Ch_10

Ch 10Ch 10

OligopolyOligopoly

Features of OligopolyFeatures of Oligopoly

1. Imperfect information2. Homogenous or Heterogeneous

Goods3. Few dominant sellers4. Strategic interdependent5. Difficult to Enter

Features of OligopolyFeatures of OligopolyOligopoly is another common market structure.Example:

Convenient StoresSupermarketsGasoline stationsMobile phonesTelecommunicationsElectronic applicants retailersUniversities

Features of OligopolyFeatures of OligopolyShould the Banking industry in HK be classified as Oligopoly or Monopolistic Competition?

There are many banks in HKBanks in HK

The no. of firm is not the most important. We should check whether there are some dominant firms.If several firms together take a very large market share, these firms are said to be dominant firms.

Market ConcentrationMarket Concentration

There are two commonly used measures of market concentration:

The four-firm concentration ratio (CR4)

The Herfindahl-Hirschman Index (HHI)

Four-Firm Concentration Four-Firm Concentration RatioRatio

The four-firm concentration ratio (CR4)

The % of sales that are accounted for by the four largest firms in an industry.Ranging from 0% to 100%≈ 0% = perfect competition> 90% = Monopoly> 40% = oligopoly

Four-Firm Concentration Four-Firm Concentration RatioRatio

Firm Sales

A 950

B 600

C 550

D 300

Remaining

1000

Industry 3400

Four largest firms

CR4 =2400

3400=70.59%

Four-Firm Concentration Four-Firm Concentration RatioRatio

Some evidences to say the mortgage market is an oligopoly

Herfindahl-Hirschman Herfindahl-Hirschman IndexIndex

The Herfindahl-Hirschman Index (HHI)

Sum of the squared % market share of the 50 largest firms in the market.< 100 = perfect competition10,000= Monopoly> 1000 = oligopoly

Herfindahl-Hirschman Herfindahl-Hirschman IndexIndex

Firm Market share (%)

A 35

B 20

C 15

D 15

E 15

Industry 100HHI = 352 + 202 + 152 + 152 + 152

= 2300

Strategic InterdependentStrategic InterdependentAs there are just few dominant firms in the market, one firm’s action will have a great effect on others.The other seller will then react to this action.This refers to Strategic Interdependent.As firms react to other’s action, they do not make their own output and pricing decision based on their own demand and cost curves.Without any information about the probable reaction of the competitors, the firm cannot set its own output and price.The analysis of firms’ behaviour under oligopoly requires knowledge on Game Theory.

Game TheoryGame Theory

Strategic interdependence a decision maker encounter a situation in which the outcome of his choice is tied to the choice of another, while the outcome of the other person’s choice also depends on the decision of the first decision maker

Game theory is a technique that is used to analyze the situation.

Game TheoryGame TheoryGame

Any situation in which individuals and their counterparts have to interact strategically to determine their outcomes

PlayersThe decision makers

StrategiesThe choices available to the players

PayoffsThe outcome of their choices

Game TheoryGame TheoryExample: Rock, Paper and Scissor Players:

You and I

StrategiesRock, Paper and Scissor

Payoffs:Win, Lose and Draw

Game TheoryGame TheoryTwo supermarkets think about advertisement.Welcome and Parkin’ ShopThe following table (Payoff Matrix) shows their payoffs:

Which strategy should the two firms choose?What is the Equilibrium?

AdvertiseAdvertise

Don’t Advertise

Don’t AdvertiseWel

com

e

Parkin’ Shop

50; 5030; 3080; 20

20; 80

Game TheoryGame Theory

Consider the choice of Welcome (W):If PS advertises, If PS does not advertise, Advertise is a dominant strategy to W.

Consider the choice of Parkin’ Shop (PS):As W advertises,

Both firms choose to advertise – Nash Equilibrium.

AdvertiseAdvertise

Don’t Advertise

Don’t AdvertiseWel

com

e

Parkin’ Shop

30; 3050; 5080; 20

20; 80

W should advertise.W should advertise.

PS should advertise.

Nash equilibrium

Nash EquilibriumNash EquilibriumNash equilibrium

A set of strategies such that each player’s strategy is the best choice, given the strategy that is chosen by the other player.Given that W is going to advertise, PS chooses the best option (advertise).Given that PS is going to advertise, W chooses the best option (advertise).A Nash equilibrium does not necessarily involve a dominant strategy

Nash EquilibriumNash EquilibriumUsually, the Nash Equilibrium does not lead to the best outcomes. This situation refers as “Prisoner Dilemma”.Example: two criminals think about confession.

Why do they end up with the inferior outcomes?

ConfessConfess

Don’t Confess

Don’t ConfessB

A

5; 51; 10; 12

12; 0

Years of being put into jail.

N.E

No cooperation!

Cooperative Eq.