Explain why and also how oligopolies existContrast collusion and competitionInterpret and analyze the prisoner’s dilemma diagramEvaluate the tradeoffs that imperfect competition

Many to buy that people make at the sleeve level are produced in sectors that are neither perfect competitive, monopolies, nor monopolistically competitive. Rather, they space oligopolies. Oligopoly arises as soon as a little number of large firms have all or many of the sales in an industry. Examples of oligopoly abound and also include the auto industry, cable television, and also commercial waiting travel. Oligopolistic that company are choose cats in a bag. They can either scrape each various other to pieces or cuddle up and also get comfortable with one another. If oligopolists contend hard, they may finish up acting very much prefer perfect competitors, driving down costs and also leading to zero earnings for all. If oligopolists collude through each other, lock may effectively act like a monopoly and succeed in advertise up prices and also earning repeatedly high level of profit. Oligopolies are typically defined by common interdependence where various decisions such as output, price, advertising, and also so on, count on the decisions of the other firm(s). Assessing the options of oligopolistic firms around pricing and also quantity created involves considering the pros and also cons of competition matches collusion at a given suggest in time.

You are watching: Which of the following is the best example of an oligopolistic industry?

Why carry out Oligopolies Exist?

A mix of the obstacles to entrance that produce monopolies and the product differentiation the characterizes monopolistic vain can develop the setup for one oligopoly. For example, as soon as a government grants a patent for an innovation to one firm, that may develop a monopoly. As soon as the government grants patents to, for example, three various pharmaceutical providers that each has actually its very own drug because that reducing high blood pressure, those 3 firms may end up being an oligopoly.

Similarly, a natural monopoly will certainly arise as soon as the quantity demanded in a industry is only big enough because that a solitary firm to operate at the minimum the the long-run average price curve. In such a setting, the market has room for just one firm, due to the fact that no smaller firm can operate at a low sufficient average cost to compete, and no bigger firm could sell what it produced given the quantity demanded in the market.

Quantity demanded in the industry may additionally be two or three times the quantity required to produce at the minimum the the average cost curve—which method that the sector would have actually room for only two or 3 oligopoly this firm (and they need not produce differentiated products). Again, smaller firms would certainly have higher average costs and also be can not to compete, while additional big firms would develop such a high amount that they would not have the ability to sell it at a financially rewarding price. This mix of economic climates of scale and also market demand creates the obstacle to entry, which caused the Boeing-Airbus oligopoly for large passenger aircraft.

The product differentiation in ~ the heart of monopolistic competition can additionally play a duty in developing oligopoly. Because that example, firms might need to with a certain minimum size prior to they room able to spend enough on advertising and also marketing to produce a recognizable brand name. The problem in contending with, say, Coca-Cola or Pepsi is not that producing fizzy drinks is technologically difficult, however rather that developing a brand name and marketing effort to same Coke or Pepsi is an huge task.

Collusion or Competition?

When oligopoly that company in a certain market decision what quantity to produce and also what price to charge, they confront a temptation to act together if they were a monopoly. By exhilaration together, oligopolistic firms deserve to hold down sector output, fee a higher price, and also divide increase the profit among themselves. Once firms act together in this way to minimize output and keep price high, that is dubbed collusion. A team of that company that have actually a formal commitment to collude to create the syndicate output and also sell at the syndicate price is referred to as a cartel. View the adhering to Clear that Up function for a an ext in-depth evaluation of the difference between the two.


Collusion versus cartels: How deserve to I call which is which?

In the joined States, and many various other countries, the is illegal for firms come collude due to the fact that collusion is anti-competitive behavior, i beg your pardon is a violation the antitrust law. Both the Antitrust department of the justice Department and the Federal trade Commission have responsibilities for staying clear of collusion in the united States.

The difficulty of enforcement is detect hard evidence of collusion. Cartels are formal agreements to collude. Because cartel agreements provide evidence the collusion, they room rare in the joined States. Instead, many collusion is tacit, where firms implicitly reach an knowledge that vain is negative for profits.


