Oligopoly

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An oligopoly is a market dominated by a few large suppliers. The degree of market concentration is very high. Firms within an oligopoly produce branded products (advertising and marketing is an important feature of competition within such markets) and there are also barriers to entry.
Another important characteristic of an oligopoly is interdependence between firms. This means that each firm must take into account the likely reactions of other firms in the market when making pricing and investment decisions. This creates uncertainty in such markets - which economists seek to model through the use of game theory.
Game theory may be applied in situations in which decision makers must take into account the reasoning of other decision makers. It has been used, for example, to determine the formation of political coalitions or business conglomerates, the optimum price at which to sell products or services, the best site for a manufacturing plant, and even the behaviour of certain species in the struggle for survival.
The ongoing interdependence between businesses can lead to implicit and explicit collusion between the major firms in the market. Collusion occurs when businesses agree to act as if they were in a monopoly position
Mergers

• While many oligopolies have emerged through the growth of dominant firms in a certain industry, many have also emerged through mergers.
o Ex.steel, airlines, banking, and entertainment industries
• Merging of two or more competing firms is beneficial in that it may increase their market share significantly, and thus achieve greater economies of scale. In this way, competition can also be reduced.
• Firms may also merge hoping to achieve monopoly power.
• The larger firm that results from a merger would have greater control over market supply and price than a few smaller firms.

The Four Firm Concentration Ratio

• Is the scale that determines whether a industry is monopolistic competition or oligopoly. If the combination of market share of the four largest firm in a single industry is equal or greater than 40%, the industry is consider as oligopoly.
• A concentration ratio reveals the percentage of total output produced and sold by the industry's largest firms

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Herfindahl Index (Herfindahl-Hirschman Index or HHI,)

• The HHI measures of the number and size of firms in ratio to the industry. It serves as an indicator of the amount of competition within a market. It is defined as the sum of the squares of the market shares of each individual firm
•

Main Characteristic:
(See the text book for a complete list of features. These are the essential elements.)

Few firms:
1. Each firm is a large enough part of the market that the behaviour of one firm has a large impact on the demand curve of the others.
2. The result is that the firms do not have stable demand curves. If Pepsi changes its price, Coka Cola’s demand curve shifts.
3. As a result the method of finding the profit maximising output by comparing the firm’s costs to the firm’s demand curve is complicated or unworkable. Pepsi can decide on its best price and output, but then Coke will react and change its price or output. That will shift Pepsi’s demand curve, changing its best strategy and so one and so on.

The ordinary model of the firm is less applicable, because the demand curve of one firm depends on the behaviour of other firms. If Pepsi introduces a price cut, the Coke will lose large numbers of customers. The price of a substitute will have changed

If Pepsi raises its price, Coke’s demand curve shifts out. Coke won’t mind, but Pepsi will very likely find the quantity it sells falls very sharply. If Pepsi lowers its price, it will likely win many customers from Coke and have a very large increase in total revenue. Coke’s demand curve will shift in sharply and Coke will be very unhappy.
Coke is very unlike to stand by and let Pepsi undercut its price. If Pepsi insists on reducing its price, Coke will very like have to match the cut. When Coke matches Pepsi’s price, the other things equal assumption doesn’t hold. Pepsi’s price reduction causes an equally large change in price by Coke, and Pepsi’s demand will not increase nearly so much.

Common Behaviours:
1. Fix prices and act like a monopolist.
a. In some nations, can sign a contract and form a cartel that sets a price and assigns an output to each firm.
b. It may be profitable for some firm to ‘cheat’ and try to sell a larger quantity, even at a lower price. So cartels are unstable.
2. Enter into competition which results in relatively low prices. Depending on the nature of the market for the product, expenditures on advertising, packaging and product development may be high.
3. Compete on quality, advertising, packaging or other non-price characteristics.
a. This behaviour avoids the tendency of price competition to reduce profits.
b. It has proved to be a more stable behaviour than cartels.
c. Free trade increased price competition in automobiles and many other commodities.
Game theory:
A method of analysing behaviour in an oligopoly. It plots out the strategies of firms. Each firm plots out its best behaviour, depending on what the other firm does. It’s like two people arrested for a crime. If neither confesses they both go free. But the first one to confess receives a sentence of 3 months. The other receives a sentence of 3 years. Most likely they will each rush to be first to confess. They would be better off if both kept quiet, but that strategy requires a very high degree of trust. – Now if the mafia lurks in the background and promises to shoot whoever confesses, they will keep quiet.

In oligopoly the ‘confess’ strategy may be to cut prices. The first to cut prices will make the big gains in the market. The one who maintains a fixed price will take a large loss. So, if there is no equivalent to the ‘mafia’ both will rush to cut prices. However, there may be something like the ‘mafia’ to prevent price cutting. The biggest, strongest, lowest cost firm may be able to really hurt a smaller, weaker firm by cutting prices in its home market, or by maintaining a low price until the weak firm goes bankrupt. It is costly even for the big firm, but may discourage the small firm from even thinking about cutting prices.
Main Point:

Oligopolistic behaviour is complex – and lots of fun.

Each firm behaviour regarding price, quantity, advertising, or product development influences the other firm’s profitability.

As a result, firms can not make a decision without influencing the demand curve of its rivals. As a result, the rivals most desirable choice changes. They will respond, perhaps retaliate is a better word.

A firm must consider the reaction of its rivals when it chooses its behaviours.

In a static, well established business with good understanding among the firms, they may behave like a monopoly.

In a more dynamic industry, firms are likely to want to make sure they keep their share of the dynamic market growing.

In any case, some young scalawag with a new low cost firm may upset the apple cart. If it has a substantially superior product, or substantially lower costs, then it may be able to cut prices or just expand sales and encroach on other firms and be safe from retaliation.

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Measures of national income and output

A variety of measures of national income and output are used in economics to estimate total economic activity in a country or region, including gross domestic product (GDP), gross national product (GNP), and net national income (NNI). All are specially concerned with counting the total amount of goods and services produced within some "boundary". The boundary may be defined geographically, or by citizenship; and limits on the type of activity also form part of the conceptual boundary; for instance, these measures are for the most part limited to counting goods and services that are exchanged for money: production not for sale but for barter, for one's own personal use, or for one's family, is largely left out of these measures, although some attempts are made to include some of those kinds of production by imputing monetary values to them. Mr Ian Davies defines development as 'Simply how happy and free the citizens of that country feel.'

National accounts

Arriving at a figure for the total production of goods and services in a large region like a country entails a large amount of data-collection and calculation. Although some attempts were made to estimate national incomes as long ago as the 17th century,[2] the systematic keeping of national accounts, of which these figures are a part, only began in the 1930s, in the United States and some European countries. The impetus for that major statistical effort was the Great Depression and the rise of Keynesian economics, which prescribed a greater role for the government in managing an economy, and made it necessary for governments to obtain accurate information so that their interventions into the economy could proceed as much as possible from a basis of fact.

Market value

Main article: Market value
In order to count a good or service it is necessary to assign some value to it. The value that the measures of national income and output assign to a good or service is its market value – the price it fetches when bought or sold. The actual usefulness of a product (its use-value) is not measured – assuming the use-value to be any different from its market value.

Three strategies have been used to obtain the market values of all the goods and services produced: the product (or output) method, the expenditure method, and the income method. The product method looks at the economy on an industry-by-industry basis. The total output of the economy is the sum of the outputs of every industry. However, since an output of one industry may be used by another industry and become part of the output of that second industry, to avoid counting the item twice we use, not the value output by each industry, but the value-added; that is, the difference between the value of what it puts out and what it takes in. The total value produced by the economy is the sum of the values-added by every industry.

The expenditure method is based on the idea that all products are bought by somebody or some organisation. Therefore we sum up the total amount of money people and organisations spend in buying things. This amount must equal the value of everything produced. Usually expenditures by private individuals, expenditures by businesses, and expenditures by government are calculated separately and then summed to give the total expenditure. Also, a correction term must be introduced to account for imports and exports outside the boundary.

The income method works by summing the incomes of all producers within the boundary. Since what they are paid is just the market value of their product, their total income must be the total value of the product. Wages, proprieter's incomes, and corporate profits are the major subdivisions of income.

The output approach The output approach focuses on finding the total output of a nation by directly finding the total value of all goods and services a nation produces.

Because of the complication of the multiple stages in the production of a good or service, only the final value of a good or service is included in total output. This avoids an issue often called 'double counting', wherein the total value of a good is included several times in national output, by counting it repeatedly in several stages of production. In the example of meat production, the value of the good from the farm may be $10, then $30 from the butchers, and then $60 from the supermarket. The value that should be included in final national output should be $60, not the sum of all those numbers, $100. The values added at each stage of production over the previous stage are respectively $10, $20, and $30. Their sum gives an alternative way of calculating the value of final output.

