VI. Market power
    D. Oligopoly

    Example 2: Kinked demand theory

    What does it illustrate?
    (1) uncertainty
    (2) price rigidity

    Situation: firm is trying to decide whether to change its P,Q. Doesn't know what rivals will do. Will they change P too or not?

    See Kinked demand theory worksheet

    Ex: Penn tennis balls

    Step1: Depict an initial Q and P (up and to the left)
    Step2: Draw Penn's demand if rival firms do not change price
    Step3: Draw Penn's demand if rival firms change price too
 

    ? Which will be more elastic?

    Firm's perception:
    (1) raise P, no firms follow
    (2) lower P, all firms follow

    Step4: Draw perceived D and MR
    Step5: Draw representative MCs

    Note1: Perceived D reflects uncertainty
    Note2: Price rigidity results: don't rock the boat.

E. Market power in practice

Learning objectives: Assess how the exercise of market power is affected by industry structure, conduct and performance, including the influence of concentration, barriers to entry, product differentiation, and US antitrust laws. Explain and illustrate the trade-off between static efficiency and dynamic efficiency.

    The focus of a field of its own, industrial organization (IO).
    Industrial organization approach--industry studies:
        (1) Structure  /  (2) Conduct  /  (3) Performance

    1. Structure

    Components of structure, playing off the assumptions of PC:
    --concentration
    --barriers to entry
    --product differentiation

    (1) Concentration

    Step 1: define the relevant market
    GM has a monopoly on Chevies--meaningful?
    Courts once sued GMAC under antitrust laws: It's a financing service. Courts defined GM cars as a market. (If you wanted a GM car, had to use its financing)

    Step 2: determine concentration
    (a) Monopoly: Market share = 67%
    In this case, our diagram of monopoly power is inaccurate
    Microsoft: operating systems software / Caterpillar: tractors

    (b) Oligopoly: "few" producers
    4-firm concentration ratio (CR4): the combined market share of the 4 largest producers
    Tight oligopoly => CR4 = 70%+ of the market
    Cigarettes / Aluminum / Beer

    (2) Barriers to entry (BtE)

    BtE = factors that allow existing firms to make economic profits without inducing entry. (Joe Bain)

    If BtE are low and CR high, called a contestable market instead of an oligopoly or monopoly

    BtE1: legal
    --franchise: electricity / waste disposal
    --patents: Alcoa / Xerox / GE / AT&T / pharmaceuticals

    BtE2: absolute cost barriers
    --Control of a scarce input
    Ex: Alcoa and bauxite

    --higher K costs from risk
    Ex: you and a steel loan

    --brand loyalty ex: GM / Bayer aspirin

    Key: High ATC is not necessarily a BtE. ATC must be higher for new firms than for existing firms.

    Why might a new firm's costs be higher? For example, must convince customers not just to try a product but to try theirs.

    BtE3: Economies of scale--minimum efficient scale is large relative to the size of the market
    Ex: refrigerators / power plant equipment

    (3) Product differentiation

    = characteristics other than price which distinguish the output of various firms in an industry

    Ex: Jay Leno vs. Jimmy Fallon
    Budweiser versus Becks

    Significance of product differentiation:

    --Leads to non-price competition
        Quality: Volvo vs. Prosche
        Variety: Mexican versus Italian food

    --Affects entry conditions

        May contribute to barriers to entry
    --Brand loyalty as an absolute cost barrier
    --Advertising and promotion: raise E/S: beer
    --Brand profileration: cold cereal / toothpaste

        Can be a niche for entry:
    Ex: imported small cars / granola

    Empirically, seems to be important as a BtE