The desire of businesses to avoid completing so the they can instead raise the prices that they charge and also earn greater profits has been well interpreted by economists. Adam Smith composed in Wealth of Nations in 1776: “People of the exact same trade seldom meet together, also for merriment and also diversion, yet the conversation ends in a conspiracy versus the public, or in some contrivance to raise prices.”

Even when oligopolists identify that they would advantage as a group by acting choose a monopoly, every individual oligopoly deals with a personal temptation to create just a slightly greater quantity and also earn slightly higher profit—while still counting top top the other oligopolists to organize down their production and also keep prices high. If at least some oligopolists provide in to this temptation and also start developing more, then the sector price will certainly fall. Indeed, a little handful the oligopoly this firm may end up completing so fiercely the they all finish up earning zero economic profits—as if they to be perfect competitors.

The Prisoner’s Dilemma

Because that the intricacy of oligopoly, i beg your pardon is the result of shared interdependence among firms, there is no single, generally-accepted theory of exactly how oligopolies behave, in the same method that we have actually theories for all the other market structures. Instead, economists use game theory, a branch of mathematics that analyzes cases in i beg your pardon players have to make decisions and then get payoffs based upon what other players decision to do. Video game theory has found widespread applications in the society sciences, and also in business, law, and military strategy.

The prisoner’s dilemma is a scenario in which the profit from participation are bigger than the rewards from follow self-interest. It applies well come oligopoly. The story behind the prisoner’s dilemma goes like this:


Two co-conspiratorial criminals space arrested. As soon as they room taken come the police station, they refuse come say anything and are put in separate interrogation rooms. Eventually, a police officer enters the room whereby Prisoner A is gift held and says: “You understand what? Your partner in the various other room is confessing. So your companion is walk to get a light prison sentence of just one year, and also because you’re staying silent, the judge is going to stick you with eight year in prison. Why don’t you obtain smart? If you confess, too, we’ll reduced your jail time down to 5 years, and also your partner will get five years, also.” end in the following room, one more police officer is giving specifically the same speech to prisoner B. What the police officers do not say is the if both prisoners remain silent, the evidence against them is not especially strong, and also the detainees will finish up with just two year in jail each.

The video game theory instance facing the two detainees is displayed in Table 3. To recognize the dilemma, first consider the choices from sinner A’s point of view. If A believes the B will certainly confess, climate A must confess, too, so as to not get stuck through the eight years in prison. But if A believes the B will certainly not confess, then A will be tempted to act selfishly and also confess, so as to serve only one year. The key point is the A has an incentive to confess regardless of what choice B makes! B deals with the same collection of choices, and also thus will have actually an inspiration to confess regardless of what selection A makes. Confess is taken into consideration the leading strategy or the strategy an separation, personal, instance (or firm) will seek regardless of the other individual’s (or firm’s) decision. The an outcome is that if detainees pursue their own self-interest, both are most likely to confess, and also end up doing a complete of 10 year of jail time in between them.

Prisoner B
Remain silent (cooperate with other prisoner)Confess (do not cooperate with other prisoner)
Prisoner ARemain silent (cooperate with various other prisoner)A it s okay 2 years, B gets 2 yearsA gets 8 years, B gets 1 year
Confess (do no cooperate with various other prisoner)A it s okay 1 year, B gets 8 yearsA gets 5 year B gets 5 years
Table 3. The Prisoner’s Dilemma Problem

The video game is referred to as a dilemma because if the two prisoners had cooperated through both continuing to be silent, they would just have had to serve a full of 4 years of jail time between them. If the 2 prisoners have the right to work the end some method of cooperating so that neither one will confess, they will certainly both be better off 보다 if they each follow their own individual self-interest, i m sorry in this instance leads straight right into longer prison terms.

