Amity Business School

Submitted by:

Urvashi Aggarwal -07 Shazia Salim-23 Nikita Gupta-09 Suveera Walia-24 Linda Joseph-33 Ashish Monica-34

Objectives

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Outline the fundamental characteristics of oligopoly Understand how to apply game theory to evaluate the pricing strategies of oligopolistic firms Identify features of an industry that help or hinder efforts to form a cartel that seeks to restrain output and earn economic profits Illustrate how network effects and market feedback can explain why some industries are oligopolies Explain why multiproduct firms selling complimentary sets of products may or may not want their products to be compatible with those of their competitors.

Introduction

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A situation in which a particular market is controlled by a small group of firms.

An oligopoly is much like a monopoly, in which only one company exerts control over most of a market. In an oligopoly, there are at least two firms controlling the market.
The retail gas market is a good example of an oligopoly because a small number of firms control a large majority of the market. An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists) Because there are few sellers, each oligopolistic is likely to be aware of the actions of the others. The decisions of one firm influence, and are influenced by, the decisions of other firms. Strategic planning by oligopolists needs to take into account the likely responses of the other market participants Oligopoly is a common market form. As a quantitative description of oligopoly, the four-firm concentration ratio is often utilized. This measure expresses the market share of the four largest firms in an industry as a percentage.

Oligopolistic Competition Amity Business School

Oligopolistic competition can give rise to a wide range of different outcomes. In some situations, the firms may employ restrictive trade practices (collusion, market sharing etc.) to raise prices and restrict production in much the same way as a monopoly. Where there is a formal agreement for such collusion, this is known as a cartel. A primary example of such a cartel is OPEC which has a profound influence on the international price of oil. Firms often collude in an attempt to stabilize unstable markets, so as to reduce the risks inherent in these markets for investment and product development. There are legal restrictions on such collusion in most countries. There does not have to be a formal agreement for collusion to take place (although for the act to be illegal there must be actual communication between companies) for example, in some industries there may be an acknowledged market leader which informally sets prices to which other producers respond, known as price leadership.

Characterstics of Oligopoly

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Profit maximization conditions: An oligopoly maximizes profits by producing where marginal revenue equals marginal costs. Ability to set price: Oligopolies are price setters rather than price takers. Entry and exit: Barriers to entry are high. The most important barriers are economies of scale, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy nascent firms. Additional sources of barriers to entry often result from government regulation favoring existing firms making it difficult for new firms to enter the market. Number of firms: "Few" a "handful" of sellers. There are so few firms that the actions of one firm can influence the actions of the other firms. Long run profits: Oligopolies can retain long run abnormal profits. High barriers of entry prevent sideline firms from entering market to capture excess profits. Product differentiation: Product may be homogeneous (steel) or differentiated (automobiles). Assumptions about perfect knowledge vary but the knowledge of various economic actors can be generally described as selective. Oligopolies have perfect knowledge of their own cost and demand functions but their interfirm information may be incomplete

Characterstics.. Business School Amity

Perfect knowledge:. Buyers have only imperfect knowledge as to price, cost and product quality. Interdependence: The distinctive feature of an oligopoly is interdependence. Oligopolies are typically composed of a few large firms. Each firm is so large that its actions affect market conditions. Therefore the competing firms will be aware of a firm's market actions and will respond appropriately. This means that in contemplating a market action, a firm must take into consideration the possible reactions of all competing firms and the firm's countermoves. It is very much like a game of chess or pool in which a player must anticipate a whole sequence of moves and countermoves in determining how to achieve his objectives. For example, an oligopoly considering a price reduction may wish to estimate the likelihood that competing firms would also lower their prices and possibly trigger a ruinous price war. Or if the firm is considering a price increase, it may want to know whether other firms will also increase prices or hold existing prices constant. This high degree of interdependence and need to be aware of what the other guy is doing or might do is to be contrasted with lack of interdependence in other market structures. In a monopoly there are no competitors to be concerned about. In a monopolistically competitive market each firm's effects on market conditions is so negligible as to be safely ignored by competitors.

Duopoly

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Oligopoly theory makes heavy use of game theory to model the behavior of oligopolies: Stackelberg's duopoly. In this model the firms move sequentially (see Stackelberg competition). Cournot's duopoly. In this model the firms simultaneously choose quantities (see Cournot competition). Bertrand's oligopoly. In this model the firms simultaneously choose prices (see Bertrand competition).

PRICE AND OUTPUT UNDER DUOPLOY

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If two firms share the market equally and have the same cost structures, then each firm will profit maximise at output Q and each gain the same level of super-normal profit. Consider the case of Firm A in the diagram below. The firm is assumed to have half the total market demand. It can profit maximise and still achieve economic profit. The other firm in the market will also profit maximise at the same point and earn the same total profits. In the absence of a change in demand (which may not go equally to each firm) and/or a change in each firm's costs of production, neither firm has any reason to undercut the other.

