In a market with a few firms, each firm has an incentive to act strategically, anticipating the possible actions of its fellow oligopolists.
In Brazil, a few firms dominate the market for cement, and the domestic cement producers are strategic oligopolists, with a twist.
The Brazilian cement firms are oligopolists, keeping prices high enough to make a profit, but low enough to prevent imports from entering the market.
Domestic firms cut their prices when imports become more competitive.
Domestic firms exploit their oligopoly power when imports become more expensive and less competitive.
Domestic firms increase their prices when the price of diesel fuel goes up.
Domestic firms charge high prices in the interior area of Brazil, where the costs of importers are high.
Page 613 explains why a price-fixing cartel is hard to explain.
MyLab Economics can help you study more efficiently.
A few firms serve a market.
The actions of one firm have a large effect on the other firms.
A firm considers the possible reactions of its rivals before taking a particular action.
Southwest Airlines will consider the possible reactions of other airlines before cutting fares in an attempt to sell more tickets.
Southwest's fare cut will increase its sales and profit if the rivals keep their old fares.
Southwest is likely to only gain a few customers if the rivals match the lower fare.
A strategy to maximize profit is developed by an oligopolist.
We use game theory to discuss three business strategies: conspiring to fix prices, preventing another firm from entering the market, and advertising.
A few firms have the power to control prices.
The percentage of market output pro market is the percentage of market output produced by the largest firms.
A four-firm concentration ratio is the percentage of total output in a market produced by the four largest firms.
The four firms with the highest concentration of house slippers in the United States are shown in Table 27.1
squaring the market share of each firm in the market is how it is calculated.
Consider a market with two firms, one with a 60 percent market share and the other with a 40 percent share.
According to the guidelines established by the U.S. Department of Justice, a market is "unconcentrated" if the HHI is less than 1,000.
The government can limit the number of firms in a market by issuing patents or controlling the number of business licenses.
When there are relatively large economies of scale in production, a single firm can produce for the entire market.
In some cases, scale economies are not large enough to create a natural monopoly, but are large enough to create a oligopoly, with a few firms serving the entire market.
A firm can't enter a market without an advertising campaign.
Huge advertising campaigns are required to get a foothold in the market.
In the case of economies of scale in production, a few firms will enter the market.
Firms compete with one another in a market economy to explain why price fixing is difficult to maintain.
Firms cooperate instead of competing with one another.
Adam Smith was aware of the possibility that firms would try to raise prices.
Raising prices isn't just a matter of firms getting together and agreeing on higher prices.
Unless firms find a way to punish firms that violate the agreement, an agreement to raise prices is likely to break down.
There is a duopoly in the market for air travel between two cities.
The airlines can either compete for customers or collude to raise prices.
Let's assume that the cost of providing air travel is the same every year.
The A group of firms that act in unison, monopoly price, could be formed by the two airlines.
If the two airlines act as one, they will split the monopoly output and have 30 passengers per day.
The price is $400 and each firm has 30 passengers.
Firms work together to set prices.
We will see later in the chapter that price fixing is illegal in the U.S.
Each firm would have its own demand curve if they competed.
The market demand curve for the typical firm lies to the left of it because consumers can choose between two firms.
Each firm will serve only part of the market if consumers are divided between the two firms.
Each firm has 40 passengers at a price of $300.
The high quences of different actions in a strategic price, or the low price, must be chosen by each firm.
Each firm has the ability to set.
The game tree is shown in Figure 27.3 Let's call the managers of the airlines.
The game tree has three components.
Each square has a player and a list of possible actions.
The possible paths of the game are shown in the arrows.
Jack chooses a price high or low, and then we move to one of the rectangles.
The profits for the two firms are shown in the rectangles.
The game is over when we reach a rectangle, and the players receive their profits.
There are four possible outcomes of the price fixing game.
We've calculated the profits for the two payoff rectangles.
The first image shows what happens when firms choose high prices.
Each firm makes $9,000 from this outcome.
