OLIGOPOLY AND MONOPOLISTIC COMPETITION
Up to now, we have covered two extreme types of markets. We covered perfect competition with the highest degree of competition, then we covered monopoly with the lowest degree of competition. Now, we will cover oligopoly and monopolistic competition. These two market types are in between two extremes: they show some features of competition and some features of monopoly. Oligopoly Definition: Oligopoly is a market structure in which there are a few sellers and they sell almost identical products. There are barriers to entry in oligopoly. Oligopoly is characterized by the tension between cooperation and self- interest among these sellers. For example, if the oligopolist firms can cooperate, they can charge a high price and share profits. But if they cannot cooperate and instead they compete because of following their own self-interest, then price goes down and profits decline. We will give examples of this later. Oligopoly Examples: crude oil (Kuwait, Iraq, Saudi Arabia, Venezuela, Kazakhstan, Azerbeijan) , coke (Coca Cola, Pepsi, Cola Turka), GSM providers (Turkcell, Vodafone, Avea), inter-city bus transportation (between Istanbul & Denizli: Varan, Ulusoy, Pamukkale, Köseoğlu), airline travel (between Istanbul and Frankfurt: Turkish Airlines, Pegasus, …) etc. Monopolistic Competition Definition: Many firms sell products that are similar but not identical. There is free entry and exit like perfect competition. But at the same time, there is product differentiation. Product differentiation allows firms to charge a high price and collect some profits. Monopolistic Competition Examples: music CDs (every artist has a different CD), movies (every film is different), computer games, restaurants, athletic apparel (adidas, nike, umbro, Turkish brands), etc. Two dimensions:
1-Number of firms
2-Product differentiation Perfect Competition:
First Let us start with studying Oligopoly:
A DOUPOLY EXAMPLE: A duopoly is an oligopoly with two firms. Consider a town in which only Fatih and Selim own water wells. Every day, they decide separately how much water to pump and sell. Assume all costs of pumping water is zero, so that profits are equal to revenues. Total Cost, Marginal Cost are zero. Table 1 shows the demand schedule for water in this town.
There are several possible outcomes:
If Fatih and Selim compete and pump as much as they can, perfect competition applies, price of water drops to zero. This is equal to marginal cost, which is also zero (P = MC = 0). This is a socially efficient outcome: it is desirable for the society. 2-
What if Fatih and Selim COOPERATE instead of competing? Then they can behave like a single firm. They can keep output low and prices high so that they can maximize their total profit. Then they would behave like a monopoly. They would pump 60 gallons together in total so that they make the largest profits in total. This would not be socially efficient (P = $60 > 0 = MC), but it is good for Fatih and Selim. We call the group of firms acting like a monopoly “a cartel”. Of course, to maintain the cartel, the firms must agree on how they split total output and profits. Say, they could agree to split production 30 and 30 gallons. Such an agreement is called a “collusion”. Which outcome is going to be realized depends on the game played between Fatih and Selim. Are they going to compete or cooperate? Is there an equilibrium of this game? Let us look at the game played between Fatih and Selim. Have you seen the movie “Beautiful Mind” with Russell Crowe? He plays John Nash in the movie. John Nash has found the concept of Nash Equilibrium. Now I will try to illustrate what a Nash Equilibrium is. Let us start by assuming they are currently pumping 30 gallons each. Question: Is this an equilibrium outcome? Does Fatih, for example, want to pump 30 given that Selim pumps 30?...