Models of oligopoly

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There is no single model describing the operation of an oligopolistic market. The variety and complexity of the models is because you can have two to 10 firms competing on the basis of price, quantity, technological innovations, marketing, advertising and reputation. Fortunately, there are a series of simplified models that attempt to describe market behavior under certain circumstances. Some of the better-known models : Dominant firm model Cournet nash model Kinked demand curve model Bertrand model

Dominant-firm model
One

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firm sets price and others follow Industry is composed of a large, dominant firm and many small firms, big firm has costadvantage The demand curve for the dominant firm is derived by subtracting the amount supplied by the small firms at each price from the total demanded at that price Big firm can behave as a monopolist, small firms make no super-normal profits

Cournot-Nash model

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Simplest model Equally positioned firms Firms compete on the basis of quantity The market demand curve should be a linear Marginal costs are fixed The path of equilibrium is a series of action and reactions. The equilibrium is the intersection of the two firms reaction function The reaction firm shows how one firms reacts to the quality choice of the other firm The equilibrium solution would be at the intersection of the two reaction functions The Nash Equilibrium is PA=PB=MC

Bertrand Model

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The model assumptions are: There are two firms in the market They produce a homogeneous product They produce at a constant marginal cost Firms choose prices PA and PB simultaneously Firms outputs are perfect substitutes Sales are split evenly if PA = PB Neither firm has any reason to change strategy. If the firm raises prices it will lose all its customers. If the firm lowers price P < MC then it will be losing money on every unit sold.

Kinked demand curve mode Amity Business School

Each firm faces a demand curve kinked at existing price If firm raises its price and competitors will not follow then acting firm will lose its market share. If firm lowers its prices and competitors follow then the firm will only have marginal increase in an output. The prices of the firms tend to be rigid. For the prices above, the curve is relative elastic For prices below , the curve is relative inelastic

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PRICE RIGIDITY UNDER OLIGOPOLY

INDIAN AUTOMOBILE Few facts: INDUSTRY player's India is on every major global automobile

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roadmap. India is the second largest two-wheeler market in the world Fourth largest commercial vehicle market in the world 11th largest passenger car market in the world Fifth-largest bus and truck market in the world (by volume) Key players in Indian automobile industry and their market share are: Maruti (50.37%) Hyundai (19.17%) Tata Motors (17.19%) Honda (5.33%) Others (5.73%)

GLOBAL AUTOMOBILE INDUSTRY

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The global automotive industry is a highly diversified sector. It is considered to be highly capital and labor intensive. It comprises of manufacturers, suppliers, dealers, retailers,original equipment manufacturers, aftermarket parts manufacturers, auto electricians etc.It is one of the important industries in the world, which provides employment to 25million people in the world. Top five automobile manufacturing nations are : United States, Japan, China, Germany and South KoreaThe United States of America is the worlds largest producer and consumer of motor vehicles and automobiles. It represents nearly 10% of the $10 trillion US economy Size of the automotive industry The automotive industry occupies a leading position in the global economy, accountingfor 9.5% of world merchandise trade and 12.9% of world export of manufacturers. Leading automobile manufacturing corporations are:General Motors (24.1%), FordMotor Company (17.1%), Toyota (14.9), Daimler Chrysler (14 %) others (29.9%). Thesecorporations have their presence in almost every country.

Indian Telecommunication industry

with about 464.82 million phone connections (June 2009), is the third largest telecommunication network in the world and the second largest in terms of number of wireless connections. For the past decade or so, telecommunication activities have gained momentum in India. The Indian Telecommunication Market has been dominated by few major players, and hence it is a perfect case of Oligopoly.

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Conclusion of telecommunication Amity Business School industry.

Kinked Demand Curve The cellular service provider industry already has a kinked demand curve. Below the certain price, demand is inelastic and so lowering the price does not increase sales by enough to offset the lost revenue per unit sold. (Total Revenue = Price x Quantity Sold).

Petroleum

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An industry closely tied to the market for cars is the extraction and refinement of petroleum. A few representatives in this market include ExxonMobile, ConocoPhillips, Gulf, and Shell. While the petroleum industry contains hundreds, if not thousands, of smaller firms, the biggest ones tend to dominate the market. In addition, another major player on the international scene is the Organization of Petroleum Exporting Countries (OPEC), which is an international cartel representing several petroleum-rich countries especially in the Middle East. Ownership and control of petroleum resources is a prime factor in the creation of an oligopolistic industry.

Profit Maximization by Oligopolistic Cartel

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Oligopolistic firms join a cartel to increase their market power, and members work together jointly on price each member will produce and/or the price that each member will charge. The oil-producing firms form a cartel like OPEC to determine their output and price, they will jointly face a downward-sloping market demand curve, just like a monopolist.

Impact of OPEC on Oil Prices

OPEC member countries Total Value of Value of Exports (Million Petroleum US Dollars) Export (Million US Dollars)
18543 12087 11046 7960 50183 567 18346 45417 13036 3610 13737 11724 7008 7763 42502 461 14944 6441 12217 2987 Venezuela Nigeria Algeria Libya Saudi Arabia Iran Iraq Indonesia Kuwait Qatar Percentage of Total Exports made up of Petroleum Products 74% 97: 63% 98% 85% 81% 81% 14% 94% 83%

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Factors Affecting Oil Prices

Industrialization, globalization, scarcity of crude oil resources are some factors.

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The blue line indicates what the demand of oil from 2001 to 2008 is and the bars indicate the capacity of OPEC and non-OPEC countries.

Impact of Oil Prices on Countries' Economies

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Oil price has its own impact on global economy and individual countries' economy. The increase in oil prices in 1974 and then again in 1979 were important factors in producing a slowdown in the world economy at a time when inflation was rising. Recent increases in oil prices have caused concern.

Conclusion

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From all the above discussions and data analysis, we conclude: OPEC is an inter-governmental organization which controls the major oil producing countries. Even though the non-OPEC countries are also present but these are not working under one umbrella which is causing competition with each other, and there is no scope for other countries to enter into the market because the crude oil resources are limited. Even the experts say that OPEC is monopoly, but due to the presence of non-OPEC countries which will also affect the oil prices and cause competition to affect fixing prices of crude oil, which will shows us that OPEC is probably the best example of oligopoly

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