The Oligopoly variation of the Prisoner’s Dilemma

The members of one oligopoly can challenge a prisoner’s dilemma, also. If each of the oligopolists cooperates in holding under output, climate high monopoly profits space possible. Each oligopolist, however, must worry that while that is holding down output, other firms are taking benefit of the high price by increasing output and earning greater profits. Table 4 reflects the prisoner’s dilemma for a two-firm oligopoly—known as a duopoly. If this firm A and B both agree to host down output, they space acting together as a syndicate and will certainly each earn $1,000 in profits. However, both firms’ leading strategy is to increase output, in which instance each will earn $400 in profits.

Firm B
Hold down Output (cooperate with various other firm)Increase calculation (do not cooperate with various other firm)
Firm AHold down Output (cooperate with various other firm)A it s okay $1,000, B gets $1,000A it s okay $200, B gets $1,500
Increase calculation (do not cooperate with other firm)A it s okay $1,500, B it s okay $200A gets $400, B it s okay $400
Table 4. A Prisoner’s Dilemma for Oligopolists

Can the two firms to trust each other? think about the situation of for sure A:

If A thinks the B will cooperate by holding under output, climate A may seize the opportunity to earn greater profits by raising output. ~ all, if B is going to organize down output, climate A deserve to earn $1,500 in revenues by widening output (the bottom left-hand selection in the table) contrasted with just $1,000 by holding down output as well (the upper left-hand an option in the table).

Thus, certain A will factor that it renders sense to broaden output if B holds under output and that it also makes feeling to increase output if B raises output. Again, B encounters a parallel collection of decisions.

The an outcome of this prisoner’s dilemma is often that even though A and B could make the highest linked profits through cooperating in producing a lower level of output and also acting favor a monopolist, the 2 firms might well finish up in a situation where castle each rise output and earn only $400 every in profits. The complying with Clear that Up feature discusses one cartel scandal in particular.


What is the Lysine cartel?

Lysine, a $600 million-a-year industry, is one amino acid offered by farmers together a feeding additive come ensure the suitable growth that swine and also poultry. The main U.S. Producer of lysine is Archer Daniels Midland (ADM), but several other big European and also Japanese this firm are additionally in this market. For a time in the an initial half the the 1990s, the world’s significant lysine producer met with each other in hotel conference rooms and also decided exactly how much each firm would sell and what it would charge. The U.S. Federal Bureau of examination (FBI), however, had learned that the cartel and placed cable taps top top a variety of their phone calls and meetings.

From FBI monitoring tapes, following is a comment that terry Wilson, president of the corn processing department at ADM, made to the other lysine producer at a 1994 meeting in Mona, Hawaii:


I wanna go ago and ns wanna speak something really simple. If we’re walking to trust each other, okay, and if i’m assured the I’m gonna acquire 67,000 loads by the year end, we’re gonna offer it in ~ the prices us agreed come . . . The only thing we must talk about there because we room gonna get manipulated by this buyers—they deserve to be smarter than united state if we let them it is in smarter. . . . Castle are not your friend. They are not mine friend. And we gotta have actually ‘em, however they are not my friends. You space my friend. Ns wanna be closer come you than I to be to any customer. Reason you deserve to make united state … money. … and all ns wanna tell you again is let’s—let’s placed the prices on the board. Let’s every agree it is what we’re gonna do and then walk out of here and do it.

The price of lysine doubled while the cartel was in effect. Confronted by the FBI tapes, Archer Daniels Midland pled guilty in 1996 and paid a well of $100 million. A number of top executives, both in ~ ADM and other firms, later on paid fines of up to $350,000 and also were sentenced to 24–30 month in prison.

In an additional one of the FBI recordings, the chairman of Archer Daniels Midland told an executive from one more competing firm that ADM had a slogan that, in his words, had “penetrated the entirety company.” The company president declared the slogan this way: “Our rivals are our friends. Ours customers room the enemy.” that slogan can stand together the motto that cartels everywhere.