Formulae:

GDP(gross domestic product) at market price = value of output in an economy in a particular year - intermediate consumption

NNP at factor cost = GDP at market price - depreciation + NFIA (net factor income from abroad) - net indirect taxes[3]

[edit] The income approach
The income approach focuses on finding the total output of a nation by finding the total income received by the factors of production owned by that nation.

The main types of income that are inclhose who provide the natural resources), interest (the money paid for the use of man-made resources, such as machines used in production), and profit (the money gained by the entrepreneur - the businessman who combines these resources to produce a good or service).

Formulae:

NDP at factor cost = compensation of employee + operating surplus + mixed income of self employee

National income = NDP at factor cost + NFIA (net factor income from abroad) - Depreciation

[edit] The expenditure approach
The expenditure approach is basically an output accounting method. It focuses on finding the total output of a nation by finding the total amount of money spent. This is acceptable, because like income, the total value of all goods is equal to the total amount of money spent on goods. The basic formula for domestic output combines all the different areas in which money is spent within the region, and then combining them to find the total output.

GDP = C + I + G + (X - M)
Where:
C = household consumption expenditures / personal consumption expenditures
I = gross private domestic investment
G = government consumption and gross investment expenditures
X = gross exports of goods and services
M = gross imports of goods and services

Note: (X - M) is often written as XN, which stands for "net exports"




Names

The names of the measures consist of one of the words "Gross" or "Net", followed by one of the words "National" or "Domestic", followed by one of the words "Product", "Income", or "Expenditure". All of these terms can be explained separately.

"Gross" means total product, regardless of the use to which it is subsequently put.
"Net" means "Gross" minus the amount that must be used to offset depreciation – ie., wear-and-tear or obsolescence of the nation's fixed capital assets. "Net" gives an indication of how much product is actually available for consumption or new investment.
"Domestic" means the boundary is geographical: we are counting all goods and services produced within the country's borders, regardless of by whom.
"National" means the boundary is defined by citizenship (nationality). We count all goods and services produced by the nationals of the country (or businesses owned by them) regardless of where that production physically takes place.
The output of a French-owned cotton factory in Senegal counts as part of the Domestic figures for Senegal, but the National figures of France.
"Product", "Income", and "Expenditure" refer to the three counting methodologies explained earlier: the product, income, and expenditure approaches. However the terms are used loosely.
"Product" is the general term, often used when any of the three approaches was actually used. Sometimes the word "Product" is used and then some additional symbol or phrase to indicate the methodology; so, for instance, we get "Gross Domestic Product by income", "GDP (income)", "GDP(I)", and similar constructions.
"Income" specifically means that the income approach was used.
"Expenditure" specifically means that the expenditure approach was used.
Note that all three counting methods should in theory give the same final figure. However, in practice minor differences are obtained from the three methods for several reasons, including changes in inventory levels and errors in the statistics. One problem for instance is that goods in inventory have been produced (therefore included in Product), but not yet sold (therefore not yet included in Expenditure). Similar timing issues can also cause a slight discrepancy between the value of goods produced (Product) and the payments to the factors that produced the goods (Income), particularly if inputs are purchased on credit, and also because wages are collected often after a period of production.

GDP and GNP

Main articles: GDP and GNP
Gross domestic product (GDP) is defined as "the value of all final goods and services produced in a country in 1 year".[4]

Gross National Product (GNP) is defined as "the market value of all goods and services produced in one year by labour and property supplied by the residents of a country."[5]

As an example, the table below shows some GDP and GNP, and NNI data for the United States:[6]

National income and output (Billions of dollars) Period Ending 2003
Gross national product 11,063.3
Net U.S. income receipts from rest of the world 55.2
U.S. income receipts 329.1
U.S. income payments -273.9
Gross domestic product 11,008.1
Private consumption of fixed capital 1,135.9
Government consumption of fixed capital 218.1
Statistical discrepancy 25.6
National Income 9,679.7
NDP: Net domestic product is defined as "gross domestic product (GDP) minus depreciation of capital",[7] similar to NNP.
GDP per capita: Gross domestic product per capita is the mean value of the output produced per person, which is also the mean income.

National income and welfare

GDP per capita (per person) is often used as a measure of a person's welfare. Countries with higher GDP may be more likely to also score highly on other measures of welfare, such as life expectancy. However, there are serious limitations to the usefulness of GDP as a measure of welfare:

Measures of GDP typically exclude unpaid economic activity, most importantly domestic work such as childcare. This leads to distortions; for example, a paid nanny's income contributes to GDP, but an unpaid parent's time spent caring for children will not, even though they are both carrying out the same economic activity.
GDP takes no account of the inputs used to produce the output. For example, if everyone worked for twice the number of hours, then GDP might roughly double, but this does not necessarily mean that workers are better off as they would have less leisure time. Similarly, the impact of economic activity on the environment is not measured in calculating GDP.
Comparison of GDP from one country to another may be distorted by movements in exchange rates. Measuring national income at purchasing power parity may overcome this problem at the risk of overvaluing basic goods and services, for example subsistence farming.
GDP does not measure factors that affect quality of life, such as the quality of the environment (as distinct from the input value) and security from crime. This leads to distortions - for example, spending on cleaning up an oil spill is included in GDP, but the negative impact of the spill on well-being (e.g. loss of clean beaches) is not measured.
GDP is the mean (average) wealth rather than median (middle-point) wealth. Countries with a skewed income distribution may have a relatively high per-capita GDP while the majority of its citizens have a relatively low level of income, due to concentration of wealth in the hands of a small fraction of the population. See Gini coefficient.
Because of this, other measures of welfare such as the Human Development Index (HDI), Index of Sustainable Economic Welfare (ISEW), Genuine Progress Indicator (GPI), gross national happiness (GNH), and sustainable national income (SNI) are used.

Hyperinflation & Stagnation

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The term "hyperinflation" refers to a very rapid, very large increase in the price level. Measurement problems will be too minor to notice on this scale. There is no strict formal definition for the term, but cases of hyperinflation tend to be expressed in terms of multiples rather than percentages. "For example, in Germany between January 1922 and November 1923 (less than two years!) the average price level increased by a factor of about 20 billion." Some representative examples of hyperinflation include

"Hyperinflation

1922 Germany 5,000%
1985 Bolivia >10,000%
1989 Argentina 3,100%
1990 Peru 7,500%
1993 Brazil 2,100%
1993 Ukraine 5,000%"
These quotations from other web pages are given mainly as examples of what people have in mind when they talk about hyperinflation, and I cannot say just how accurate the figures are. In any case, figures for the purchasing power lost in hyperinflations can only be rough estimates. Numismatics (coin and currency collecting) gives some examples of just how far hyperinflations can go: an information page for currency collectors tells us that, in the Hungarian hyperinflation after World War II, bills for one hundred million trillion pengos were issued (the pengo was the Hungarian currency unit) and bills for one billion trillion pengos were printed but never issued. (I'm using American terms here -- the British express big numbers differently).
The story behind the German hyperinflation illustrates how all hyperinflations have come about, and is of particular interest in itself. After World War I, Germany had a democratic government, but little stability. A general named Kapp decided to make himself dictator, and marched his troops and militias into Berlin in an attempted coup d'etat known as the "Kapp Putsch." However, the German people resisted this attempt at dictatorship with nonviolent noncooperation. The workers went out in a general strike and the civil servants simply refused to obey the orders of Kapp and his men. Unable to take command of the country, Kapp retreated and ultimately gave up his attempt.

However, the German economy, never very sound, was further disrupted by the conflict surrounding Kapp's putsch and by the strike against it; and production fell and prices rose. The rise in prices destroyed the purchasing power of wages and government revenues, and the government responded to this by printing money to replace the lost revenues. This was the beginning of a vicious circle. Each increase in the quantity of money in circulation brought about a further inflation of prices, reducing the purchasing power of incomes and revenues, and leading to more printing of money. In the extreme, the monetary system simply collapses. In Germany, people would rush out to spend the day's wages as fast as possible, knowing that only a few hours' inflation would deprive today's wages of most of their purchasing power. One source says that people might buy a bottle of wine in the expectation that on the following morning, the empty bottle could be sold for more than it had cost when full. Those with goods to barter resorted to barter to get food; those with nothing to barter suffered.

