Oligopoly
Justice Department Concentration Categories
-A market is considered unconcentrated if HHI is below 1500. -A market is considered moderately concentrated if HHI is between 1500 and 2500. -A market is considered highly concentrated if HHI is above 2500.
Three Types of Mergers
-Horizontal -Vertical -Conglomerate
Traits of an Oligopoly
-few firms -either homogeneous or differentiated products -interdependence of firms - policies of one firm affect the other firms -substantial barriers to entry examples: auto industry and cigarette industry
Collusion and Competition
-firms may collude (act as a monopoly) and earn positive profits -oligopolists may compete with each other and drive prices down to where profit are zero
Collusion is less likely to succeed when...
-secret price cuts are difficult and costly to detect. (Quality changes are difficult to monitor.) -market conditions are unstable. (Differences in expectations make it difficult to reach an agreement.) -vigorous antitrust action increases the cost of collusion.
Kinked demand curve model of oligopoly
1. If a firm raises prices, other firms won't follow and the firm loses a lot of business. So demand is very responsive or elastic to price increases. 2. If a firm lowers prices, other firms follow and the firm doesn't gain much business. So demand is fairly unresponsive or inelastic to price decreases.
Example of HHI
Consider again our seven-firm market. (shares: 5 5 10 10 20 25 25 ) Then the HHI would be HHI = 52 + 52 + 102 + 102 + 202 + 252 + 252 = 1900
Example of Four-Firm Concentration Ratio
Example: The four largest firms in the car rental industry account for 94% of all car rentals in the U.S. So, the four-firm concentration ratio for the car rental industry is 94.
Justice Department Horizontal Merger Guidelines
I. After merger HHI < 1,500 (market remains unconcentrated): Mergers are not challenged. II. After merger HHI is between 1500 & 2500 (moderately concentrated): a. Increase in HHI< 100: merger probably will not be challenged. b. Increase in HHI > 100 may be challenged. III. After merger HHI > 2500 (highly concentrated): a. Increase in HHI < 100: merger probably will not be challenged. b. Increase in HHI is between 100 & 200: merger may be challenged. c. Increase in HHI > 200: merger will likely be challenged.
Another Example of Four-Firm Concentration Ratio
Suppose a market consists of seven firms with the following shares: 5 5 10 10 20 25 25 The four firm concentration ratio would be CR = 25 + 25 + 20 + 10 = 80
Faults with collusion
While it pays for firms to collude, in order to earn positive profits, it also pays to cheat on the collusive agreement. If one firm cuts its price to slightly below the others, it could gain a lot of business. If everyone cheats on the agreement, however, the agreement falls apart.
Examples of an Oligopoly
auto industry and cigarette industry
Herfindahl-Hirschman Index (HHI)
measures the extent to which a market is dominated by a few firms. HHI = s12 + s22 + s32 + ... + sn2 where s12 is the square of the share of firm 1, and there are n firms.
Four-Firm Concentration Ratio
percentage of total industry sales accounted for by the four largest firms of an industry
Profit Possibilities in long run
positive profits or breaking even
Profit Possibilities in short run
positive profits, losses, or breaking even
price leadership
single firm sets industry price and the remaining firms charge the same price as the leader
Horizontal Merger
the combination under one ownership of the assets of two or more firms engaged in the production of similar products example: two steel manufacturing companies merging
Conglomerate Merger
the combining under one ownership of two or more firms that produce unrelated products example: a tire manufacturer and a coffee company merging
Vertical Merger
the creation of a single firm from two firms, one of which was a supplier of the other example: a lumber company and a builder merging
