It's convenient to think of the economy as a monopoly, charging higher prices, and reaping greater profits than firms in a competitive market.
Sometimes behavior in imper realities doesn't provide clear distinctions.
Market power is more important than just one firm.
The chapter focuses on one form of imperfect firms.
We examine the nature of decision making in try, for example, Coca-Cola andPepsi share tremendous mar this market structure and the likely impacts on prices, produc ket power, even though neither company qualifies as a pure tion, and profits.
monopoly is what we want to know.
Microsoft is the sole supplier of computer operating systems and has tremendous market power.
The corner grocery store has less control over prices than other stores.
Even the corner grocery isn't powerless.
There are different levels of market power between the extremes of monopoly and perfect competition.
A perfect monopoly can be created when only one firm is the exclusive supplier.
Individual firms have power in imperfect competition.
It is possible that an oligopoly exists because of a particular good or service.
Market structure is based on the number of firms in an industry.
Market power is granted when there are only a few producers or suppliers.
The size of each firm is important in addition to the number of producers.
Long-distance telephone service in the United States is supplied by over 800 firms.
An imperfectly competitive structure includes barriers to entry, the availability of substitute goods, and the size of the company.
It wouldn't make sense to categorize that industry on the basis of only the number of firms.
The extent of barriers to entry is a third determinant of market power.
The envy of other profit maximizers is caused by a highly successful monopoly.
The power of the former monopolists would be reduced if they succeeded.
The ability of a powerful firm to dictate if prices or profits increase is limited by the ease of entry into an industry.
In Chapter 24 we saw how monopolies erect barriers to entry to maintain their power.
Market power is determined by the availability of substitute goods.
If a power baron sets the price of a product too high, consumers may switch to close substitute.
The price of beer is kept in check by the price of coke, while the price of steak is restrained by the price of chicken and pork.
A lack of substitute products keeps the prices of AZT high.
This ratio shows the share of output and market share accounted for by the largest proportion of firms in an industry.
One can easily distinguish between the output of the four largest firms using this ratio.
Table 25.2 shows concentration ratios for products in the United States.
The proportion of domestic production accounted for by the four largest firms is depicted in the standard measure.
Check single firm is so large that it is almost a monopoly in some markets.
This country's disposable diapers are made by P&G.
In other words, a small firm could have a lot of power in a relatively small market.
Table 25.2 should be enough to convince you that we're not talking about small product markets here.
The broadbased market is enjoyed by every one of the products listed.
The chewing gum market has annual sales of $2 billion.
The three companies that make video game consoles have 100 percent of the market.
Market power and firm size go hand in hand for most of the firms listed in the table.
A large firm size isn't the only way to achieve market power.
Many firms acting in unison can change the supply and price of a product.
1,000 small producers can band together to change the quantity supplied to the market.
Universal Electronics exercised market power by coordinating the production decisions of its many separate plants.
Domestic production of many familiar products is concen price.
The share of total output is measured by the concentration ratio.
The firms have control over the largest producers in the market.
The American Bar Association and the American Medical Association maintain uniform fee schedules for their members.
The American Milk Producers, Mid-America Dairies, and Dairymen, Inc. control 50 percent of all milk production.
Uniform fee schedules are illegal and individual lawyers and doctors have the right to advertise their prices, according to the courts.
A combination of inertia and self-interest has kept high fee schedules.
The twenty-second largest force in global markets would be the firms in the United States.
In terms of national GDP, they export products to foreign countries.
The giants of the world are Toyota and Royal Dutch Shell.
Wal-mart is one of the foreign giants that compete in global markets.
Market power is determined by firm size.
The value of total output in most of the world's 200-plus countries is less than the total revenue of the largest firms.
Many industries with low concentration ratios are represented by just one or a few firms.
Milk, newspapers, and transportation are prime examples.
In the United States, less than 60 cities have two or more independently owned daily newspapers, and nearly all of them rely on two news services.
Most college campuses have one bookstore.
It's not realistic to expect market outcomes to resemble those of perfect competition with so much market power concentrated in so few hands.
A quantity of 20,000 per month is demanded by the market.
The behavior of a more common market structure is called oligopoly.
The computer market is where we'll return to find the unique character of oligopoly.
When entry barriers were low and hundreds of firms were producing similar products, the computer market was very competitive.
The computer industry became a monopoly of Universal Electronics because of a patent on the electronic brain of the computer.
We will transform the industry again.
We'll create an oligopoly by assuming that Universal, World, and International all have patent rights.
We create nant firms with these assumptions.
We want to see how market outcomes would change in such a structure.
Universal Electronics is thought to be making 8,000 computers per month.
World Computers has a market share of over 30 percent.