This is the way that hyperinflations happen: by a self-reinforcing vicious cycle of printing money, leading to inflation, leading to printing money, and so on. This is one reason why inflation is feared. There is always the concern that even a little inflation this year will lead to more next year, and so on. But some countries have experienced very great inflations -- 50 to 100% per year -- without ever falling into the cycle of hyperinflation, and there has never been a hyperinflation that could not have been avoided by a simple government determination to stop the expansion of the money supply.

The key point is this: the monetary system can function reasonably well as long as the value of the monetary unit is reasonably stable and predictable, and the high standards of living of modern societies cannot exist without a functioning monetary system.

Stagnation
A stagnation is a period of many years of slow growth of gross domestic product, in which the growth is, on the average, slower than the potential growth in the economy.
We should stress that this is quite controversial. There are economists who do not believe that stagnation exists as a problem. The difficulty is with the idea that growth is "less than the potential growth in the economy." But what is the potential? Those who see a great potential will see stagnation where those who see less potential will not.
In any case, the idea of stagnation was first discussed in the 1930's. The Great Depression, a period in which the growth of national product was generally negative, was thought of "by some economists" as a symptom of "secular stagnation." The word "secular" in this context meant that the causes of the stagnation were beyond the control of the government. The closing of the frontier, slowing technological progress, and higher savings rates because of higher average incomes were mentioned as possible causes.

Some economists believe that the U. S. A. has suffered from a stagnation in recent decades. One reason for their thinking is expressed in the following table:

Growth of Real GDP by Decades, U.S.A.

decade rate of
growth
1960's 4.46%
1970's 3.24%
1980's 2.84%
1990-1995 1.81%
Remember that in this table we are looking at rates of growth, not the levels of RGDP. Real GDP was greater in the 1990's, but is rising at a slower rate than in the 1960's. Since the middle of the 1990's, we have had a period of fairly steady higher rates of economic growth, around 4%, so it may be that the period of stagnation is over.

It is clear that in 1970-1995, American economic growth slowed down. But is a growth slowdown a problem? It might not be a problem, depending on the reasons for the slowdown.

Causes of Stagnation

There are several reasons why actual or potential Real GDP growth might slow down. The table below shows evidence on some of these possibilities. If both potential and actual growth have slowed to about the same extent, then perhaps we do not have a stagnation problem. (The Table is derived from data from the Bureau of Labor Statistics, Penn World Tables, The Economic Report of the President, and the U. S. Census Bureau).

Population growth might slow
Population growth increases both the demand for goods and services and the supply of labor to produce them, so slower population growth would mean slower potential economic growth. American population growth has slowed to some extent.
Fewer people might choose to work
The proportion of the population who choose to work is called the "rate of labor force participation." A decrease in the rate of labor force participation would slow the potential growth of output, while an increase in the rate of labor force participation would increase it. The American rate of labor force participation has tended to increase in the last few decades, to some extend offsetting the slowing of population growth.
The growth of labor productivity might slow
One of the most important sources of economic growth is the increase in output per worker. Labor productivity is output per unit of labor. If this growth of labor productivity is slower, the growth of total output would also be slower. Productivity growth itself might be stagnant -- that is, less than its own potential -- so it is not clear whether a decrease in productivity growth would be associated with stagnation or not. If productivity growth is itself below potential, we would see that as stagnation, but if potential and actual productivity growth have decreased about the same, then we would not see that as stagnation.
All of these related variables have indeed changed along with economic growth in recent decades.

The Advantages and Disadvantages of Traditional, Command and Market Economies

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In the world of today there are three major types of economies.
Traditional economies are dictated by tradition, customs, and, to
a large extent, religion. As time goes on this type of economy is
becoming more and more scarce. Command economies, such as
the former Soviet Union, North Korea, and Cuba, have a central
government that controls just about everything in the society.
The third and final major economy is the market economy. This
is a mostly free economy, where the central government is weak
and the businesses do as they please to make a profit. Each of
these economies has many positive and negative aspects.

Traditional Economy

One of the few advantages existing in a traditional economy is
that the roles of individuals are clearly defined. Every member of
the society knows exactly what they are to do and most don’t
have any complaints about it. There are also many disadvantages
to this type of society. These societies are often very slow to
change and when new technologies are introduced, these ideas
and techniques are discouraged.

Command Economy

Command economies have many advantages to it. One
advantage is that equality is focused on. The government tries to
eliminate all private property and distribute its good equally. If
done correctly no one is in poverty and no one is wealthier than
another. Social services are also emphasized in this type of
economy. The government will provide equal health care,
education opportunities, and make sure all people are fed.
A third advantage to this type of economy is that it is capable of
rapid change for major problems. The government owns the
companies, so if production needs need to be shifted into a
different area, the government is capable of doing it rather
quickly.
A final major advantage of command economies is that they are
very stable. Command economies will never have sudden
depressions. Although command economies may seem like a
utopian form of economics, they also have many disadvantages.
In command economies there is very little freedom. The
individual usually doesn’t have the opportunity to decide what
they want to do for a career, and they have no control over the
goods they receive. Another major problem is that there is little
reason for innovations, hard work, or quality of the work.
Since no one makes more money than everyone else, the people
feel like there is no reason to work hard. A third disadvantage is
that there is little focus on consumer wants. Finally, when it
comes to minor day-to-day changes, the government has a hard
time coping with them.

Market Economies

In recent years, market economies have been coming more and
more popular. Three major examples of market economies are
The United States, Japan, and France. One major advantage is
that market economies can adjust to change easily. If there is a
demand for one thing, companies have the ability to change
what they produce instead of having to go through too much
government protocol first. Rational self-interest in market
economies is also encouraged. People have the ability to make as
much money as they can and do what is in their best interest.
Another positive to market economies is that the government
tries to stay out of the way of businesses. Although the
government sets certain standards businesses must follow, for
the most part businesses can do as they please, allowing them to
produce what they want, how they want. A fourth advantage to
the market economy is that there is a great variety of goods and
services for consumers. If there is a demand for a good or
service, the demand will almost always be met in a market
economy.
Although there are a lot of positives to market economies, there
are also many negatives that go along with it too. One major
problem with this type of economy is that it doesn’t always
provide the basic needs to everyone in the society. The weak,
sick, disabled, and old sometimes have trouble providing for
themselves and often slip into poverty.
Another problem is that it becomes hard for a government with
so many private businesses to provide adequate defense,
education, and health care to its people. A third disadvantage to
this type of economy is that there is uncertainty in the business
world. One company could easily be forced out of business
causing all of its employees to become unemployed and lose
their means of income.
The final major disadvantage is that occasionally there are market
failures. This can cause some companies to become way to
powerful and become a monopoly. If the government doesn’t
step in, the monopoly can take advantage of the consumers and
charge ridiculously high prices.

Conclusion

Each of these types of economies has its own unique positives
and negatives. It may seem like one economic system is better
than another, but it all depends on what the viewer deems important.

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The term surplus is used in economics for several related quantities. The consumer surplus (sometimes named consumer's surplus or consumers' surplus) is the amount that consumers benefit by being able to purchase a product for a price that is less than the most that they would be willing to pay. The producer surplus is the amount that producers benefit by selling at a market price mechanism that is higher than the least that they would be willing to sell for.
Note that producer surplus generally flows through to the owners of the factors of production: in perfect competition, no producer surplus accrues to the individual firm. This is the same as saying that economic profit is driven to zero. Real-world businesses generally own or control some of their inputs, meaning that they receive the producer's surplus due to them: this is known as normal profit, and is a component of the firm's opportunity costs. If the markets for factors are perfectly competitive as well, producer surplus ultimately ends up as economic rent to the owners of scarce inputs such as land.



Overview

On a standard supply and demand (S&D) diagram, consumer surplus (CS) is the triangular area above the price level and below the demand curve, since intramarginal consumers are paying less for the item than the maximum that they would pay. In contrary, producer surplus (PS) is the triangular area below the price level and above the supply curve, since that is the minimum quantity a producer can produce.
If the government intervenes by implementing, for example, a tax or a subsidy, then the graph of supply and demand becomes more complicated and will also include an area that represents government surplus.
Combined, the consumer surplus, the producer surplus, and the government surplus (if present) make up the social surplus or the total surplus. Total surplus is the primary measure used in welfare economics to evaluate the efficiency of a proposed policy.
A basic technique of bargaining for both parties is to pretend that their surplus is less than it really is: sellers may argue that the price they ask hardly leaves them any profit, while customers may play down how eager they are to have the article.
In national accounts, operating surplus is roughly equal to distributed and undistributed pre-tax profit income, net of depreciation.
In some schools of heterodox economics, the economic surplus denotes the total income which the ruling class derives from its ownership of scarce factors of production, which is either reinvested or spent on consumption.
In Marxian economics, the term surplus may also refer to surplus value, surplus product and surplus labour.

