2. Need curve and mutual interdependence

3. Empirical procedures of oligopoly

4-firm concentration ratio

Herfindahl-Hirschman Index

4. Oligopoly vs monopolistic competition 5. Cournot solution: (assume the rival will not adjust his out) 6. Reaction functions 7. Bertrand solution (assume the rival will certainly not adjust his price) 8. Stackelberg solution (Leader-follower equilibrium)

1. Entry obstacles to Oligopoly
Market organizations
In the spectrum of industry structures, there room two extremes. In regards to the variety of firms, syndicate is at one finish of the market, and also perfect vain lies at the other end. Monopolistically competitive markets and also oligopolistic industries lie somewhere between these 2 extremes.

You are watching: When general mills and a few other firms dominate the american cereal market, this is an example of

Definition “Oligopoly” originates from the Greek words, oligos = few, polein = selling. Thus, that is a industry structure in which (i) there are a few sellers who room price setters. (ii) common interdependence exists amongst firms.
Entry barriers Some entry barariers. If there to be no entry barriers, there would be lots of firms. There have to be significant entry obstacles so that just a few sellers get over the barriers.
role that patents

Patents cannot be permanent entry barriers.

Patent protection last just 17 years. Copycats go into the market sooner or later.

Oligopoly occurs from huge capital costs or urbanbreathnyc.comomies of scale.

Some firms get over the hurdle while others don\"t. Accordingly, just a few firms survive.

WIPO, Geneva

World intellectual Property company (WIPO)

WIPO was produced in 1967 to promote defense of pundit property. That is a UN agency, headquartered in Geneva. WIPO joined the UN in 1974.

International patent system starts operation in 1978. Arbitration and Mediation facility (AMC) is created in 1994.

Homogeneous oligopoly


Product differentiatiation is not straightforward in fruits and also vegetables.

Three firms, Chiquita, Dole and Del Monte, own huge banana plantations in central America, and also control 65% of world banana exports.

TNC = transnational company

Other examples: cement, steel, aluminum, chemistry producers

e.g., hydrogen fluorides are provided to etch silicon wafers. Purity is required.

Heterogeneous Oligopoly

Most oligopolies identify their products from the competition.

Most air paths are offered by only two or three airlines.

Most cola beverages are marketed by Coca-cola and also Pepsi.

2. Demand Curve

How perform oligopolists separation the sector demand?

There is lot uncertainty, because the behaviors of other firms room not predictable.

How to predict the outcome

Certain assumptions are made about the behavior of oligopolists come predict prices and outputs.

Mutual Interdependence

One\"s price and also output cannot be predicted independent of the prices and outputs of various other oligopolists.

An oligopolist\"s demand and MR rely on what the competitor firms do.

Thus, the is essential to make assumptions around what the rivals will do.

Examples the oligopolies


Commercial airplanes: Boeing, Airbus, McDonell Douglas, Lockheed

Cereals: Kellogg\"s, basic Mills, Quaker Foods, Posts

other examples: passenger cars, cigarettes, soft drinks.


soft drinks: Coca-cola, Pepsi, 7-up.

Augustiner-Keller beergarten, Munich

Tools the competition

price, output are key tools

Quality,innovation, commercial spying, bribes, and also other illegal means, etc.

Oligopoly is like the Olympic games yet without rules.

Cooperative games

Some oligopolists cooperate and also agree ~ above prices and also outputs.

Explicit cooperative agreements are illegal.

Noncooperative games

Others do not cooperate.

Some agree on policies and also cheat.

Noncooperative oligopoly is prefer a war among states, and anything goes.

If Pepsi introduces diet cola, it has actually to consider the reaction of Coca-cola in a noncooperative game.

1. I beg your pardon of the complying with markets are oligopolistic? a. Corn b. Funeral services c. Airline take trip d. Hamburgers e. Gasoline f. Breakfast cereals

Answer: The adhering to markets space oligopolistic: b. Funeral services, c. Airline travel, e. Petrol (but there are over 100 oil firms), and also f. Breakfast cereals.

2. Which of the complying with are properties of oligopolistic industries? a. A large number of firms b. A couple of firms c. A high level of product differentiation d. High barriers to entry e. Cost-free entry and also exit f. Mutual interdependence

Answer: Oligopolistic sectors are defined by b) a few firms which space f) mutually interdependent. In addition, the d) obstacles to entrance are regularly quite high.

3. Empirical actions of Oligopoly

How do we distinguish oligopoly native competitive markets?

There are an ext than 100 oil carriers in the US.

Is the us oil industry oligopolistic or competitive?

4 certain concentration ratio (CR4)

The 4-firm concentration proportion is the percentage of market output created by the industry\"s biggest 4 firms.

This ratio varies from 0 to 100. If that is nearly zero, the industry is competitive.

If it is 100, the 4 firms consist of the whole industry.

The higher the index, the much less competitive the sector is.