When each firm chooses a low price, it is shown in the 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 888-666-1846 Firms compete and each firm makes a profit of $8,000.
Jack will capture a large share of the market and gain atJill's expense if he chooses the high price.
The other underpricing outcome is shown.
In this case, Jack chooses the high price, soJill gains at his expense.
The roles are reversed and the numbers are the same.
The equilibrium of the game can be predicted by elimination.
We'll eliminate the rectangles that would require one or both firms to act irrationally, leaving us with the rectangle showing the equilibrium of the game.
Jack would be irrational if he were to choose the high price.
He can make $12,000 profit if he chooses the low price instead of the high price.
If Jack chooses the low price, we'll move along the lower branches of the tree.
Jack won't choose the high price because he can earn $8,000 with the low price, compared to $3,000 with the high price.
The two profit rectangles that represent a high price for Jack have been eliminated.
Jack's best choice is the low price.
No matter what the other player's equilibrium is, an action that is the best choice for a Two profit rectangles is left--2 and 4--and that's whatJill's action will determine.
Jack will choose the lowest price no matter what.
She could choose the high price and allow Jack to capture most of the market, leaving her with only a small profit.
If you pick the low price, you can get a profit of $8,000.
The outcome of the game is shown by profit rectangle 4 because it would be irrational forJill to allow herself to be underpriced.
Each firm could earn a higher profit with rectangle 1.
Each firm must choose a high price to get there.
If both firms chose the low price, there would be a big payoff from underpricing the other firm and a big penalty from being underpriced.
To avoid the dilemma, high price, but each chooses the low price, will be shown later in the chapter.
A game tree can be used to find equilibrium in a game.
Each player is doing the best he or she can with the actions of another player.
An outcome of a game in which each of the players who developed his equilibrium concept was a graduate student at the University is doing the best he or she can.
The life story of Nash includes a 25-year battle with schizophrenia.
Jack's best action is to pick the low price ifJill picks the high price.
Jack's best action is to pick the lowest price.
It is possible that both firms pick the high price.
This isn't a Nash equilibrium because neither firm is doing the best they can with the other firm's actions.
Jack's best action is to pick the high price.
There is a chance that Jack picks the high price andJill picks the low price.
This is not a Nash equilibrium because Jack is not doing the best he can when it comes to picking a price.
The concept of the Nash equilibrium has been applied to many different deci sions.
Nuclear arms race, terrorism, evolution ary biology, art auctions, environmental policy, and urban development have been studied by analysts.
We use it to predict the outcomes of games of entry deterrence.
The prices decreased at 3:02 PM.
Salt producers colluded by forming salt pools and setting a uniform price for all of them.
The practice of deadrenting a salt furnace is known as output quota or paid firms not to produce salt for a year.
Within a year or two of its formation, every salt pool broke down.
Individual firms cheated on the cartel by selling salt outside of it.
The artificially high price caused new firms to enter the market.
The exercises 1.9 are related.
Salt producers were protected from competition with one another by high overland transportation costs.
The duopolists are in a dilemma because they can't coordinate their guarantees.
The low-price firm will capture a larger share of the market and earn a larger profit if it underprices the other.
Firms can avoid the dilemma by guaranteeing low prices and repetition of the pricing game.
The duopolists have a dilemma because the payoff from underpricing the other firm is too lucrative to miss.
One firm can guarantee that it will match a lower price of a competitor.
If you buy an airline ticket from me and discover that Jack offers the same trip at a lower price, I will pay you the difference.
I will pay you $100 if I charge you $400 and Jack's price is $300.
Jack would match a lower price if he could.
The effect of low-price guarantees on the game tree is shown in Figure 27.4 There are two decision nodes.
If Jack picks the high price, we end up at the same place as before.
Each of her consumers will be given a $100 refund.
She retroactively chose the low price, and the duopoly outcome is that both firms pick the low price.
For the lower half of the game tree, Jack has committed to match a lower price byJill, so the old payoff rectangle 3 disap pears, leaving us with rectangle 4 where both firms choose the low price and get the duopoly profit.