Consumer surplus

The individual consumer surplus is the difference between the maximum total price a consumer would be willing to pay for the amount he buys and the actual total.If someone is willing to pay more than the actual price, their benefit in a transaction is how much they saved when they didn't pay that price. For example, a person is willing to pay a tremendous amount for water since he needs it to survive, however since there are competing suppliers of water he is able to purchase it for less than he is willing to pay. The difference between the two prices is the consumer surplus.
The maximum price a consumer would be willing to pay for a given amount is the sum of the maximum price he would be willing to pay for the first unit, the maximum additional price he would be willing to pay for the second unit, etc. Typically these prices are decreasing; in that case they are given by the individual demand curve. If these prices are first increasing and then decreasing there may be a non-zero amount with zero consumer surplus. The consumer would not buy an amount larger than zero and smaller than this amount because the consumer surplus would be negative. The maximum additional price a consumer would be willing to pay for each additional unit may also alternatingly be high and low, e.g. if he wants an even number of units, such as in the case of tickets he uses in pairs on dates. The lower values do not show up in the demand curve because they correspond to amounts the consumer does not buy, regardless of the price. For a given price the consumer buys the amount for which the consumer surplus is highest.
The aggregate consumers' surplus is the sum of the consumer's surplus for each individual consumer. This can be represented on the figure of the aggregate demand curve.

Pakistan's Economy - overview:

Pakistan, an impoverished and underdeveloped country, has suffered from decades of internal political disputes and low levels of foreign investment. Between 2001-07, however, poverty levels decreased by 10%, as Islamabad steadily raised development spending. Between 2004-07, GDP growth in the 5-8% range was spurred by gains in the industrial and service sectors - despite severe electricity shortfalls - but growth slowed in 2008-09 and unemployment rose. Inflation remains the top concern among the public, jumping from 7.7% in 2007 to 20.8% in 2008, and 14.2% in 2009. In addition, the Pakistani rupee has depreciated since 2007 as a result of political and economic instability. The government agreed to an International Monetary Fund Standby Arrangement in November 2008 in response to a balance of payments crisis, but during 2009 its current account strengthened and foreign exchange reserves stabilized - largely because of lower oil prices and record remittances from workers abroad. Textiles account for most of Pakistan's export earnings, but Pakistan's failure to expand a viable export base for other manufactures have left the country vulnerable to shifts in world demand. Other long term challenges include expanding investment in education, healthcare, and electricity production, and reducing dependence on foreign donors.

GDP (purchasing power parity):

$448.1 billion (2009 est.)

$436.4 billion (2008 est.)
$422 billion (2007 est.)
note: data are in 2009 US dollars


GDP (official exchange rate):
$166.5 billion (2009 est.)


GDP - real growth rate:
2.7% (2009 est.)

3.4% (2008 est.)
6% (2007 est.)

GDP - per capita (PPP):
$2,600 (2009 est.)

$2,500 (2008 est.)
$2,500 (2007 est.)
note: data are in 2009 US dollars

GDP - composition by sector:
agriculture: 20.8%

industry: 24.3%

services: 54.9% (2009 est.)

Labor force:
55.88 million
note: extensive export of labor, mostly to the Middle East, and use of child labor (2009 est.)


Labor force - by occupation:
agriculture: 43%

industry: 20.3%

services: 36.6% (2005 est.)

Unemployment rate:
15.2% (2009 est.)

13.6% (2008 est.)
note: substantial underemployment exists

Population below poverty line:
24% (FY05/06 est.)

Household income or consumption by percentage share:
lowest 10%: 3.9%

highest 10%: 26.5% (2005)


Distribution of family income - Gini index:
30.6 (FY07/08)

41 (FY98/99)

18.1% of GDP (2009 est.)


Budget:
revenues: $23.21 billion

expenditures: $30.05 billion (2009 est.)


Public debt:
45.3% of GDP (2009 est.)

51.2% of GDP (2008 est.)

Inflation rate (consumer prices):
14.2% (2009 est.)

20.3% (2008 est.)

Central bank discount rate:
15% (31 December 2008)

10% (31 December 2007)

Commercial bank prime lending rate:
NA% (31 December 2008)


Stock of money:
$NA (31 December 2008)

$52.76 billion (31 December 2007)

Stock of quasi money:
$NA (31 December 2008)

$18.42 billion (31 December 2007)

Stock of domestic credit:
$NA (31 December 2008)

$65.05 billion (31 December 2007)

Market value of publicly traded shares:
$23.49 billion (31 December 2008)

$70.26 billion (31 December 2007)
$45.52 billion (31 December 2006)

Agriculture - products:
cotton, wheat, rice, sugarcane, fruits, vegetables; milk, beef, mutton, eggs

Industries:
textiles and apparel, food processing, pharmaceuticals, construction materials, paper products, fertilizer, shrimp

Industrial production growth rate:
-3.6% (2009 est.)


Electricity - production:
90.8 billion kWh (2007 est.)


Electricity - consumption:
72.2 billion kWh (2007 est.)


Electricity - exports:
0 kWh (2008 est.)


Electricity - imports:
0 kWh (2008 est.)


Oil - production:
61,870 bbl/day (2008 est.)


Oil - consumption:
383,000 bbl/day (2008 est.)


Oil - exports:
30,090 bbl/day (2007 est.)

Oil - imports:
319,500 bbl/day (2007 est.)

Oil - proved reserves:
339 million bbl (1 January 2009 est.)


Natural gas - production:
37.5 billion cu m (2008 est.)


Natural gas - consumption:
37.5 billion cu m (2008 est.)

Natural gas - exports:
0 cu m (2008 est.)


Natural gas - imports:
0 cu m (2008 est.)


Natural gas - proved reserves:
885.3 billion cu m (1 January 2009 est.)


Current account balance:
$-2.42 billion (2009 est.)

$-15.68 billion (2008 est.)
Exports:
$17.87 billion (2009 est.)

$21.09 billion (2008 est.)

Exports - commodities:
textiles (garments, bed linen, cotton cloth, yarn), rice, leather goods, sports goods, chemicals, manufactures, carpets and rugs

Exports - partners:
US 16%, UAE 11.7%, Afghanistan 8.6%, UK 4.5%, China 4.2% (2008)

Imports:
$28.31 billion (2009 est.)

$38.19 billion (2008 est.)

Imports - commodities:
petroleum, petroleum products, machinery, plastics, transportation equipment, edible oils, paper and paperboard, iron and steel, tea

Imports - partners:
China 14.1%, Saudi Arabia 12%, UAE 11.2%, Kuwait 5.4%, India 4.8%, US 4.7%, Malaysia 4.1% (2008)

Reserves of foreign exchange and gold:
$15.68 billion (31 December 2009 est.)

$8.903 billion (31 December 2008 est.)

Debt - external:
$52.12 billion (31 December 2009 est.)

$46.39 billion (31 December 2008 est.)

Stock of direct foreign investment - at home:
$27.95 billion (31 December 2009 est.)

$25.44 billion (31 December 2008 est.)

Stock of direct foreign investment - abroad:
$1.078 billion (31 December 2009 est.)

$1.017 billion (31 December 2008 est.)
Exchange rates:
Pakistani rupees (PKR) per US dollar - 81.41 (2009), 70.64 (2008), 60.6295 (2007), 60.35 (2006), 59.515 (2005)

Price Discrimination

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Price Discrimination


Most businesses charge different prices to different groups of consumers for what is more or less the same good or service! This is price discrimination and it has become widespread in nearly every market. This note looks at variations of price discrimination and evaluates who gains and who loses?

What is price discrimination?

Price discrimination or yield management occurs when a firm charges a different price to different groups of consumers for an identical good or service, for reasons not associated with costs.

It is important to stress that charging different prices for similar goods is not pure price discrimination.

We must be careful to distinguish between price discrimination and product differentiation – differentiation of the product gives the supplier greater control over price and the potential to charge consumers a premium price because of actual or perceived differences in the quality / performance of a good or service.

