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