AP Microeconomics

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AP Microeconomics

• Oligopoly

Warm Up Who is the main competitor for each of
the pictured firms? How are all of these firms
both powerful and weak?
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Oligopoly Characteristics

• An industry with a small number of firms selling
  a standardized or differentiated product these
  few firms control at least 2/3s (67) of the
  industry collectively.
• Significant pricing power (Lerner Index)
• Significant barriers to entry sheer size of the
  few firms prevents others firms from entering the
  market (Herfindahl Index)

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Oligopoly Characteristics

• Examples include
• Airlines
• Soft drinks
• Car Manufacturers
• Car tires
• Beer
• Cereal makers
• Unlike Perfect Competition that are so small that
  they have no effect on each other and monopolies
  that face an entire market alone, oligopolistic
  firms must consider the reactions of their rivals
  to marketing decisions.

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Oligopoly Models

• There are four different models that all
  represent oligopolies (a few firms dominating the
  industry).
• Collusion Model
• Kinked Demand Curve Model
• Duopoly
• Price Leadership

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1. Collusion Model

• The small group of controlling firms conspire on
  price and output and the result is exactly the
  same as it would be if a monopoly controlled the
  entire industry
• P ? (MR MC)
• b) Ex) Cartels like OPEC

MC
Price Cost
PX
ATC
Profit
Demand
QX
MR
Output
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2. Kinked Demand Curve Model

1. The demand curve facing each individual firm has
   a kink in it.
2. Firms will follow each other if they cut prices
   but not if they raise prices
3. The demand above P is elastic and raising prices
   will decrease total revenue
4. The demand below P is inelastic and changing
   price will see little change in demand for
   products

Price Cost
MC
PX
ATC
Profit
Demand
QX
Output
MR
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More Oligopoly Models

• (3) Duopoly (Cournet Model)
• Two firms controlling market
• Was once a monopoly but another firm was able to
  grasp some of the market

• (4) Price Leadership
• a. There is a dominant firm and this firm will
  change price and the others will be forced to
  follow

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Strategy!!!

• Because oligopolies follow one another, they must
  strategize as to what the competition is always
  doing!!
• Game Theory
• Considers the strategic decisions of players in
  anticipation of their rivals reaction.
• Often illustrated in a payoff matrix. Lets Play

John Nash A Beautiful Mind
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What would you do?
LIZ
Raise Lower
Raise 400, 300 -800, 500
Lower 600, -800 -500, -500
BOB
Dominant Strategy
Bob Lower chance to make most or lose least
the strategy that is the best regardless of what
the opponent does.
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Player 2chooses Left Player 2chooses Right
Player 1chooses Up 4, 3 1, 1
Player 1chooses Down 0, 0 3, 4
Goal
1 Earn the Most Points 2 Do Not Let your
Opponent Win!!
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Prisoner's Dilemna
Cooperate Defect
Cooperate 2, 2 0, 3
Defect 3, 0 1, 1
Do you cooperate with police or lie (defect) The
numbers represent extra years in prison you get
for attempting an escape so you want the least
amount of years!!!
Goal
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As times get more complicated

• ROCKPAPERSCISSORS!!!
• Is there a dominant strategy?