Conditions necessary for price discrimination to work

Essentially there are two main conditions required for discriminatory pricing

Differences in price elasticity of demand between markets: There must be a different price elasticity of demand from each group of consumers. The firm is then able to charge a higher price to the group with a more price inelastic demand and a relatively lower price to the group with a more elastic demand. By adopting such a strategy, the firm can increase its total revenue and profits (i.e. achieve a higher level of producer surplus). To profit maximise, the firm will seek to set marginal revenue = to marginal cost in each separate (segmented) market.
Barriers to prevent consumers switching from one supplier to another: The firm must be able to prevent “market seepage” or “consumer switching” – defined as a process whereby consumers who have purchased a good or service at a lower price are able to re-sell it to those consumers who would have normally paid the expensive price. This can be done in a number of ways, – and is probably easier to achieve with the provision of a unique service such as a haircut rather than with the exchange of tangible goods. Seepage might be prevented by selling a product to consumers at unique and different points in time – for example with the use of time specific airline tickets that cannot be resold under any circumstances.
Examples of price discrimination

Price discrimination is an extremely common type of pricing strategy operated by virtually every business with some discretionary pricing power. It is a classic part of price competition between firms seeking a market advantage or to protect an established market position.

(a) Perfect Price Discrimination – charging whatever the market will bear
Sometimes known as optimal pricing, with perfect price discrimination, the firm separates the whole market into each individual consumer and charges them the price they are willing and able to pay. If successful, the firm can extract all consumer surplus that lies beneath the demand curve and turn it into extra producer revenue (or producer surplus). This is impossible to achieve unless the firm knows every consumer’s preferences and, as a result, is unlikely to occur in the real world. The transactions costs involved in finding out through market research what each buyer is prepared to pay is the main block or barrier to a businesses engaging in this form of price discrimination.

If the monopolist is able to perfectly segment the market, then the average revenue curve effectively becomes the marginal revenue curve for the firm. The monopolist will continue to see extra units as long as the extra revenue exceeds the marginal cost of production.

The reality is that, although optimal pricing can and does take place in the real world, most suppliers and consumers prefer to work with price lists and price menus from which trade can take place rather than having to negotiate a price for each unit of a product bought and sold.

Second Degree Price Discrimination

This type of price discrimination involves businesses selling off packages of a product deemed to be surplus capacity at lower prices than the previously published/advertised price.

Examples of this can often be found in the hotel and airline industries where spare rooms and seats are sold on a last minute standby basis. In these types of industry, the fixed costs of production are high. At the same time the marginal or variable costs are small and predictable. If there are unsold airline tickets or hotel rooms, it is often in the businesses best interest to offload any spare capacity at a discount prices, always providing that the cheaper price that adds to revenue at least covers the marginal cost of each unit.

There is nearly always some supplementary profit to be made from this strategy. And, it can also be an effective way of securing additional market share within an oligopoly as the main suppliers’ battle for market dominance. Firms may be quite happy to accept a smaller profit margin if it means that they manage to steal an advantage on their rival firms.

The expansion of e-commerce by both well established businesses and new entrants to online retailing has seen a further growth in second degree price discrimination.

Early-bird discounts – extra cash-flow

The low cost airlines follow a different pricing strategy to the one outlined above. Customers booking early with carriers such as EasyJet will normally find lower prices if they are prepared to commit themselves to a flight by booking early. This gives the airline the advantage of knowing how full their flights are likely to be and a source of cash-flow in the weeks and months prior to the service being provided. Closer to the date and time of the scheduled service, the price rises, on the simple justification that consumer’s demand for a flight becomes more inelastic the nearer to the time of the service. People who book late often regard travel to their intended destination as a necessity and they are therefore likely to be willing and able to pay a much higher price very close to departure.

Airlines call this price discrimination yield management – but despite the fancy name, at the heart of this pricing strategy is the simple but important concept – price elasticity of demand!



The airlines have become masters at price discrimination as a means of maximising revenue from passengers travelling on the flight networks. Other transport businesses do the same!

Peak and Off-Peak Pricing

Peak and off-peak pricing and is common in the telecommunications industry, leisure retailing and in the travel sector. Telephone and electricity companies separate markets by time: There are three rates for telephone calls: a daytime peak rate, and an off peak evening rate and a cheaper weekend rate. Electricity suppliers also offer cheaper off-peak electricity during the night.

At off-peak times, there is plenty of spare capacity and marginal costs of production are low (the supply curve is elastic) whereas at peak times when demand is high, we expect that short run supply becomes relatively inelastic as the supplier reaches capacity constraints. A combination of higher demand and rising costs forces up the profit maximising price.




Third Degree (Multi-Market) Price Discrimination

This is the most frequently found form of price discrimination and involves charging different prices for the same product in different segments of the market. The key is that third degree discrimination is linked directly to consumers’ willingness and ability to pay for a good or service. It means that the prices charged may bear little or no relation to the cost of production.

The market is usually separated in two ways: by time or by geography. For example, exporters may charge a higher price in overseas markets if demand is estimated to be more inelastic than it is in home markets.

MC=AC





Suppose that a firm has separated a market by time into a peak market with inelastic demand, and an off-peak market with elastic demand. The demand and marginal revenue curves for the peak market and off peak markets are labelled A and B respectively. This is illustrated in the diagram above. Assuming a constant marginal cost for supplying to each group of consumers, the firm aims to charge a profit maximising price to each group.

In the peak market the firm will produce where MRa = MC and charge price Pa, and in the off-peak market the firm will produce where MRb = MC and charge price Pb. Consumers with an inelastic demand for the product will pay a higher price (Pa) than those with an elastic demand who will be charged Pb.

The internet and price discrimination

A number of recent research papers have argued that the rapid expansion of e-commerce using the internet is giving manufacturers unprecedented opportunities to experiment with different forms of price discrimination. Consumers on the net often provide suppliers with a huge amount of information about themselves and their buying habits that then give sellers scope for discriminatory pricing. For example Dell Computer charges different prices for the same computer on its web pages, depending on whether the buyer is a state or local government, or a small business.

Two Part Pricing Tariffs

Another pricing policy common to industries with pricing power is to set a two-part tariff for consumers. A fixed fee is charged (often with the justification of it contributing to the fixed costs of supply) and then a supplementary “variable” charge based on the number of units consumed. There are plenty of examples of this including taxi fares, amusement park entrance charges and the fixed charges set by the utilities (gas, water and electricity). Price discrimination can come from varying the fixed charge to different segments of the market and in varying the charges on marginal units consumed (e.g. discrimination by time).



Peak time pricing – a common feature of many local transport markets

Product-line pricing

Product line pricing is also becoming an increasingly common feature of many markets, particularly manufactured products where there are many closely connected complementary products that consumers may be enticed to buy. It is frequently observed that a producer may manufacture many related products. They may choose to charge one low price for the core product (accepting a lower mark-up or profit on cost) as a means of attracting customers to the components / accessories that have a much higher mark-up or profit margin.


Manufacturers charge low prices for the razors but high prices for the razor blades – a good example of product line pricing

Good examples include manufacturers of cars, cameras, razors and games consoles. Indeed discriminatory pricing techniques may take the form of offering the core product as a “loss-leader” (i.e. priced below average cost) to induce consumers to then buy the complementary products once they have been “captured”. Consider the cost of computer games consoles or Mach3 Razors contrasted with the prices of the games software and the replacement blades!

The Consequences of Price Discrimination - Welfare and Efficiency Arguments

To what extent does price discrimination help to achieve a more efficient allocation of resources? There are arguments on both sides of the coin – indeed the impact of price discrimination on welfare seems bound to be ambiguous.

The impact on consumer welfare

Consumer surplus is reduced in most cases - representing a loss of consumer welfare. For the majority of consumers, the price charged is significantly above marginal cost of production. Those consumers in segments of the market where demand is inelastic would probably prefer a return to uniform pricing by firms with monopoly power! Their welfare is reduced and monopoly pricing power is being exploited.

However some consumers who can buy the product at a lower price may benefit. Previously they may have been excluded from consuming it. Low-income consumers may be “priced into the market” if the supplier is willing and able to charge them a lower price. Good examples to use here might include legal and medical services where charges are dependent on income levels. Greater access to these services may yield external benefits (positive externalities) which then have implications for the overall level of social welfare and the equity with which scarce resources are allocated.

Producer surplus and the use of profit

Price discrimination is clearly in the interests of businesses who achieve higher profits. A discriminating monopoly is extracting consumer surplus and turning it into extra supernormal profit. Of course businesses may not be driven solely by the aim of maximising profit. A company will maximise its revenues if it can extract from each customer the maximum amount that person is willing to pay.

Price discrimination also might be used as a predatory pricing tactic – i.e. setting prices below cost to certain customers in order to harm competition at the supplier’s level and thereby increase a firm’s market power. This type of anti-competitive practice is difficult to prove, but would certainly come under the scrutiny of the UK and European Union competition authorities.