How come Enforce Cooperation

How deserve to parties who uncover themselves in a prisoner’s dilemma instance avoid the undesired outcome and also cooperate through each other? The method out the a prisoner’s dilemma is to uncover a method to penalize those who perform not cooperate.

Perhaps the easiest technique for colluding oligopolists, together you can imagine, would certainly be to sign a contract through each various other that castle will hold output low and also keep price high. If a group of U.S. Service providers signed such a contract, however, it would certainly be illegal. Particular international organizations, favor the countries that space members the the Organization of Petroleum Exporting nations (OPEC), have signed global agreements to act favor a monopoly, hold down output, and keep prices high for this reason that all of the nations can make high revenues from oil exports. Such agreements, however, because they autumn in a gray area of global law, space not legit enforceable. If Nigeria, because that example, decides to begin cutting prices and also selling much more oil, Saudi Arabia can not sue Nigeria in court and force it come stop.


Visit the organization of the Petroleum Exporting nations website and also learn an ext about its history and exactly how it defines itself.

\"*\"


Because oligopolists cannot sign a legitimate enforceable contract come act favor a monopoly, the this firm may rather keep close tabs on what other firms room producing and charging. Alternatively, oligopolists may choose to action in a way that generates push on every firm to stick come its agreed amount of output.

One instance of the pressure these firms can exert top top one an additional is the kinked need curve, in which completing oligopoly that company commit to complement price cuts, but not price increases. This instance is presented in figure 1. Say that an oligopoly airline has actually agreed v the remainder of a cartel to administer a amount of 10,000 seats on the brand-new York come Los Angeles route, in ~ a price that $500. This an option defines the kink in the this firm perceived demand curve. The reason that the firm encounters a kink in its need curve is due to the fact that of how the other oligopolists reaction to changes in the that company price. If the oligopoly decides to produce an ext and cut its price, the other members of the cartel will automatically match any price cuts—and therefore, a lower price bring very little increase in quantity sold.

If one firm cuts its price come $300, that will have the ability to sell just 11,000 seats. However, if the airline looks for to advanced prices, the various other oligopolists will certainly not raise your prices, and also so the certain that increased prices will lose a significant share the sales. Because that example, if the certain raises its price to $550, the sales drop come 5,000 seat sold. Thus, if oligopolists constantly match price cut by various other firms in the cartel, but do not match price increases, climate none of the oligopolists will have actually a solid incentive to readjust prices, due to the fact that the potential gains are minimal. This strategy can work like a silent kind of cooperation, in i m sorry the cartel properly manages to organize down output, boost price, and share a monopoly level of profits also without any legally enforceable agreement.

\"*\"
Figure 1. A Kinked demand Curve. Consider a member for sure in an oligopoly cartel that is supposed to produce a quantity of 10,000 and sell in ~ a price that $500. The various other members of the cartel have the right to encourage this for sure to respect its commitments by exhilaration so the the firm deals with a kinked need curve. If the oligopolist attempts to broaden output and also reduce price slightly, other firms also cut prices immediately—so if the firm broadens output come 11,000, the price per unit drops dramatically, come $300. ~ above the various other side, if the oligopoly attempts to raise its price, various other firms will certainly not do so, therefore if the firm raises its price come $550, the sales decrease sharply come 5,000. Thus, the members of a cartel can discipline each other to stick to the pre-agreed levels of quantity and price v a strategy of corresponding all price cuts yet not matching any type of price increases.

Many real-world oligopolies, prodded by economic changes, legal and also political pressures, and the egos of their peak executives, go with episodes that cooperation and also competition. If oligopolies might sustain collaboration with each other on output and also pricing, they can earn earnings as if they were a single monopoly. However, every firm in one oligopoly has actually an catalyst to produce much more and take a bigger re-publishing of the in its entirety market; when firms start behaving in this way, the sector outcome in terms of prices and also quantity deserve to be comparable to the of a extremely competitive market.

