Measuring Market Concentration
Definition 1
- Concentration ratio (CR)is a ratio that indicates the size of firms in relation to their industry as a whole.
- It is the ratio of the combined market shares of a given number of firms to the whole market size.
- Usually, it is defined as the percentage of the market's total output supplied by its four largest firms.
Example 1
Calculate the 4-firm CR of the following example:| Firm | Sales |
|---|---|
| 1 | 20 |
| 2 | 20 |
| 3 | 20 |
| 4 | 20 |
| ....... | ....... |
| 5 | 10 |
| 6 | 10 |
Definition 2
Oligopoly is a market form wherein a small number of large sellers dominate a market or industry.In this market form, a firm's decisions regarding the price or quantity can affect other firms and cause them to react.
Hence, the firm needs to consider these reactions when making such decisions about P and Q.
Example 2
|
|
The revenues, costs, and profits are shown below.
| P | Q | Revenue | Cost | Profit |
|---|---|---|---|---|
| $0 | 1000 | $0 | $10,000 | −$10,000 |
| $5 | 900 | $4,500 | $9,000 | −$4,500 |
| $10 | 800 | $8,000 | $8,000 | 0 |
| $15 | 700 | $10,500 | $7,000 | $3,500 |
| $20 | 600 | $12,000 | $6,000 | $6,000 |
| $30 | 500 | $15,000 | $5,000 | $10,000 |
| $40 | 420 | $16,800 | $4,200 | $12,600 |
| $50 | 340 | $17,000 | $3,400 | $13,600 |
| $60 | 200 | $12,000 | $2,000 | $10,000 |
| $70 | 100 | $7,000 | $1,000 | $6,000 |
Note that Competitive outcome happens when P = MC = $10, Q = 800, Profit = $0, and
Monopoly outcome occurs when P = $50, Q = 340, Profit = $13,600
In this situation, one possible outcome from this scenario is collusion, where an agreement among the two firms about Q or P.
For example, both would agree to each produce half of the monopoly output.
So, for each firm: Q = 170, P = $50, Profits = $6,800
Exercise 1
Exercise-1 on Collusion vs. self-interestCheck your answers here: Solution-1 to the Exercise on Collusion vs. self-interest
Exercise 2
Exercise-2 on Collusion vs. self-interestCheck your answers here: Solution-2 to the Exercise on Collusion vs. self-interest
Note that in the above example, both firms choose their best strategy given the strategies that all the others have chosen (Nash equilibrium)
Our duopoly example has a Nash equilibrium in which each firm produces Q = 340.
- Oligopoly Q is greater than monopoly Q but smaller than competitive Q.
- Oligopoly P is greater than competitive P but less than monopoly P.
The Size of the Oligopoly
As the number of firms in the market increases,- the price effect becomes less
- the oligopoly starts behaving like a competitive market
- P gets closer to MC
- the market quantity draws near the socially efficient quantity
Game Theory
- Game theory is the study of mathematical models, which helps to understand oligopoly and other situations
where "players" and rational decision-makers interact and behave strategically. - Dominant strategy: a strategy that is best for a decision-maker (player) in a game
regardless of the strategies chosen by the other decision-makers (players) - Prisoners' dilemma: a "game" between two captured criminals that
illustrates why cooperation is difficult even when it is mutually beneficial
Example 3: Prisoners' Dilemma
- Police officers have caught Joe and Mike, two suspected hackers, but only have enough evidence to imprison each for 6 months
- After a thorough investigation, an offer is made to each one the following deal:
- If you confess and implicate your partner, you go free.
- But if you do not confess but your partner implicates you, you get 12 years in jail.
- If you both confess, each gets 5 years in prison.
- Outocme
- Both would have been better off if both remained silent.
- If both Joe and Mike confess, each gets 5 years in jail.
- But even if Joe and Mike had agreed before being caught to remain silent, the logic of self-interest takes over and leads them to confess.
Oligopoly as a Prisoners' Dilemma
- In a situation of oligopoly where cartel members hope to reach a monopoly outcome,
they endup playing the prisoners' dilemma example - In the previous example: Vodafone and O2 qre duopolists in a city.
- The cartel outcome maximizes profits: Each firm agrees to serve Q = 340 customers.
Exercise 3
Exercise on Fare Wars GameCheck your answers here: Solution to the Exercise on Fare Wars Game