8-firm concentration ratio (CR8) This is also commonly used.
examples 4-firm concentration ratios, united state 2007

> 80% high CR

tight oligopoly

cigarettes 98%

beer 90%

computers 87%

aircraft 81%

discount department shop 97%

Medium CR (>50%)

electronic shop 70%

athletic footwear shop 68%

pharmacies/drugstores 63%

dog and also cat food 71%

automobiles 68%

Low CR (0 - 50%), 1982

petroleum 28%

pharmaceuticals 26%

women\"s costume 6%

nuts and also bolts 13%

cigarette brands

Hirfindahl-Hirschman table of contents (used in merger cases)

HHI = s12 + s22 + s32 + ... (market share are often expressed as whole numbers, i.e., 50% ⇒ is created as 50).

HHI is the amount of market shares squared. If four firms had actually equal shares, HHI would be 625×4 = 2500.

HHI or (simply the Herfindahl index) can range from 0 to 10000, inclusive (HHI is 10000 when there is a single firm). Horizontal mergers rise HHI.

below 100 ⇒ the market is extremely competitive

below 1500 ⇒ market is no concentrated

below 2500 ⇒ industry is middle concentrated

above 2500 ⇒ sector is highly concentrated (mergers increasing HHI by more than 200 points advanced antitrust concerns.)

The Antitrust department of the justice department would monitor merger if HHI above 2500. In oil mergers (e.g., BP/Amoco in 1998) the HHI ranged 1500-3600. FTC approved.


Horizontal merger: consolidation of 2 or an ext firms in the exact same industry.

Vertical merger: consolidation of 2 or an ext firms that have actually buyer-seller connection (one\"s calculation is an input of an additional firm, e.g., tire and also car companies)

Vertical mergers often tend to it is in neutral or procompetitive (i.e., carry out not raise the Herfindahl index).

Conglomerate merger: any type of merger of unrelated businesses (e.g., Walt Disney and also American transfer Company). This form of mergers is neutral.

4. Oligopoly versus Monopolistic Competition

Paul Krugman received a Nobel prize in urbanbreathnyc.comomics for his donation to the theory of monopolistic competition.


(i) Oligopoly exists since of far-reaching entry barriers, e.g., urbanbreathnyc.comomies the scale.

Accordingly, relatively couple of sellers conquer the industry.

In monopolistic competition, entrance is free, and also a big number of firms complete one another.

product differentiation

(ii) In theory, there room homogeneous oligopoly and also differentiated oligopoly.

In practice, there are a few industries in i m sorry oligopolists market homogenous products.

In a monopolistically vain market, commodities are differentiated.

Mutual dependence (iii) Firms room not support interdependent in a monopolistically competitive market.

(iv) In oligopoly, prices are reasonably stable; they execute not adjust frequently, except when there space price battles or as soon as there is collusive price fixing.

In a monopolistically competitive market, price can change frequently.

5. Cournot Solution

The French math urbanbreathnyc.comomist Antoine Cournot released his theory of duopoly in 1838.

Although most of his models were crude and involved an extremely unrealistic assumptions, his method of evaluation has been advantageous for subsequent theoretical advance in the area the oligopoly.


Two-player game

Boeing vs Airbus

Coca-cola vs Pepsi


two-person game Cournot’s design is a really special example of a two-person game. Even when there are two players, in the real civilization there space no rules. Competition in between Coca-cola and also Pepsi is not a sequential game.

Cournot’s model is an example of games in i m sorry players make moves sequentially, e.g., chess and also igo.

weiqi/igo/baduk, a two-player, sequential game (Shutterstock)

If there room two players, A and B, A makes the an initial move, A1, climate B responds by picking B1. In the surbanbreathnyc.comd round, they choose A2 and B2, and so on. That is prefer playing chess.

multiple moves

In the real world, a player deserve to make numerous moves at a time, as in boxing.

If several actions have the right to be combined as one move, the design applies.

assumptions 1. There are two profit-maximizing duopolists. 2. Both duopolists create an the same product. (homogeneous product) 3. Duopolists act individually without collusion. (noncooperative game) 4. Each duopolist assumes that the rival\"s calculation will stay unchanged.

When the video game is played countless times, the players will soon learn that rivals almost always respond.

The last presumption is very naïve since it means that the duopolists do not discover from experience. However this presumption gives a deterministic equipment to the problem.

homogenous oligopoly

In Cournot\"s example, two firms create mineral water indigenous two adjacent springs, produced at zero marginal cost.


Heterogeneous duopoly

Airbus vs Boeing (manufacturers of big aircrafts)

(source: Shutterstock)

First Round,

morning and also afternoon

The very first Round In the morning, for sure #1 opens his business, offering mineral water. Production price is zero, and also hence marginal cost is likewise zero. Each customer brings his bottles. His need curve has actually a vertical intercept, equal to 1, and the horizontal intercept is additionally 1. Native this demand curve, certain #1 derives mr curve, which intersects MC in ~ q = ½. Price is also ½.