It is impossible for one firm to underprice the other when there is a low-price guarantee.
The thick arrows show the path of the game.
Jack can choose between a pair of high prices or a pair of low prices.
If he picks the high price, he will too, because his profit is higher at $9,000.
Jack is committed to the low price ifJill picks it.
Consider the decision of the person making it.
She chooses between profit 1 and 4 because she knows Jack will match her price.
She will pick the high price because profit is higher with rect angle 1.
The duopolists' dilemma is eliminated by the low-price guarantee because it eliminates the possibility of underpricing.
Firms don't have to create a formal cartel to get the benefits.
Both firms charge the high price because the motto of a low-price guar antee is "low for one means low for all."
The duopoly will be replaced by an informal cartel, with each firm picking the price that a monopolist would pick.
The idea that a low-price guarantee leads to higher prices is surprising to most people.
IfJill promises to give refunds if her price surpasses Jack's price, we might expect her to keep her price low to avoid handing out a lot of refunds.
Jack will also choose the high price and that's whyJill doesn't have to worry about giving refunds.
Consumers might think that a low-price guarantee will protect them from high prices, but they are more likely to pay the high price.
We assumed the price-fixing game was only played once.
Each firm has a price that they keep for the lifetime of the firm.
Repetition makes price fixing more likely because firms can punish firms that cheat on a price-fixing agreement.
For the remaining lifetime of her firm, she chooses the lower duopoly price.
When Jack underpricesJill, she responds by dropping her underpricing by choosing a price so low that each firm will make zero economic profit.
This is known as profit.
One firm can choose what price the other firm chooses.
As long as Jack prices the other firm's price, the arrangement will continue.
Jack underprices the preceding period.
The Cartel will break down.
The figure shows how the system works.
Jack underpricesJill in the second month, so she chooses the low price for the third month, resulting in a duopoly outcome.
Jack will have to choose between the high price and underprice him for a month.
The cartel is restored in the fifth month after this happens.
If Jack wants to restore pricing, he must allow her to gain at his expense during some other month.
A duopolist does exactly what his or her rival did in the last round.
Firms are encouraged to cooperate rather than compete.
The first firm chooses the price the second firm chooses the month before.
The firm that underprices the other firm is punished by these three pricing schemes.
Jack has to consider the short-term benefit against the long-term cost in deciding whether to underprice.
Jack can increase his profit from the Cartel profit of $9,000 to the $12,000 earned by a firm that underprices the other firm.
The short term benefit of underpricing is $3,000.
The long-term cost is the loss of profit in later periods.
Jack's profit will be decreased byJill cutting her price.
Jack's future profit will be $8,000 per day instead of the $9,000 he could have earned if he went along with the price of the duopoly.
The daily loss of $1,000 is the cost of underpricing.
The long-term cost of underpricing will exceed the short-term benefit if the two firms expect to share the market for a long time.
It is easier to resist the temptation to cheat when there is a threat of punishment.
The Sherman Antitrust Act of 1890 made explicit price fixing illegal.
Firms are not allowed to discuss pricing strategies or methods of punishing firms that underprice them.
The firms merged into a single firm after the Supreme Court ruled that their pricing was illegal.
Executives from General Electric and Westinghouse were convicted of fixing prices for electrical generators, resulting in fines of over $2 million and imprisonment for 30 corporate executives.
The European Union Commission fined 19 manufacturers of carton board a total of 132 million euros for fixing prices at secret meetings in luxury hotels.
An employee of a huge food company gave audio and videotapes of executives conspiring to fix prices.
The company was fined $100 million for price fixing.
Music retailers agreed to adhere to the minimum advertised prices in exchange for advertising subsidies.
If a retailer advertised a CD for less than the MAP, it would lose all of its cooperative advertising funds.
The Federal Trade Commission reached an agreement with music distributors in 2000.
The world's largest diamond producer, DeBeers, pled guilty to conspiring with General Electric to fix the price of industrial diamonds and paid a $10 million fine.