World Computers and International Semiconductor don't like being second or third fiddle to Universal Electronics.
Each company wants to be the number one.
Universal would like a bigger market share in view of the huge profits being made on computers.
Universal would love to grab the market shares of its competitors.
A single producer could expand production at will in a truly competitive market.
Increased sales by one firm will be noticed by the other firms.
Increased sales by one firm will have to take place either at the existing market price or at a lower price.
The corporate headquarters of the other two firms will be alarmed by either of these events.
Sales increased at thevailing market price.
Universal Electronics could increase its sales at the price of $1,000 per computer.
The combined monthly sales of World and International would have to fall from 12,000 to 11,000 if Universal were to increase its sales.
Universal's sales must be offset by those of its rivals.
Universal's sales success will be noticed by the market shares of the three oligopolists.
It will not be necessary for World Computers or International Semiconductor to engage in industrial espionage.
The firms can figure out what Universal is doing by looking at their own sales figures.
Increased sales at lower prices.
A different strategy could be pursued by Universal.
Universal could try to increase its sales by lowering the price of its computers.
Universal might be able to increase its sales without affecting the sales of either World or International.
This outcome is not likely.
If Universal lowered its price from $1,000 to $900, consumers would flock to Universal Computers, and the sales of World and International would plummet.
We've always thought that consumers would want to pay the lowest possible price for a particular good.
It's not likely that consumers would continue to pay $1,000 for a World or International machine when they could get the same computer from Universal for only $900.
Consumers perceive differences in the products of rival oligopolists even when they are essentially the same.
If Universal reduced the price of its computers, it would gain customers, but not all of them.
We'll assume that's the outcome.
There is no way that Universal can increase its sales at reduced prices without causing alarm at World and International.
World and International may not be content to watch their market shares and profits decline.
Once they discover what's going on, World and International are likely to take action of their own.
Once they decide to act, World and International can do two things.
They are increasing their own marketing efforts.
They are cutting prices on their computers.
RC Cola is following in the footsteps of Brady Bunch and push-up bras.
RC is spending the largest amount of money in the company's history on an advertising campaign to promote its drink as the hip alternative to "corporate colas" in the Midwest and South.
RC's new tactics are smart.
Excerpted with permission.
Rival firms in an oligopoly rely on advertising and product differentiation to gain market share.
To step up their marketing efforts, World and International might increase their advertising expenditures, repackage their computers, put more sales representatives on the street, or sponsor a college homecoming week.
Coke andPepsi have a Fea market share.
RC Cola sales will increase if marketing efforts are successful.
Universal's hopes of increasing its market share at the old price will be destroyed by such price reductions.
This is the other side of the story we've already told.
It's ridiculous to assume that Universal will be able to expand its market share at a price of $1,000 if the price of World and International computers drops to $900.
If World and International drop their prices to $900, Universal's market share will shrink.
Universal would be forced to cut computer prices or accept a reduced market share if they carried out this threat.
In the second case, we assumed that Universal Electronics would expand its sales by cutting prices.
Universal's marketing success isn't going to be applauded by world and international.
They will have to cut prices of their own.
Universal would have the highest price on the market.
The slide down the market demand curve will result in lower prices, increased output, and smaller profits.
The three oligopolists will use price reductions as weapons in the battle for market shares, the kind of behavior normally associated with competitive firms.
The main moral of this story is the close interdependence of oligopolists and the limitations they impose on individual price and output decisions.
The story can be summarized with the help of the demand curve.
Universal Electronics had a market share of 40% and was selling 8000 computers per month for $1,000 each.
The rest of the demand curve shows what would happen if Universal changed its selling price.
We have to figure out why this demand curve has a weird shape.
We expect a price reduction to increase sales.
Universal would be the only low-priced computer in the market.
In order to maintain their market shares, World and International are going to cut their prices to $900.
Rivals in the airline industry were forced to match Delta's price cuts.
It is assumed that the demand for computers iselastic in the vicinity of $1,000 and that all computers are the same.
Universal will be out there alone with a higher price and reduced sales if World and International do not follow suit.
Rival oligopolists may not match price increases.
The price of a computer at Universal is $1,100.
World Computers and International Semi conductor wouldn't be upset about increasing their market shares.
Unless they see the desirability of an industrywide price increase, they're not likely to come to Universal's rescue with price increases of their own.
Northwest Airlines did not match the fare hikes announced by its rivals.
World and International might match Universal's price increase.
Universal's sales would diminish, too, in accordance with its share of a smaller market.
The central message of the demand curve is that oligopolists can't make their own decisions.
There are a number of factors that can lead to such differentiation, including slight product variations, advertising, customer habits, location, friendly service, or any number of other factors.
The majority of oligopolies exhibit some variation.
