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N. GREGORY MANKIW
Measuring Market Concentration
PRINCIPLES OF
 Concentration ratio
MICROECONOMICS
Eighth Edition – Percentage of total output in the market
supplied by the four largest firms
– The higher the concentration ratio, the
less competition
CHAPTER
Oligopoly  This chapter focuses on oligopoly, a
market structure with high concentration
ratios.
Premium PowerPoint Slides by:
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Eastern Illinois University
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Concentration Ratios in Selected U.S. Industries

Industry Concentration ratio
Oligopoly
Video game consoles 100%  Oligopoly
Tennis balls 100%
– Market structure in which only a few
Credit cards 99%
Batteries 94% sellers offer similar or identical products
Soft drinks 94% – Strategic behavior in oligopoly:
Web search engines 92% • A firm’s decisions about P or Q can affect
Breakfast cereal 92% other firms and cause them to react
Cigarettes 89%
• The firm will consider these reactions when
Greeting cards 88%
making decisions
Beer 85%
Cell phone service 82%  Game theory: the study of how people
Autos 79% behave in strategic situations
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EXAMPLE: Cell Phone Duopoly in Small-town EXAMPLE: Cell Phone Duopoly in Small-town

P Q • Smalltown has 140 residents Competitive

P Q Revenue Cost Profit
outcome:
$0 140 • The “good”: cell phone service with $0 140 $0 $1,400 –1,400
P = MC = $10
5 130 unlimited anytime minutes and free 5 130 650 1,300 –650
phone Q = 120
10 120 10 120 1,200 1,200 0
Profit = $0
15 110 • Smalltown’s demand schedule 15 110 1,650 1,100 550
20 100 20 100 2,000 1,000 1,000
25 90
• Two firms: AT&T, Verizon Monopoly
25 90 2,250 900 1,350
(duopoly: an oligopoly with two firms) outcome:
30 80 30 80 2,400 800 1,600
35 70 • Each firm’s costs: FC = $0, MC = $10 35 70 2,450 700 1,750
P = $40
40 60 40 60 2,400 600 1,800 Q = 60
45 50 45 50 2,250 500 1,750 Profit = $1,800
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Cell Phone Duopoly in Small-town Collusion vs. Self-Interest

 One possible duopoly outcome: collusion  Both firms would be better off if both stick
 Collusion: to the cartel agreement.
– Agreement among firms in a market about – But each firm has incentive to renege on
quantities to produce or prices to charge the agreement.
– AT&T and Verizon could agree to each – Lesson: It is difficult for oligopoly firms to
produce half of the monopoly output: form cartels and honor their agreements.
• For each firm: Q = 30, P = $40, profits = $900
 Cartel:
– A group of firms acting in unison
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Equilibrium for an Oligopoly Equilibrium for an Oligopoly

 Nash equilibrium  When firms in an oligopoly individually
– Economic actors interacting with one choose production to maximize profit
another, each choose their best strategy – Produce Q
– Given the strategies that all the other • Greater than monopoly Q
actors have chosen • Less than competitive Q
 Duopoly example has a Nash equilibrium – The price is
• Given that Verizon produces Q = 40, • Less than the monopoly P
AT&T’s best move is to produce Q = 40 • Greater than the competitive P = MC
• Given that AT&T produces Q = 40,
Verizon’s best move is to produce Q = 40
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The Output & Price Effects The Size of the Oligopoly

 Increasing output has two effects on a  As the number of sellers in an oligopoly
firm’s profits: increases:
– Output effect: – The price effect becomes smaller
If P > MC, increasing output raises profits – The oligopoly looks more and more like a
– Price effect: competitive market
Raising output increases market quantity, – P approaches MC
which reduces price and reduces profit – The market quantity approaches the
on all units sold socially efficient quantity

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The Economics of Cooperation Prisoners’ Dilemma Example

 The Prisoners’ Dilemma The police have caught Bonnie and Clyde, two
suspected bank robbers, but only have enough
– Particular “game” between two captured
evidence to imprison each for 1 year.
prisoners
 The police question each in separate rooms, offer
– Illustrates why cooperation is difficult to each the following deal:
maintain even when it is mutually beneficial
– If you confess and implicate your partner,
 Dominant Strategy you go free.
– Strategy that is best for a player in a game – If you do not confess but your partner implicates
you, you get 20 years in prison.
– Regardless of the strategies chosen by
– If you both confess, each gets 8 years in prison.
the other players
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Prisoners’ Dilemma Example