Tradeoffs of Imperfect Competition

Monopolistic competition is most likely the solitary most typical market framework in the U.S. Economy. The provides an effective incentives because that innovation, together firms seek to earn earnings in the short run, while entry assures that firms perform not earn economic profits in the long run. However, monopolistically competitive firms carry out not create at the lowest point on your average expense curves. In addition, the endless search to admire consumers through product differentiation might lead to excessive social expenses on advertising and also marketing.

Oligopoly is most likely the second most usual market structure. As soon as oligopolies an outcome from patented technologies or from taking benefit of economic climates of scale to develop at low average cost, castle may administer considerable advantage to consumers. Oligopolies are regularly buffeted by far-reaching barriers come entry, which allow the oligopolists to knife sustained profits over long periods of time. Oligopolists additionally do not generally produce at the minimum of their average price curves. As soon as they lack vibrant competition, they may absence incentives to carry out innovative products and high-quality service.

The job of public policy with regard to competition is to sort through these multiple realities, attempting to encourage behavior that is valuable to the broader society and also to discourage actions that just adds come the earnings of a few large companies, with no corresponding advantage to consumers. Syndicate and Antitrust plan discusses the fragile judgments that go into this task.


The Temptation come Defy the Law

Oligopolistic firms have been referred to as “cats in a bag,” as this thing mentioned. The French detergent makers chose to “cozy up” v each other. The result? one uneasy and tenuous relationship. When the Wall Street Journal reported on the matter, it wrote: “According to a declare a Henkel manager made come the commission, the detergent machines wanted ‘to limit the strongness of the competition in between them and clean increase the market.’ Nevertheless, by the at an early stage 1990s, a price war had broken out amongst them.” during the soap executives’ meetings, which sometimes lasted more than four hours, complex pricing frameworks were established. “One executive recalled ‘chaotic’ meetings together each next tried to occupational out just how the other had actually bent the rules.” Like many cartels, the soap cartel disintegrated due to the very strong temptation for each member to maximize its very own individual profits.

How did this soap opera end? ~ an investigation, French antitrust authorities fined Colgate-Palmolive, Henkel, and Proctor & gambling a total of €361 million ($484 million). A comparable fate befell the icemakers. Bagged ice is a commodity, a perfect substitute, typically sold in 7- or 22-pound bags. Nobody cares what brand is ~ above the bag. By agreeing come carve up the ice cream market, control broad geographic swaths of territory, and collection prices, the icemakers moved from perfect competition to a syndicate model. ~ the agreements, each firm was the single supplier of bagged ice to a region; there were earnings in both the long run and the short run. According to the courts: “These suppliers illegally conspired to manipulate the marketplace.” Fines totaled around $600,000—a steep good considering a bag of ice sells because that under $3 in most parts the the unified States.

Even though it is illegal in plenty of parts the the people for this firm to set prices and also carve up a market, the temptation come earn greater profits renders it exceptionally tempting to defy the law.


Key Concepts and also Summary

An oligopoly is a instance where a few firms sell many or all of the items in a market. Oligopolists earn their highest possible profits if they can band with each other as a cartel and act prefer a monopolist by reduce output and also raising price. Since each member of the oligopoly can benefit individually from widening output, such collusion often breaks down—especially since explicit collusion is illegal.

The prisoner’s dilemma is an example of game theory. It shows how, in details situations, all sides can advantage from cooperative actions rather 보다 self-interested behavior. However, the an obstacle for the parties is to find ways to encourage cooperative behavior.


Self-Check Questions

Consider the curve displayed in number 2, which reflects the industry demand, marginal cost, and marginal revenue curve for firms in an oligopolistic industry. In this example, we assume firms have actually zero addressed costs.
\"*\"
Figure 2.Suppose the that company collude to kind a cartel. What price will the cartel charge? What amount will the cartel supply? how much profit will certainly the cartel earn?Suppose currently that the cartel division up and the oligopolistic firms compete as intensely as possible by cut the price and increasing sales. What will the industry quantity and price be? What will certainly the collective profits be of every firms in the industry?Compare the equilibrium price, quantity, and profit because that the cartel and cutthroat compete outcomes.

