Microeconomics - Eighth Edition (Updated)

Chapter 14: Oligopoly - Firms in Less Competitive Markets

Chapter Outline

• 14.1 Oligopoly and Barriers to Entry
• 14.2 Game Theory and Oligopoly
• 14.3 Sequential Games and Business Strategy
• 14.4 The Five Competitive Forces Model

Key Topics

Oligopoly Overview

• Market structure with a small number of interdependent firms.
• Different from perfect and monopolistic competition.
• Barriers to entry prevent profits from being competed away.

Barriers to Entry

• Economies of Scale: Smaller firms have higher costs than established firms.
• Ownership of Key Inputs: Control over key resources limits entry (e.g., Alcoa with bauxite).
• Government-Imposed Barriers: Licensing, patents, and tariffs.

Oligopoly and Market Concentration

• Four-Firm Concentration Ratio: Measures market power; >40% indicates an oligopoly.
• Examples in industries: Retail, manufacturing, etc.

Limitations of Concentration Ratios

• Excludes foreign firms.
• Often based on national rather than local markets.
• Market definitions can be ambiguous.

14.2 Game Theory and Oligopoly

• Game Theory: Analyzes strategic interactions where a firm's outcome depends on other firms' actions.
• Key Elements:
  • Rules, strategies, and payoffs.
  • Example: Pricing strategies in a duopoly with Spotify and Apple.
• Dominant Strategy: Best strategy regardless of competitors' actions.
• Nash Equilibrium: Best strategy given the strategy of the other firm.
• Collusion vs. Competition: Collusion can lead to higher profits but is illegal.

14.3 Sequential Games and Business Strategy

• Sequential Games: Decisions are made in sequence, not simultaneously.
• Decision Trees: Used to map sequential decisions and outcomes.

14.4 The Five Competitive Forces Model (Michael Porter)

• Existing Firms: Current competition level.
• Threat of New Entrants: Potential for new competitors.
• Substitutes: Availability of alternative products or services.
• Buyer Power: Influence buyers have over a firm's pricing and terms.
• Supplier Power: Influence suppliers have over a firm's costs.

Additional Concepts

Cooperative vs. Noncooperative Equilibrium

• Noncooperative Equilibrium: Firms act independently in self-interest.
• Cooperative Equilibrium: Firms coordinate to improve mutual outcomes.

Prisoners Dilemma

• Pursuing dominant strategies leads to worse outcomes for all parties involved.

Cartels

• Groups of firms collude to control prices and limit competition (e.g., OPEC).

Real-World Applications

• Occupational Licensing: Could limit competition beyond public safety needs.
• Price Collusion: DOJ indictments in chicken price-fixing.

Dynamic Market Changes

• Large firms have longevity but face threats from new technologies and entrants.
• Fortune 500 changes over time demonstrate the impact of market dynamics.