A converse argument to this is that price discrimination may be a way of making a market more contestable in the long run. The low cost airlines have been hugely successful partly on the back of extensive use of price discrimination among consumers.

The profits made in one market may allow firms to cross-subsidise loss-making activities/services that have important social benefits. For example profits made on commuter rail or bus services may allow transport companies to support loss making rural or night-time services. Without the ability to price discriminate these services may have to be with drawn and employment might suffer. In many cases, aggressive price discrimination is seen as inimical to business survival during a recession or sudden market downturn.

An increase in total output resulting from selling extra units at a lower price might help a monopoly supplier to exploit economies of scale thereby reducing long run average costs.

The Harrod-Domar Model

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The Harrod-Domar Model
Main Prediction: GDP growth is proportional to the share of investment spending in GDP.
Assumptions:
1. Assume unemployed labor, so there is no constraint on the supply of labor.
2. Production is proportional to the stock of machinery.
Growth Rate of GDP
We want to determine the growth rate of GDP, which is defined as:
G(Y) = (change in Y) / Y where Y = GDP
To do this, we estimate the Incremental Capital-Output Ratio (ICOR), which is a measure of capital efficiency.
ICOR = (change in K) / (change in Y) where K = capital stock
A high ICOR implies a high increase in capital stock relative to the increase in GDP. Thus, the higher the ICOR, the lower the productivity of capital.
Since capital is assumed to be the only binding production constraint, investment (I) in the Harrod-Domar model is defined as the growth in capital stock.
I = (change in K)
But investment is also equal to savings (S), which is equal to the average propensity to save (APS) times GDP (Y). Denote APS = s
I = S = APS * Y = s*Y
So,
ICOR = (s Y) / (change in Y)
Rearranging terms,
G(Y) = (change in Y) / Y = s / ICOR (1)
Growth Rate of GDP per Capita
The growth rate of GDP per Capita is defined as
G(Y/P) = G(Y) – G(P) where G(P) = the population growth rate
From (1),
G(Y/P) = s / ICOR - G(P) (2)
Thus, a 1 percent increase in population growth will cause the growth rate of GDP per capita to decrease by 1 percent.
The empirical question is whether policy makers can achieve a constant marginal product of capital when the centralize investment decisions.
Examples
1. Assume that a country has a savings/investment rate of 4 percent of their GDP and an ICOR of 4, they will have a growth rate of 1 percent.
But if the population growth rate were also 1 percent, then the country would have zero GDP growth per capita.
These assumptions imply that for a country to develop, it needed to have an investment rate of around 12-15 percent of GDP, which would result in a GDP growth rate of 3 percent. The country in our example, however, only invests 4 percent.
The difference between the required investment rate (12 percent) and the country’s own investment (4 percent) is what development economists call the financing gap. Foreign aid by Western countries fills this financing gap in order to attain the target growth for the country. However, unless the investment is used productively, there is no guarantee that it will generate the desired change in output.
2. The Harrod-Domar model assumes fixed coefficients:
Y = F(K,L) = min (AK,BL) where
A and B are positive constants. With fixed proportions, if the available capital and labor happen to fit AK=BL, then all workers and equipment are fully employed. However, if AK>BL, then only BLA⎛⎞⋅⎜⎟⎝⎠ of the capital is used and the rest is unemployed.
If AK3. Assume that Shanistan producers cigars with a fixed coefficient technology:
Y = min (1/4K, 1/2L)
Currently, Shanistan has 80 units of K and 100 L. What is the feasible output?
Y = 20
What is employment? (1/2) 80 = 40
Divide both sides by L to get per capita output:
y = min (Ak, B)
If k< B/A, then K is fully employed and output y = Ak
For k> B/A, then Y = BL and capital would be unemployed, so y = B.
(In the graph, below, we derive y and k when 0
Another View

The Harrod–Domar model is used in development economics to explain an economy's growth rate in terms of the level of saving and productivity of capital. It suggests that there is no natural reason for an economy to have balanced growth. The model was developed independently by Sir Roy F. Harrod in 1939 and Evsey Domar in 1946. The Harrod–Domar model was the precursor to the exogenous growth model.



Criticisms of the model

The main criticism of the model is the level of assumption, one being that there is no reason for growth to be sufficient to maintain full employment; this is based on the belief that the relative price of labour and capital is fixed, and that they are used in equal proportions. The model explains economic boom and bust by the assumption that investors are only influenced by output (known as the accelerator principle); this is now widely believed to be false.
In terms of development, critics claim that the model sees economic growth and development as the same; in reality, economic growth is only a subset of development. Another criticism is that the model implies poor countries should borrow to finance investment in capital to trigger economic growth; however, history has shown that this often causes repayment problems later.
The endogenity of savings: Perhaps the most important parameter in the Harrod–Domar model is the rate of savings. Can it be treated as a parameter that can be manipulated easily by policy? That depends on how much control the policy maker has over the economy. In fact, there are several reasons to believe that the rate of savings may itself be influenced by the overall lever of per capita income in the society , not to mention the distribution of that income among the population.

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Oligopoly: its Price and Output Behaviours

An oligopoly is a market condition in which the production of identical or similar products is concentrated in a few large firms. Examples of oligopolies in the United States include the steel, aluminum, automobile, gypsum, petroleum, tire, and beer industries. The introduction of new products and processes can create new oligopolies, as in the computer or synthetic fiber industries. Oligopolies also exist in service industries, such as the airlines industry.

An oligopoly may be categorized as either a homogeneous oligopoly or a differentiated oligopoly. In a homogeneous oligopoly the major firms produce identical products, such as steel bars or aluminum ingots. Prices tend to be uniform in homogeneous oligopolies. In a differentiated oligopoly, similar but not identical products are produced. Examples include the automobile industry, the cigarette industry, and the soft drink industry. In differentiated oligopolies companies attempt to differentiate their products from those of their competitors. To the extent that they are able to establish differentiated products, companies may be able to maintain price differences.

Being part of an oligopoly affects a company's competitive behavior. In a competitive market situation that is not an oligopoly, firms compete by acting for themselves to maximize profits without regard to the reactions of their competitors. In an oligopoly, a firm must consider the effects of its actions on others in the industry. While smaller firms may operate at the fringes of an oligopoly without affecting the other firms in the industry, the actions of a major firm in the oligopoly typically cause reactions in the other firms in the industry. For example, if one company in the oligopoly attempts to undersell the others, then the other firms will respond by also lowering prices. As a result, price cuts in oligopolies tend to result in lower profits for all of the firms involved.

Prices in oligopolistic industries tend to be unstable to the extent that companies will shade, or lower, their prices slightly to gain a competitive advantage. It must be remembered that collusion between firms to fix prices is illegal under U.S. antitrust laws, so oligopolies must reach industry agreements on pricing indirectly. Companies can signal their pricing intentions indirectly in a variety of ways, such as through press releases, speeches by industry leaders, or comments given in interviews. In some cases there is a recognized price leader in the oligopoly, and other firms in the oligopoly set their prices according to that of the industry's price leader.

Industrial concentration is a matter of degree. This means that there is no absolute definition of an oligopoly in terms of the number of firms accounting for a certain percentage of an industry's output. In the United States the Census of Manufacturers reports on each industry's four-firm concentration ratio. This figure indicates what percentage of an industry's output is accounted for by its four largest companies. It is not uncommon for the four largest firms to account for 30 percent or more of an industry's output, and in some cases they account for more than 70 percent of production.

In the United Kingdom, for example, the top four food retailers accounted for 45 to 67 percent of the nation's $150 billion grocery market in 1998. In Russia, economic development under Boris Yeltsin has been described as a "new oligarchy," in which government officials and business leaders join together to gain control of industries such as banking, television, the business press, and other companies.

Oligopolies tend to develop in industries that require large capital investments. Studies have shown that industries with high four-firm concentration ratios tend to have higher margins than other industries. In order to maintain an oligopoly, potential investors must be discouraged from establishing competing companies. Oligopolies are able to perpetuate themselves and discourage new investments in several ways. In some cases the oligopoly is the result of access to key resources, which may be either natural resources or some patented process or special knowledge. New firms cannot enter the industry without access to those resources.

The established, experienced firms in an oligopoly also enjoy significant cost advantages that make it difficult for new firms to enter the industry. These cost advantages may be the result of the large scale of production required as well as of experience in keeping manufacturing or operating costs down. Another factor that tends to perpetuate oligopolies is the difficulty of introducing new products into an oligopoly characterized by a high degree of product differentiation. Prohibitively large expenditures would be required of a new firm to overcome consumer reluctance to try a new product over an established one. Finally, oligopolies perpetuate themselves through predatory practices such as obtaining lower prices from suppliers, establishing exclusive dealerships, and predatory pricing aimed at driving smaller competitors out of business.

