9781118041581

Summary 383

SUMMARY

Decision-Making Principles

1. The key to making optimal decisions in an oligopoly is anticipating the
   actions of one’s rivals.


2. In the dominant-firm model, smaller firms behave competitively; that is,
   they take price as given when making their quantity decisions.
   Anticipating this behavior, the dominant firm maximizes its profit by
   setting quantity and price (and applying MR MC) along its net
   demand curve.


3. When competition is between symmetrically positioned oligopolists (the
   Cournot case), each firm maximizes its profit by anticipating the (profit-
   maximizing) quantities set by its rivals.


4. Intense price competition has the features of the prisoner’s dilemma;
   optimal behavior implies mutual price cuts and reduced profits.


5. Advertising should be undertaken up to the point where increased profit
   from greater sales just covers the last advertising dollar spent.

Nuts and Bolts

1. An oligopoly is a market dominated by a small number of firms. Each
   firm’s profit is affected not only by its own actions but also by actions of
   its rivals.


2. An industry’s concentration ratio measures the percentage of total sales
   accounted for by the top 4 (or 8 or 20) firms in the market. Another
   measure of industry structure is the Herfindahl-Hirschman Index
   (HHI), defined as the sum of the squared market shares of all firms. The
   greater the concentration index or the HHI, the more significant the
   market dominance of a small number of firms. Other things being equal,
   increases in concentration can be expected to be associated with
   increases in prices and profits.


3. There are two main models of quantity rivalry: competition with a
   dominant firm or competition among equals. In each model,
   equilibrium quantities are determined such that no firm can profit by
   altering its planned output. In the quantity-setting model, the
   equilibrium approaches the perfectly competitive outcome as the
   number of (identical) firms increases without bound.


4. If a firm expects price cuts (but not price increases) to be matched by its
   rivals, the result is a kink in the firm’s demand curve. Prices will be
   relatively stable (because price changes will tend to be unprofitable).

c09Oligopoly.qxd 9/29/11 1:32 PM Page 383