutthroat Competitor)
◦ Graph of the oligopolist is similar to that of the
monopolist.
◦ Therefore, the oligopolist is analyzed in the same manner with respect
to price, output, profit, and efficiency.
◦ Price is higher than the minimum point of the ACT curve, therefore
the oligopolist is not as efficient as the perfect competitor
◦ The oligopolist has a higher price and a lower output than does the
perfect competitor
◦ The oligopolist, like the monopolist, makes profit
The Cutthroat Oligopolist

Note discontinuity
(gap) in MR Curve

No cutthroat
oligopolists will raise or
lower price. They keep
the price just where it is:
at the kink in D curve
The Cutthroat Oligopolist

 Find P* and Q*
 Calculate Profit
 Firms set Q* where MR =
MR, so Q* = 4
 P* = $27
 Profit = (P – ATC) x Q*
* ($27 - $24) x 4 = $12
 Game Theory
◦ Definition: the study of how people behave in strategic
situation

◦ One application is a duopoly: an industry with just 2

firms.
◦ The behavior of one firm affects the other
◦ Should they collude or compete?
◦ Example: 2 bottled water companies, Maine Water Company
and Michigan Water Company
 Four Profit Outcomes for the Bottled
Water Duopoly

Should they collude to charge high prices?

Answer: Yes, because if your competitor lowers his/her price, you will
also lower yours, so you both lose. You both win in collusion.
Conclusion: The Competitive Spectrum

At one end, the cartel, which no longer operates within the U.S. economy,
although it may be found in world markets.
At the other end, the cutthroat competitor, the firm that will stop at nothing to beat
out its rivals. (e.g. fast food chains)

Where is the U.S. economy?

It depends upon the industry and the situation.
Current Issue: Cutthroat Competition
in the College Textbook Market
◦ Unlike nearly any other market, you, as a consumer of college
textbooks have only 1 choice.
- Do I buy my books new or used?

◦ Is students had a say in choosing their own texts, you can be sure
publishers would produce no frills texts at much lower prices.

◦ With only 3 major textbook publishers today, the odds of this

happening are non-existent.
 Questions for Further Thought and
Discussion
◦ Think about the things that you buy in your local area (around
school or home)

◦ Are there any products that you purchase from a market

dominated by only a few firms?

◦ Are these local, regional, national, or international oligopolies?

◦ Are they in similar industries to those with very high concentration

ratios in the text?
 The Four Types of Competition: A
Review (Appendix)
Learning Objectives:

1. Perfect Competition
2. Monopoly
3. Monopolistic Competition
4. Oligopoly
 The Four Types of Competition: Definitions
(Number of Sellers and Type of Product)

Type of Competition Number of Sellers Type of Product

Perfect competition Many Identical

Monopoly One Unique
Monopolistic Many Differentiated
competition Few Either identical or
Oligopoly differentiated
 The Four Types of Competition:
Profit or Loss in the Short Run or Long Run
◦ Perfect Competition
◦ SR: Profit or Loss
◦ LR: break even
◦ Monopoly
◦ No distribution between SR and LR (profit)
◦ Monopolistic Competition
◦ SR: profit or loss
◦ LR: break even
◦ Oligopoly
◦ SR; profit or loss
◦ LR: profit
The Four Types of Competition
Questions for Thought and Discussion
◦ Which of the 4 market structures charges higher prices and sells
less?

◦ Which of the 4 market structures is efficient in the long run?

◦ Suggest a name of a firm/company that operates under each of

the 4 market structures, if possible.
THE END, thank you