Module
33
Oligopoly in Practice
Module Objectives
Students will learn in this module:
• The legal constraints of antitrust policy.
• The factors that limit tacit collusion.
• The cause and effect of product differentiation and price leadership.
• The importance of oligopoly in the real world.
Module Outline
I.The Legal Framework
A.Before 1890 in the United States, cartels were legal but legally unenforceable.
B.Definition: Antitrust policy refers to the efforts of the government to prevent
oligopolistic industries from becoming or behaving like monopolies.
C. The Sherman Antitrust Act was passed in 1890; its goal was to prevent the
creation of monopolies and to break up existing ones.
1. One of the first actions taken under the Sherman Antitrust Act was the
breakup of Standard Oil.
II.Tacit Collusion and Price Wars
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A.Oligopolists do succeed in keeping prices above their noncooperative level.
B.Tacit collusion is a normal state for an oligopoly.
C. However, four major factors make it hard for an industry to coordinate on
high prices.
1. Large numbers: The more firms in an oligopoly, the less incentive for
firms to behave cooperatively.
2. Complex products and pricing schemes: In the real world, oligopolists
produce many products, which makes it difficult for a firm to track what
its competitors are doing.
3. Differences in interests: Firms differ in what they perceive as fair and
what strategies are in their real interests.
4. Bargaining power of buyers: Often, oligopolists sell to large buyers who
can bargain for lower prices.
D.Definition: A price war occurs when tacit collusion breaks down and prices
collapse.
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OLIGOPOLY in practice
III.Product Differentiation and Price Leadership
A.Product differentiation lessens the competitiveness between firms in an oligopoly.
B.Definition: Firms engage in product differentiation when they try to convince
buyers that their product is different from the products of other firms in the
industry.
C. Definition: In price leadership, one firm sets the price and the other firms follow.
D.Definition: Firms that have a tacit understanding not to compete on price often
engage in intense nonprice competition, using advertising and other means
to try to increase their sales.
IV.How Important Is Oligopoly?
A.Important parts of the economy are fairly well described by perfect competition.
B.Even in oligopolies, the limits to cooperation keep prices fairly close to marginal costs.
C. Predictions from supply and demand analysis are often accurate for oligopolies.
D.While it is difficult to model oligopolies, most economists take a pragmatic
approach and know that there are important issues—from antitrust to price
wars—that need to be analyzed and understood.
Teaching Tips
Oligopoly in Practice
Creating Student Interest
Ask students if they know of any cases where the Department of Justice has sued a company for violating antitrust laws, or if they know of any cases where two companies
wanted to merge and the Department of Justice had to decide if the merger should be
allowed. You can find several examples at http://www.wsj.com if you enter either collusion or price fixing into the search box. Some notable examples are Microsoft, the merger of Whole Foods and Wild Oats, and the proposed merger of AT&T and T-Mobile. Other recent (2011) examples are price fixing of detergent in France, e-book pricing, and
the pricing of optical disk drives by Hitachi-LG Data Storage Inc.
Presenting the Material
Review the welfare effects of monopoly to help students understand why antitrust laws
exist. Given that explicit collusion is illegal, and tacit collusion can be challenging, companies have an incentive to differentiate their products so that they have more pricing
power. Present the reasons why it can be challenging for an industry to tacitly collude
and set high prices, and then brainstorm on strategies for product differentiation.
Common Student Pitfalls
• Illegal behaviors. Students may think that the marketplace is a “free-for-all” in
which there are no rules of the game. Explain that U.S. antitrust laws lay out rules
for the game, and that certain practices are illegal, such as predatory pricing and
price setting.
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oligopoly i n p r a c t i c e
Case Studies in the Text
Economics in Action
The Price Wars of Christmas—This EIA uses the toy industry to show how price wars break
out when the opportunity for collusion through repeated interaction diminishes.
Ask students the following questions:
1. What changes in the retail toy market have led to the price wars described
in the EIA? (The future payoff from collusion is shrinking because the
industry is in a state of decline and there are new entrants.)
2. Explain what this EIA means by “creeping Christmas.” (Price wars are
beginning earlier and earlier each year as firms try to expand sales.)
Activities
Guilty or Not? (3–5 minutes)
Ask students to go to the Justice Department’s web page (www.usdoj.gov/) and look
under Antitrust Division to find an interesting case of price fixing. Have them bring the
case in and present it to the class.
Microsoft’s Monopoly (5–10 minutes)
Ask students to research the Microsoft antitrust case. What specific business practices of
Microsoft were in violation of antitrust laws? Pair students and ask them to share their
findings with their partners. Ask a few students to report.
Web Resources
The Department of Justice’s Microsoft web page: http://www.usdoj.gov/atr/cases/
ms_index.htm.