VI. Market power

    D. Oligopoly

    In between case: neither PC nor complete monopoly.
    More common than either extreme.

    Situation:
    Few sellers
    High barriers to entry

    --basic situation

    There is no general theory regarding behavior
    Lots of little theories
    The best the industry can do to max profits is act like a monopolist. Many minds can't do better than one

    Characteristics:
    (1) interdependence--moves affect each other
        Ex: whopper ads hurt mcdonalds

    (2) uncertainty--can't predict rivals' responses

    --Examples
    Text covers many in Ch.13. Just skim (from start of "Cournot" to end of "Stackleberg")

    I will focus on ones here that each illustrate a distinct point

    Example 1: Dominant firm (DF) theory (price leadership)

    What does it illustrate?
    (1) interdependence
    (2) price umbrellas for high cost fringe producers

    Situation: a leading producer. It sets its profit-maximizing price, other firms take the leader's price as given and profit maximize as perfect competitors.

    Often plausible in real world--many industries have a dominant firm leader
    Ex: American Can / Alcoa

    Fits cartels too--dominant group
    Notation:
    DF: leading (dominant) firm
    f: perfectly competitive fringe
    T: total: f + DF

    Ex: Bleach--Clorox = the leader

    Step1: diagram industry D and Sf
    Step2: derive demand facing DF, Ddf (for any P, Qd,df = Qd - Qs,f
    Step3: determine p-max output by DF
    Step4: determine final price, Qd and Qs,f

    --See worksheet

    Note1: Interdependence: DF sees larger e because of fringe competition
    Note2: Price umbrella effect--DF tolerates high-cost fringe even though it could undercut them.
    DF earns excess profits and provides a price umbrella for fringe
    --Ex: U.S. Steel
    --Demsetz: Found profits rise with firm size => oligopoly profits are due to lower costs.
        But note that P > P(efficient) too => efficiency loss vs. best outcome

    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?

    Ex: Penn tennis balls

    See Kinked demand theory worksheet

    Step1: Depict an initial (Qo,Po) (up and to the left)
    Step2: Draw D(all) (firm's D if rival firms change price too)
    Step3: Draw D1 (firm's D if rival firms do not change price)
    Step4: Draw perceived D and MR
    Step5: Draw representative MCs

    ? Will D1 be more or less elastic than Dall?

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

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