REVIEW OF RECOGNISED MUTUAL INTERDEPENDENCE

Four possibilities: Because of the recognised mutual interdependence and uncertainty in price and output, there are four possibilities of behaviour ranging from outright price competition, price rigidity and non-price competition, price leadership and collusion.

OUTRIGHT PRICE COMPETITION

Because different cost advantages, firms tend to compete one another by cutting prices hoping to increase market share, TR and profit. Succeed if other firms will not react to reduce their prices. The demand curve for your product is elastic; Fail if other firms do react, thus leading to zero economic profit for all firms, loss for some firms and a higher market concentration. This possibility often prevails in the oligopolistic market with a few equally sized firms.

PRICE LEADERSHIP

A large firm takes the lead in setting a price which is followed by other firms. Necessary Conditions: The leading firm must be able to predict how other firms to react to (follow) its price and quantity decisions. If the reaction is as expected, there will be no pressure on the leading firm to change price other than due to new changes in costs. Two Problems: How is the first price is established ? How is the established price changed ? This possibility often prevails in the oligopolistic market with very high concentration ratio.

PRICE RIGIDITY AND KINKED DEMAND CURVE

Without cost advantages, firms are reluctant to change their prices because, if one firm reduces its price, all other firms will follow and no increase in Q sold is possible; if one firm increases price, no other firms will follow and there is a decrease in quantity sold. No benefit but loss; Kinked Demand Curve: One firm decreases price, all other firms follow, no increase in quantity sold. One firm increases price, no other firms will follow a decrease in quantity sold. There is no benefit but loss in changing prices. There is rigidity in price.
Firms go for non-price competition such as product differentiation, product proliferation, and advertising, etc. Price rigidity in oligopoly is expressed by a kinked demand curve.



COLLUSION AS A CARTEL

Collusion is opposite to price competition. Oligopolistic firms always have incentives to collude by agreements to act as if they were a monopoly in order to capture the maximum monopoly profit. But the collusion is always temporary and the competition is inevitable because of the conflict of interest.

GAME THEORY

The decision behaviours of oligopolistic firms are not stable and predictable because of mutually recognised interdependence. The conflict of interest and the strategies in the context of conflicting goals are demonstrated in the game theory and expressed by a payoff-matrix. It indicates a profit gain or loss from each possible move for each possible rival reaction.

PAY-OFF MATRIX FOR A DUOPOLY IN PRICE WAR (millions in profit)

FIRM Y’s strategy FIRM X’s max loss
cut price
do not cut price

FIRM X’s strategy cut price (1) X’s profit - $3
Y’s profit - $3 (2) X’s profit +$2
Y’s profit -$5 -$3
do not cut price (3) X’s profit -$5
Y’s profit +$2 (4) X’s profit, no change
Y’s profit, no change -$5
FIRM Y’s max loss -$3 -$5

1. Firm X is worse off because it cuts price when Firm Y follows. the worse case for all
2. Firm X is better off because it cuts price when Firm Y does not follow. the case in favour of Firm X
3. Firm X is worse off because it takes no action when Firm Y cuts price. the case in favour of Firm Y
4. Both firms are better off because no price is cut. the best case for all

• Logically, the best case (No. 4) for all firms is that no one cuts price (they collude tightly). But in reality, due to the conflict of interest, the worse case (No. 1) always prevails because:
• each of them wants to seek +2 m for which the necessary condition is that one person cuts price while the other person does not cut; and ironically
• no one can get +2 m because everyone chooses to cut price due to the fact that the maximum loss -3 m (if they cut price) is smaller than -5m (if they refuse to cut price).
• Competition is inevitable and collusion is temporary.

COMPARISON OF OLIGOPOLY WITH OTHER MARKET STRUCTURES

Views on Oligopoly: The strict comparison of oligopoly with other markets is largely a fiction. Advantages: 1. Oligopoly is more realistic; 2. It is an ideal combination of the opportunity for profit giving incentive to innovation and the existence of competition encouraging efficiency. Problems: concentration ratios are higher in some industries than can be justified by economies of scale; industrial concentration and large firm size are not consistently related to inventive and innovative activity; There is also a positive relationship between industrial concentration ratio and the amount of advertising..

Challenge on Assumption of Profit Maximisation: The theory of firm is based on the assumption that the only business goal for a firm is to maximise its profit. In reality, firms may maximise either short run profit or long run profit, or something other than profits altogether, such as growth of sales revenue, market share, salary and life style package for executives, the luxury of inefficiency, etc. However, the profit maximisation is fundamentally important for firms' survival.

Protectionism-An Introduction

NEAR the window by which I write, a great bull is tethered by a ring in his nose. Grazing round and round he has wound his rope about the stake until now he stands a close prisoner, tantalized by rich grass he cannot reach, unable even to toss his head to rid him of the flies that cluster on his shoulders. Now and again he struggles vainly, and then, after pitiful bellowings, relapses into silent misery.

This bull, a very type of massive strength, who, because he has not wit enough to see how he might be free, suffers want in sight of plenty, and is helplessly preyed upon by weaker creatures, seems to me no unfit emblem of the working masses.

In all lands, men whose toil creates abounding wealth are pinched with poverty, and, while advancing civilization opens wider vistas and awakens new desires. are held down to brutish levels by animal needs. Bitterly conscious of injustice, feeling in their inmost souls that they were made for more than so narrow a life, they, too, spasmodically struggle and cry out. But until they trace effect to cause, until they see how they are fettered and how they may be freed, their struggles and outcries are as vain as those of the bull. Nay, they are vainer. I shall go out and drive the bull in the way that will untwist his rope. But who shall drive men into freedom? Till they use the reason with which they have been gifted, nothing can avail. For them there is no special providence.

Under all forms of government the ultimate power lies with the masses. It is not kings nor aristocracies, nor land-owners nor capitalists, that anywhere really enslave the people. It is their own ignorance. Most clear is this where governments rest on universal suffrage. The workingmen of the United States may mould to their will legislatures, courts and constitutions. Politicians strive for their favor and political parties bid against one another for their vote. But what avails this? The little finger of aggregated capital must be thicker than the loins of the working masses so long as they do not know how to use their power. And how far from any agreement as to practical reform are even those who most feel the injustice of existing conditions may be seen in the labor organizations. Though beginning to realize the wastefulness of strikes and to feel the necessity of acting on general conditions through legislation, these organizations when they come to formulate political demands seem unable to unite upon any measures capable of large results.

This political impotency must continue until the masses, or at least that sprinkling of more thoughtful men who are the file leaders of popular opinion, shall give such head to larger questions as will enable them to agree on the path reform should take.

It is with the hope of promoting such agreement that I propose in these pages to examine a vexed question which must be settled before there can be any efficient union in political action for social reform—the question whether protective tariffs are or are not helpful to those who get their living by their labor.

This is a question important in itself, yet far more important in what it involves. Not only is it true that its examination cannot fail to throw light upon other social-economic questions, but it leads directly to that great "Labor Question" which every day as it passes brings more and more to the foreground in every country of the civilized world. For it is a question of direction—a question which of two divergent roads shall be taken. Whether labor is to be benefited by governmental restrictions or by the abolition of such restrictions is, in short, the question of how the bull shall go to untwist his rope.

In one way or another, we must act upon the tariff question. Throughout the civilized world it everywhere lies within the range of practical politics. Even when protection is most thoroughly accepted there not only exists a more or less active minority who seek its overthrow, but the constant modifications that are being made or proposed in existing tariffs are as constantly bringing the subject into the sphere of political action, while even in that country in which free trade has seemed to be most strongly rooted, the policy of protection is again raising its head. Here it is evident that the tariff question is the great political question of the immediate future. For more than a generation the slavery agitation, the war to which it led and the problems growing out of that war have absorbed political attention in the United States. That era has passed, and a new one is beginning, in which economic questions must force themselves to the front. First among these questions, upon which party lines must soon be drawn and political discussion must rage, is the tariff question.