Review Questions

Will the firms in an oligopoly act more like a monopoly or an ext like competitors? summary explain.Does every individual in a prisoner’s dilemma benefit more from participation or from pursuing self-interest? explain briefly.What stops oligopolists from acting together as a monopolist and also earning the highest feasible level the profits?

Critical reasoning Questions

Would you suppose the kinked demand curve to be much more extreme (like a right angle) or less too much (like a normal need curve) if every firm in the cartel to produce a near-identical product favor OPEC and petroleum? What if every firm produces a somewhat different product? describe your reasoning.When OPEC increased the price that oil significantly in the mid-1970s, experts said it to be unlikely that the cartel might stay together over the long term—that the incentives because that individual members come cheat would end up being too strong. More than fourty years later, OPEC tho exists. Why execute you think OPEC has been able come beat the odds and also continue come collude? Hint: You might wish to think about non-economic reasons.
References

The United says Department the Justice. “Antitrust Division.” Accessed October 17, 2013. Http://www.justice.gov/atr/.

eMarketer.com. 2014. “Total US ad Spending to See biggest Increase since 2004: Mobile heralding leads growth; will certainly surpass radio, magazines and newspapers this year. Accessed in march 12, 2015. Http://www.emarketer.com/Article/Total-US-Ad-Spending-See-Largest-Increase-Since-2004/1010982.

Federal profession Commission. “About the Federal trade Commission.” Accessed October 17, 2013. Http://www.ftc.gov/ftc/about.shtm.


Glossary

cartela group of firms the collude to develop the monopoly output and also sell at the syndicate pricecollusionwhen that company act with each other to reduce output and keep price highduopolyan oligopoly with only two firmsgame theorya branch that mathematics often used by economists that analyzes cases in i m sorry players need to make decisions and also then get payoffs based upon what decision the other players makekinked demand curvea perceived need curve that arises when contending oligopoly firms commit to complement price cuts, however not price increasesprisoner’s dilemmaa game in i m sorry the profit from cooperation are bigger than the rewards from pursuing self-interest

Solutions

Answers to Self-Check Questions

If the firms form a cartel, they will certainly act favor a monopoly, choosing the amount of output wherein MR = MC. Drawing a line from the monopoly quantity approximately the need curve mirrors the syndicate price. Assuming the fixed expenses are zero, and also with an knowledge of cost and profit, we have the right to infer that once the marginal cost curve is horizontal, average cost is the same as marginal cost. Thus, the cartel will earn positive financial profits same to the area that the rectangle, through a base equal to the syndicate quantity and also a height equal come the difference between price (on the demand above the syndicate quantity) and average cost, as presented in the following figure.
\"*\"
Figure 3.The that company will broaden output and also cut price as long as there are earnings remaining. The long-run equilibrium will happen at the allude where average expense equals demand. Together a result, the oligopoly will earn zero economic profits due to “cutthroat competition,” as presented in the following figure.
\"*\"
Figure 4.

See more: The Basic Idea Behind Residual Income Is To Have A Division Maximize Its:

Pc > Pcc. Qc firm B reasons that if that cheats and also Firm A does no notice, it will twin its money. Due to the fact that Firm A’s profits will decrease substantially, however, it is likely that for sure A will notice and if so, firm A will cheat also, through the an outcome that firm B will shed 90% of what it got by cheating. Firm A will reason that for sure B is i can not qualify to threat cheating. If no firm cheats, certain A earns $1000. If firm A cheats, assuming certain B does not cheat, A can an increase its profits only a little, due to the fact that Firm B is therefore small. If both this firm cheat, then Firm A loses at least 50% of what it could have earned. The opportunity of a small gain ($50) is more than likely not sufficient to induce for sure A come cheat, so in this case it is likely that both firms will collude.