In the afternoon, firm #2 inspects the market and also assumes for sure #1’s calculation is ½. Thus, that sees the remaining (blue) area as his need curve. His mr curve intersects MC curve at q = ¼. His price is additionally ¼.


morning, surbanbreathnyc.comd day In the morning, firm #1 recognizes Firm #2 has gone into the market, noticing his calculation (1/4). He subtracts this native the whole market. Firm #2 perceives that his need curve now has a vertical intercept, ¾ (= 1 – ¼). The brand-new MR curve intersects MC curve at q = 3/8. Accordingly, price is same to 3/8.


afternoon, surbanbreathnyc.comd day

In the afternoon, firm #2 notices the Firm #1 decreased his output by 1/8.

Accordingly, firm #2 perceives his demand curve boosted to 5/8 (= 1 –3/8). Equating the new MR curve through MC, he produces q2 = 5/16.


You now notice that in the surbanbreathnyc.comd round, for sure #1 decreased his output and Firm #2 enhanced his output. On the 3rd round, for sure #2 again notices the Firm #1 increased output and adjusts is production, and also Firm #2 responds come this change. This procedure goes on and also on.

6. Reaction Functions
Reaction function

RF is additionally called the best an answer function.

Due to interdependence, for sure 1\"s profit relies not just on its calculation but additionally on that rival\"s output, π(X,Y). Likewise, certain 2\"s profit depends on the outputs that both firms, Π(X,Y).

For instance, certain 1\"s reaction duty X(Y) is that is best solution to certain 2\"s output Y. The is, for any kind of given output Y, certain 1 choose its best output, which maximizes for sure 1\"s profit. This implies that certain 1\"s isoprofit curve is tangent to horizontal line.


Note the X(Y) is negative sloped. The is,

firm 1 reduces its output X as Y increases.

Likewise, we can derive for sure 2\"s reaction curve Y(X), which is also negatively sloped.

That is, firm 2 reduce its calculation Y together X increases.

Cournot equilibrium

Cournot Equilibrium is the intersection of 2 reaction curves: X(Y) and also Y(X). The is, in ~ the Cournot equilibrium, neither side wants to change. If #1 chooses X then #2 choose Y. If #2 choose Y, climate #1 choose X. Thus, as soon as they come at (X,Y), they space in equilibrium.

Since it is a noncooperative systems that was cleared up by man Nash, that is likewise called Cournot-Nash equilibrium.



when a player alters his output, the rival practically always responds and also changes his output.

Only at Cournot equilibrium, neither side wishes to change.

Nevertheless, every player assumes his competitor does not change his output. Neither player learns anything indigenous experience.

Why should output be the decision variables?

7. Bertrand Equilibrium
Price or Quantity Cournot’s model is based on the assumption that duopolists use quantity as the strategic variable. Cournot\"s assumption that every firm believes the the rival firm will certainly not change its calculation was criticized by a French mathematician Joseph Bertrand in his testimonial of Cournot\"s publication in 1883.

(i) Bertrand said that a an ext realistic presumption is that each certain believes that the rival firm will not adjust its price.

(ii) he further added the presumption that each duopolist has sufficient capacity to accomplish the entire market.

To do the story an ext interesting, assume the the duopolists have constant costs, i.e., average price is equal to marginal cost. In this case, firm i starts v the monopoly price. For sure II then enters the industry reducing the price somewhat, and also captures the whole market.

Firm ns then lowers the price below that of certain II, and also captures the entire market and so on. Finally, the price war ends at suggest B (Bertrand point), whereby price is MC because that both firms, and the full output is same to the competitive market. When price is same to marginal cost, neither firm have the right to undercut the rival, because it would be occurs a loss.

Reaction curve q(p) is slightly below the 45 degree line (not drawn) as Firm 1 fees a price slightly listed below that that its rival. Similarly, p(q) is slightly above the 45 level line.

Result Due to price competition, price converges come the compete level (unit Cost).

Stackelberg\"s Solution

A German urbanbreathnyc.comomist Heinrich von Stackelberg released \"Marktform und Gleichgewicht\" (Market structure and equilibrium) in 1934. At the moment Hitler came to be the Führer. Afterward, German unemployment decreased from 30% to nearly zero in 1938. That was exceptionally popular, although he met one ignominious fatality a couple of years later.

President Hindenburg passed away on august 2, 1934, and also Hitler unified the two positions (chancellor and president), and called that Führer. Stackelberg may have been inspired by this event.


Two players:

(i) leader (Führer): choose the best suggest along the follower\"s best an answer curve.

(ii) monitor (nachfolger): offers his best an answer function


The leader is better off at Stackelberg\"s leader-follower equilibrium 보다 at the Cournot equilibrium.

The follower is worse turn off


Stackelberg\"s leader-follower equilibrium requires coordination or cooperation in between the two players.

If both desire to be pendant (using best response functions), they come at the Cournot solution.

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If both want to it is in leaders, there is no equilibrium. Both firms produce an ext than at the Cournot equilibrium, and price falls listed below that in ~ the Cournot equilibrium.