Ch 10

Oligopoly

Features of Oligopoly
1. 2. 3. 4. 5. Imperfect information Homogenous or Heterogeneous Goods Few dominant sellers Strategic interdependent Difficult to Enter

Features of Oligopoly
Oligopoly is another common market structure. Example:
Convenient Stores Supermarkets Gasoline stations Mobile phones Telecommunications Electronic applicants retailers Universities

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

There are many banks in HK

Banks 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 Concentration
There are two commonly used measures of market concentration:
The four-firm concentration ratio (CR4) The Herfindahl-Hirschman Index (HHI)

Four-Firm Concentration Ratio

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 Ratio

Firm A B Four largest firms C D Remaining Industry Sales 950 600 550 300 1000 3400

2400 CR4 = =70.59% 3400

Four-Firm Concentration Ratio

Some evidences to say the mortgage market is an oligopoly

Herfindahl-Hirschman Index
The Herfindahl-Hirschman Index (HHI)
Sum of the squared % market share of the 50 largest firms in the market. < 100 = perfect competition 10,000= Monopoly > 1000 = oligopoly

Herfindahl-Hirschman Index
Firm A B C D E Industry

Market share (%) 35 20 15 15 15 100

HHI = 352 + 202 + 152 + 152 + 152 = 2300

Strategic Interdependent
As there are just few dominant firms in the market, one firms 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 others 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 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 persons choice also depends on the decision of the first decision maker

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

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

Players
The decision makers

Strategies
The choices available to the players

Payoffs
The outcome of their choices

Game Theory
Example: Rock, Paper and Scissor Players:
You and I

Strategies
Rock, Paper and Scissor

Payoffs:
Win, Lose and Draw

Game Theory
Two supermarkets think about advertisement. Welcome and Parkin Shop The following table (Payoff Matrix) shows Parkin Shop their payoffs: Advertise Dont Advertise
Advertise Dont Advertise

Welcome

50; 50 20; 80

80; 20 30; 30

Which strategy should the two firms choose?

Game Theory
Welcome

Nash equilibrium Advertise Dont Advertise

Parkin Shop Advertise Dont Advertise

30; 30 80; 20 20; 80 50; 50 Consider the choice of Welcome (W):

If PS advertises, should advertise. W W If PS does not advertise, should advertise. Advertise is a dominant strategy to W.

Consider the choice of Parkin Shop (PS):

PS As W advertises, should advertise.

Both firms choose to advertise Nash Equilibrium.

Nash Equilibrium
Nash equilibrium
A set of strategies such that each players 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 Equilibrium
Usually, the Nash Equilibrium does not lead to the best outcomes. This situation refers as Prisoner Dilemma. A Example: two criminals think about Confess Dont Confess confession. Confess 5; 5 N.E 0; 12 Cooperative
B Dont Confess

12; 0 1; 1 Eq. Years of being put into jail.

No cooperation!

Why do they end up with the inferior