Major airlines abandoned fare increases of as much as $20 on one-way tickets after all carriers failed to match the increases.
Gary McWilliams west and US Airways immediately said they would match Delta's 25 percent fare reductions in markets where they compete.
Excerpted with permission.
The demand curve will be affected if rivals match price cuts but not price increases.
When firms agree to raise prices at the same time, prices will increase.
It can't be certain of that response.
The odds of rivals not matching a price cut should be considered by Universal.
Universal might offer price discounts to just a few select customers, hoping that World and International will not notice or react to small changes in market share.
The table summarizes the options the oligopolist faces.
Let's assume Universal is considering a price cut.
One scenario in which Universal reduces its price is the only one that increases Universal's profit.
Universal's two rival oligopolists will lose money under this scenario.
The payoff to an oligopolist's price cut depends on its rivals' scenarios.
Reducing price doesn't guarantee a profit, but at least it won't decimate the theory problem.
Try to find a solution to Universal's market share or profits.
The other games at www.princeton.edu/ lists will suffer small losses if rivals match the Universal price cut.
If an individual oligopolist holds the line on price, it could lose a lot of money.
The expected gain is the loss.
You would be more inclined to reduce price if you thought the risk was high.
The foundation of game theory is risk assessment.
Reducing price is an option.
As the first row of Table 25.4 shows, rivals can respond either way.
Universal incurs a small loss if they follow suit.
There is a huge gain for Universal if they don't.
The size of each payoff and the probability of its occurrence are two pieces of information that we need to quantify the risk assessment.
The "big gain" is $1 million and the "small loss" is $20,000.
We now know that the huge gain is not likely to happen.
It's not a good idea.
If potential payoffs and probabilities are taken into account, a price cut doesn't look promising.
The odds are that a price cut will result in a loss.
Cold War games were played by the world's one-time super powers.
Both sides knew a nuclear first strike could cause destruction.
As a result, the United States and the former Soviet Union constantly probed each other's responses but were quick to retreat from the brink whenever all-out retaliation was threatened.
Oligopolists play the same kind of game on a much smaller scale, using price discounts and advertising rather than nuclear as their main weapons.
The oligopoly profits that they continue to share are the reward for coexistence.
oligopolists limit their price rivalry because of this reward and the threat of mutual destruction.
Coke andPepsi ended their price war quickly.
The companies pulled back from the brink of mutual profit destruction after finger-pointing about who started the war.
Coke's CEO explicitly rejects price competition as a viable strategy for oligopolists in the last paragraph of the News.
This isn't to say that oligopolists won't cut prices or use other means to gain market decision making.
They could, given the right circumstances and expectations of how rivals will act.
There are different price, output, and marketing strategies between rivals.
A brief but bitter pricing war within the soft-drink concern that profit margins for Pepsi and Coke bottlers may industry might be drawing to a close--all because no one erodes as a result of cutthroat pricing.
Coca-Cola's biggest bottler, A. Schimberg, said in a recent memo to executives that it will attempt Cola.
The memo was written in response to statements made to analysts.
We don't have a week by top executives.
DOW Cola Enterprises did not want to be criticized for JONES & Company, Inc.
In the wake of the statements expressed Center, Indeed, and Company, Inc. in the format Textbook via the Copyright Clearance industry analysts.
oligopoly profits can be destroyed by price discounting.
Rival oligopolists want to end it quickly.
There are many different strategies that oligopolists might use to gain market share, just like there are many different moves in a chess game.
They want to avoid behavior that will destroy their profits.
The market is no longer competitive.
Market outcomes will be affected by a change in industry structure.
It would charge whatever price consumers were willing and able to pay for the rate of output if it was chosen to do this.
An oligopoly would like to make the same amount of money.
There is a challenge to replicating monopoly outcomes.
The trend of oil an oligopoly must find the monopoly price and maintain it is checked by the firms in agreement.
A common view of the industry demand curve, satisfaction with respective market shares, and precise coordination are required to reach agreement.
Competitive industries would like to make a lot of money.
Competitive industries experience relentless pressure on profits, as individual firms expand output, reduce costs, and lower prices.
To maximize industry profits, competitive firms would have to band together and agree to raise prices.
The indus Pain at the Pump would no longer be competitive if they did.
The potential for maximizing industry profits is greater in an oligopoly because fewer firms are involved and each is aware of its dependence on the others.
The impact of the latest output move on oil markets is not known.
DOW ally will be given permission to implement the decision, which calls for a collective cut of JONES & COMPANY, Inc.
An oligopoly is trying to act like a monopoly.
Firms in an oligopoly must agree to maintain the monopoly price and limit output in order to maximize industry profit.
A successful oligopoly will achieve monopoly-level profits.