Market Structure on Imperfect Competition II

Oligopoly = market with a small number of large firms whose actions materially affect each other.

Characteristics:

• Few large firms.
• STRATEGIC INTERDEPENDENCE (each firm considers rivals' likely response).
• High barriers to entry (capital, brand, patents, scale economies).
• Differentiated or homogeneous products.

Examples: smartphones (Apple, Samsung, Google), aviation (Boeing, Airbus), oil majors, soft drinks (Coca-Cola, Pepsi), supermarkets in many countries.

Kinked demand curve (Sweezy 1939). Explains price rigidity:

• If a firm RAISES price, rivals WON'T match → firm loses share → demand ELASTIC above current P.
• If firm LOWERS price, rivals WILL match → no share gain → demand INELASTIC below current P.

Result: kink at current P. MR has a vertical gap at that quantity. Within the gap, even moderate cost changes don't change profit-max output → PRICE RIGIDITY.

Game theory and prisoner's dilemma. Two firms choosing between cooperate (high price) and defect (low price).

	B cooperates	B defects
A cooperates	$80,$80	$10,$100
A defects	$100,$10	$30,$30

• A's dominant strategy: defect (better off whatever B does).
• B's dominant strategy: defect.
• NASH equilibrium: both defect → both get $30.
• BOTH would be better off if both cooperated ($80 each) — but each individually prefers to defect → trapped at bad outcome.

Collusion to escape this trap:

• Cartel (explicit agreement) — like OPEC for oil.
• Tacit collusion — silent coordination (price leadership).

Most jurisdictions BAN cartels because they raise prices and harm consumers (EU Competition Law, US antitrust).

Non-price competition. Without competing on price, oligopolists compete via:

• Advertising.
• Product differentiation.
• Customer service.
• R&D.

Monopoly.

Single firm dominates market. Causes (barriers to entry):

• Legal — patents, copyrights, licences.
• Natural — production technology with declining LRAC means single firm produces most cheaply (rail, water).
• Economies of scale — incumbents have cost advantages.
• Control of essential resources — De Beers historically with diamonds.
• Network effects — value depends on number of users (search engines, social media).

Monopoly equilibrium. Profit max at MR = MC. Because D slopes down, P > MR. Therefore at profit-max output: P > MC → allocative inefficiency.

Monopoly outcomes vs PC outcomes:

• Higher price.
• Lower quantity.
• Supernormal profit (sustained in LR due to barriers).
• DEADWEIGHT LOSS (welfare not captured).
• Potential X-inefficiency (lazy management).

Natural monopoly. Where LRAC declines over the relevant output range — one firm produces most efficiently. Examples: rail networks, water utilities, electricity grids.

• Breaking up natural monopoly duplicates infrastructure → higher costs.
• Better to REGULATE (price caps, quality standards).

Price discrimination (HL extension):

• First degree (perfect): charge each consumer their maximum WTP. Captures entire CS as PS.
• Second degree: different prices for different quantities (bulk discounts).
• Third degree: different prices to different MARKETS (student discounts, peak/off-peak).

Requires market power + ability to separate markets + prevent resale.

Policy responses to market power:

• Antitrust — block anti-competitive mergers, break up monopolies (AT&T 1984, Standard Oil 1911).
• Regulation — price caps, quality standards.
• Public ownership — government provides the monopoly service.
• Promote competition — reduce barriers, allow entrants.