Firms sometimes use implicit pricing agree ments to fix prices at the monopoly level because of the legality of explicit price fixing.
One firm in an oli other firms match the price.
Firms can cooperate without gopoly taking the lead in setting prices.
The problem with implicit pricing agreements is that they rely on indirect signals that are often garbled and misinterpreted.
Two firms cooperated for a long time, both sticking to the price.
It is possible that the first firm noticed a change in demand and decided that both firms would benefit from a lower price.
The customer will be paid a percentage of the price gap.
The December price was higher than the November price for each of the 35 types of tires.
A low-price guarantee resulted in higher prices.
A study of the retail tire market suggests that prices are higher in markets where firms offer low-price guarantees.
The exercises 2.5 are related.
In November and December, a Florida tire retailer listed prices for 35 types of tires in the newspaper.
The average price in December was $55.
The first firm may be trying to increase its market share at the expense of the second firm.
The first interpretation would probably cause the second firm to match the lower price of the first firm, and price fixing would continue at the lower price.
The price-fixing agreement could be undermined by the second interpretation.
Learning Objectives 27.3 Simultaneous Decision Making and the Payoff Matrix describe the dilemma of the prisoners.
We have yet to consider a game with sequential decisions.
Jack observes her choice and then makes his own.
An alternative scenario is that the two firms make their decisions at the same time.
There is a payoff matrix for the game.
The payoffs are shown in each cell in the matrix.
In the northwest corner of the matrix, if both firms choose the high price, each earns a profit of $9,000.
In the southeast corner, if both firms choose the low price, each firm will make a profit of $8,000.
If one firm picks the low price and the other picks the high price, the low-price firm earns $12,000 and the high-price firm earns only $3,000.
In the north east corner, if Jack picks the high price andJill picks the low price, both will make a profit.
The payoff matrix can be used to predict the equilibrium of the game.
Jack doesn't know ifJill will pick the low price or the high price in a simultaneous-decision game.
If Jack picks the low price, we will be in the middle of the matrix, and ifJill picks the high price, we will be in the upper half.
The Payoff Matrix for the Price-Fixing Game is red and blue.
Each firm makes a profit of $9,000 if both firms pick a high price.
Each firm will make a profit of $8,000 if they pick the low price.
The low price is $12,000.
He can earn $9,000 if he picks the high price in the northwest corner.
If Jack picks the low price, we will be in the lower half of the matrix.
He can make $8,000 by picking the low price in the southeast corner of the matrix.
He can earn $3,000 if he picks the high price in the southwest corner.
The low price is the main strategy for Jack.
The equilibrium will be in the eastern half of the matrix.
The low price is her best response.
She can earn $8,000 if she chooses the low price in the southeast corner of the matrix.
She can earn $3,000 in the northeast corner if she chooses the high price.
The equilibrium is the same as with the game-tree approach.
The classic pris oners' dilemma can give us some insight into the duopolists' dilemma.
Consider two people who have been accused of committing a crime.
Each person is given an opportunity to confess.
The two are put in separate rooms, and neither knows the other's choice.
In the southeast corner of the matrix, you can see that if both confess, each gets 5 years in prison.
In the northwest corner of the matrix, you can see that the police can convict both of them on lesser charges if neither admits.
The other prisoner will be implicated if only one confessed.
The confessor gets a one-year prison sentence, while the other prisoner gets 10 years.
We are in the southwest corner of the matrix if Bonnie and Clyde confess.
We are in the northeast corner if the roles are reversed.
The payoff matrix can be used to predict the equilibrium of the prisoner game.
If Bonnie does not confess, we are in the upper half of the matrix, and Clyde's best response is to confess.
He gets a year in prison in the northeast corner if he admits to a crime.
He would get 2 years in the northwest corner if he didn't confess.
The prisoners' dilemma is that if neither confessed, they would be worse off than if they did.
If Bonnie admits, we are in the lower half of the matrix.
He gets 5 years in prison in the southeast corner of the matrix.
He would get 10 years in the southwest corner if he didn't confess.