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Chapter 16

Chapter 16 Full Notes

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ECON 1131
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Chapter 16 Oligopoly  No general model exists for analyzing the noncompetitive oligopoly sector Why no general principles of Oligopoly?  The industry is dominated by a few large firms that are somewhat protected from the pressures of competition by barriers to entry Domination by a Few Firms  Law of Large Numbers: a property of statistics, which says that the average behavior of a large group of firms (or people) becomes highly predictable, even if the behavior of individual members of the group is highly unpredictable o Ex: number of students admitted to college every year  Because of the law of large numbers, we can confidently predict average market outcomes under monopolistic competition without concerning ourselves very much about the attributes of each individual firm, or even the distinctive features of each industry  But, law of large numbers is no help at all in predicting market behavior under oligopoly  We cannot be sure how the firms within any industry will respond to changing events over time Strategic Behavior Over the Long Run  Strategic behavior need not lead to unpredictable outcomes, even when only a few firms are involved  The firms in an oligopoly are not attempting to cooperate and collude o They are openly competing among themselves and trying to gain the upper hand  What happens when competing, noncooperating firms interact strategically over a long period of time? o Almost anything is possible. Market outcomes can vary drastically Setting Prices in Oligopoly: Sticky Prices and Nonprice Competition  Prices in the highly concentrated industries vary much less than do prices in the effectively competitive industries, especially in the downward direction  The behavior of list prices is misleading o The relevant prices are the actual prices of market transactions, not the list prices Tacit Collusion  Tacit collusion: an implicit, silent, agreement among the large corporations in an oligopoly, most often in the form of an agreement not to compete in terms of prices o Pricing behavior is not much different than if they had openly colluded o Tacit agreements do not extend to nonprice method of competition  The fact that different firms charge essentially the same price for similar products is not an issue o Firms selling similar products have no choice but to charge similar prices, or higher priced firms will be shut out of the market  Firms engage in repeated strategic interactions with their competitors over a very long period of time o Firms have the opportunity to adjust their own prices as they receive new information about the pricing decisions of other firms o The opportunity to engage in repeated interactions can lead to prices above average costs and to maintained profits for all firms Repeated Interaction: The Trigger Strategy Model  Trigger strategy: a punishment strategy within the context of a tacit collusion to maintain prices above average cost, in which the rival firms threaten to cut their prices to average cost forever if one of the firms cheats on the pricing agreement  If the firm cheats and cuts the price, it steals customers from other firms and earns much larger profits than if it does not cheat  The extra profits continue only for a short time, until the other firms discover what has happened o At that point, the agreement falls apart, prices are slashed to average cost, and all firms earn zero prof
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