Prisoners’ Dilemma Example
Confessing is the dominant strategy for both players.
Nash equilibrium:
 Outcome: Bonnie and Clyde both
Bonnie’s decision confess, each gets 8 years in prison.
both confess
Confess Remain silent – Both would have been better off if both
Bonnie gets Bonnie gets remained silent.
8 years 20 years
Confess – But even if Bonnie and Clyde had agreed
Clyde Clyde
Clyde’s gets 8 years goes free before being caught to remain silent, the
decision Bonnie goes Bonnie gets logic of self-interest takes over and leads
Remain free 1 year them to confess.
silent Clyde Clyde
gets 20 years gets 1 year
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AT&T & Verizon in the Prisoners’ Dilemma

Oligopolies as a Prisoners’ Dilemma
Each firm’s dominant strategy: renege on agreement,
 When oligopolies form a cartel produce Q = 40.
– In hopes of reaching the monopoly AT&T
outcome, they become players in a Q = 30 Q = 40
prisoners’ dilemma. AT&T’s profit AT&T’s profit
= $900 = $1000
 Our earlier duopoly example: Q = 30
Verizon’s Verizon’s
 AT&T and Verizon are duopolists in Smalltown profit = $900 profit = $750
Verizon
– The cartel outcome maximizes profits: AT&T’s profit = AT&T’s
$750 profit = $800
– Each firm agrees to serve Q = 30 Q = 40
Verizon’s Verizon’s
customers. profit = $1000 profit = $800
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Welfare of Society Another Example:

Negative Campaign Ads
 Noncooperative Oligopoly Equilibrium  Election with two candidates, “R” and “D.”
– May be bad for oligopolists – If R runs a negative ad attacking D, 3000
• Prevents them from achieving monopoly fewer people will vote for D (1000 of these
profits people vote for R, the rest abstain).
– May be bad for society – If D runs a negative ad attacking R, R loses
• Examples: Arms race game, Common 3000 votes, D gains 1000, 2000 abstain.
resource game
– R and D agree to refrain from running attack
– May be good for society
ads. Will each of them stick to the
• Quantity and price – closer to optimal level
agreement?
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Another Example: Negative Campaign Ads Another Example:

Negative Campaign Ads
Each candidate’s
dominant strategy: R’s decision  Nash equilibrium
run attack ads. – Both candidates run attack ads.
Do not run attack Run attack ads
ads (cooperate) (defect)
 Effects on election outcome: NONE
Do not run no votes lost R gains 1000
or gained votes – Each side’s ads cancel out the effects of
attack ads
(cooperate) no votes D loses
the other side’s ads.
D’s decision
lost or gained 3000 votes  Effects on society: NEGATIVE
R loses 3000 R loses
Run votes 2000 votes – Lower voter turnout, higher apathy about
attack ads politics, less voter scrutiny of elected
D gains D loses
(defect) 1000 votes 2000 votes officials’ actions.
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Why People Sometimes Cooperate Public Policy Toward Oligopolies

– When the game is repeated many times,  Governments
cooperation may be possible – Can sometimes improve market outcomes
 Two strategies may lead to cooperation:  Policymakers
– If your rival reneges in one round, you – Try to induce firms in an oligopoly to
renege in all subsequent rounds. compete rather than cooperate
– “Tit-for-tat” – Move the allocation of resources closer to
Whatever your rival does in one round the social optimum
(whether renege or cooperate), you do in
the following round.
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Public Policy Toward Oligopolies Controversies Over Antitrust Policy

 Antitrust laws – Most people agree that price-fixing
– The Sherman Antitrust Act, 1890 agreements among competitors should be
• Elevated agreements among oligopolists from
illegal.
an unenforceable contract to a criminal – Some economists are concerned that
conspiracy policymakers go too far when using
– The Clayton Act, 1914 antitrust laws to stifle business practices
• Further strengthened the antitrust laws that are not necessarily harmful, and may
– Used to prevent mergers have legitimate objectives.
– Used to prevent oligopolists from colluding
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Summary Summary
• Oligopolists can maximize profits if they form • The prisoners’ dilemma shows that self-
a cartel and act like a monopolist. interest can prevent people from cooperating,
• Yet, self-interest leads each oligopolist to a even when cooperation is in their mutual
higher quantity and lower price than under the interest. The logic of the prisoners’ dilemma
monopoly outcome. applies in many situations.
• The larger the number of firms, the closer will • Policymakers use the antitrust laws to prevent
be the quantity and price to the levels that oligopolies from engaging in anticompetitive
would prevail under competition. behavior such as price-fixing. But the
application of these laws is sometimes
controversial.
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