It behooves not merely those who aspire to political leadership, but those who would conscientiously use their influence and their votes, to come to intelligent conclusions upon this question, and especially is this incumbent upon the men whose aim is the emancipation of labor. Some of these men are now supporters of protection; others are opposed to it. This division, which must place in political opposition to each other those who are at one in ultimate purpose, ought not to exist. One thing or the other must be true—either protection does give better opportunities to labor and raises wages, or it does not. If it does, we who feel that labor has not its rightful opportunities and does not get its fair wages should know it, that we may unite, not merely in sustaining present protection, but in demanding far more. If it does not, then, even if not positively harmful to the working classes, protection is a delusion and a snare, which distracts attention and divides strength, and the quicker it is seen that tariffs cannot raise wages the quicker are those who wish to raise wages likely to find out what can. The next thing to knowing how anything can be done, is to know how it cannot be done. If the bull I speak of had wit enough to see the uselessness of going one way, he would surely try the other.

My aim in this inquiry is to ascertain beyond per adventure whether protection or free-trade best accord with the interests of those who live by their labor I differ with those who say that with the rate of wages the state has no concern. I hold with those who deem the increase of wages a legitimate purpose of public policy. To raise and maintain wages is the great object that all who live by wages ought to seek, and workingmen are right in supporting any measure that will attain that object. Nor in this are they acting selfishly, for, while the question of wages is the most important of questions to laborers, it is also the most important of questions to society at large. Whatever improves the condition of the lowest and broadest social stratum must promote the true interests of all. Where the wages of common labor are high and remunerative employment is easy to obtain, prosperity will be general. Where wages are highest, there will be the largest production and the most equitable distribution of wealth. There will invention be most active and the brain best guide the hand. There will be the greatest comfort, the widest diffusion of knowledge, the purest morals and the truest patriotism. If we would have a healthy, a happy, an enlightened and a virtuous people, if we would have a pure government, firmly based on the popular will and quickly responsive to it, we must strive to raise wages and keep them high. I accept as good and praiseworthy the ends avowed by the advocates of protective tariffs. What I propose to inquire is whether protective tariffs are in reality conducive to these ends. To do this thoroughly I wish to go over all the ground upon which protective tariffs are advocated or defended, to consider what effect the opposite policy of free trade would have, and to stop not until conclusions are reached of which we may feel absolutely sure.

To some it may seem too much to think that this can be done. For a century no question of public policy has been so widely and persistently debated as that of Protection vs. Free Trade. Yet it seems to-day as far as ever from settlement—so far, indeed, that many have come to deem it a question as to which no certain conclusions can be reached, and many more to regard it as too complex and abstruse to be understood by those who have not equipped themselves by long study.

This is, indeed, a hopeless view. We may safely leave many branches of knowledge to such as can devote themselves to special pursuits. We may safely accept what chemists tell us of chemistry, or astronomers of astronomy, or philologists of the development of language, or anatomists of our internal structure, for not only are there in such investigations no pecuniary temptations to warp the judgment, but the ordinary duties of men and of citizens do not call for such special knowledge, and the great body of a people may entertain the crudest notions as to such things and yet lead happy and useful lives. Far different, however, is it with matters which relate to the production and distribution of wealth, and which thus directly affect the comfort and livelihood of men. The intelligence which can alone safely guide in these matters must be the intelligence of the masses, for as to such things it is the common opinion, and not the opinion of the learned few, that finds expression in legislation.

If the knowledge required for the proper ordering of public affairs be like the knowledge required for the prediction of an eclipse, the making of a chemical analysis, or the decipherment of a cuneiform inscription, or even like the knowledge required in any branch of art or handicraft, then the shortness of human life and the necessities of human existence must forever condemn the masses of men to ignorance of matters which directly affect their means of subsistence. If this be so, then popular government is hopeless, and, confronted on one side by the fact, to which all experience testifies, that a people can never safely trust to any portion of their number the making of regulations which affect their earnings, and on the other by the fact that the masses can never see for themselves the effect of such regulations, the only prospect before mankind is that the many must always be ruled and robbed by the few.

But this is not so. Political economy is only the economy of human aggregates, and its laws are laws which we may individually recognize. What is required for their elucidation is not long arrays of statistics nor the collocation of laboriously ascertained facts, but that sort of clear thinking which, keeping in mind the distinction between the part and the whole, seeks the relations of familiar things, and which is as possible for the unlearned as for the learned.

Whether protection does or does not increase national wealth, whether it does or does not benefit the laborer, are questions that from their nature must admit of decisive answers. That the controversy between protection and free trade, widely and energetically as it has been carried on, has as yet led to no accepted conclusion cannot therefore be due to difficulties inherent in the subject. It may in part be accounted for by the fact that powerful pecuniary interests are concerned in the issue, for it is true, as Macaulay said, that if large pecuniary interests were concerned in denying the attraction of gravitation, that most obvious of physical facts would have disputers. But that so many fair-minded men who have no special interests to serve are still at variance on this subject can only, it seems to me, be fully explained on the assumption that the discussion has not been carried far enough to bring out that full truth which harmonizes all partial truths.

The present condition of the controversy, indeed, shows this to be the fact. In the literature of the subject, I know of no work in which the inquiry has yet been carried to its proper end. As to the effect of protection upon the production of wealth, all has probably been said that can be said; but that part of the question which relates to wages and which is primarily concerned with the distribution of wealth has not been adequately treated. Yet this is the very heart of the controversy, the ground from which, until it is thoroughly explored, fallacies and confusions must constantly arise, to envelop in obscurity even that which has of itself been sufficiently explained.

The reason of this failure is not far to seek. Political economy is the simplest of the sciences. It is but the intellectual recognition, as related to social life, of laws which in their moral aspect men instinctively recognize, and which are embodied in the simple teachings of him whom the common people heard gladly. But, like Christianity, political economy has been warped by institutions which, denying the equality and brother-hood of man, have enlisted authority, silenced objection, and ingrained themselves in custom and habit of thought. Its professors and teachers have almost invariably belonged to or been dominated by that class which tolerates no questioning of social adjustments that give to those who do not labor the fruits of labor's toil. They have been like physicians employed to make a diagnosis on condition that they shall discover no unpleasant truth. Given social conditions such as those that throughout the civilized world today shock the moral sense, and political economy, fearlessly pursued, must lead to conclusions that will be as a lion in the way to those who have any tenderness for "vested interests." But in the colleges and universities of our time, as in the Sanhedrim of old, it is idle to expect any enunciation of truths unwelcome to the powers that be.

Adam Smith demonstrated clearly enough that protective tariffs hamper the production of wealth. But Adam Smith—the university professor, the tutor and pensioner of the Duke of Buccleugh, the prospective holder of a government place—either did not deem it prudent to go further, or, as is more probable, was prevented from seeing the necessity of doing so by the atmosphere of his time and place. He at any rate failed to carry his great inquiry into the causes which from "that original state of things in which the production of labor constitutes the natural recompense or wages of labor" had developed a state of things in which natural wages seemed to be only such part of the produce of labor as would enable the laborer to exist. And, following Smith, came Malthus, to formulate a doctrine which throws upon the Creator the responsibility for the want and vice that flow from man's injustice—a doctrine which has barred from the inquiry which Smith did not pursue even such high and generous minds as that of John Stuart Mill. Some of the publications of the Anti-Corn-Law League contain indications that if the struggle over the English corn laws had been longer continued, the discussion might have been pushed further than the question of revenue tariff or protective tariff; but, ending as it did, the capitalists of the Manchester school were satisfied, and in such discussion as has since ensued English free traders, with few exceptions, have made no further advance, while American advocates of free trade have merely followed the English free traders.

On the other hand, the advocates of protection have evinced a like indisposition to venture on burning ground. They extol the virtues of protection as furnishing employment, without asking how it comes that any one should need to be furnished with employment; they assert that protection maintains the rate of wages, without explaining what determines the rate of wages. The ablest of them, under the lead of Carey, have rejected the Malthusian doctrine, but only to set up an equally untenable optimistic theory which serves the same purpose of barring inquiry into the wrongs of labor, and which has been borrowed by Continental free traders as a weapon with which to fight the agitation for social reform.

That, so far as it has yet gone, the controversy between protection and free trade has not been carried to its logical conclusions is evident from the positions which both sides occupy. Protectionists and free traders alike seem to lack the courage of their convictions. If protection have the virtues claimed for it, why should it be confined to the restriction of imports from foreign countries? If it really "provides employment" and raises wages, then a condition of things in which hundreds of thousands vainly seek employment, and wages touch the point of bare subsistence, demands a far more vigorous application of this beneficent principle than any protectionist has yet proposed. On the other hand, if the principle of free trade be true, the substitution of a revenue tariff for a protective tariff is a ridiculously inefficient application of it.

Like the two knights of allegory, who, halting one on each side of the shield, continued to dispute about it when the advance of either must have revealed a truth that would have ended their controversy, protectionists and free traders stand to-day. Let it be ours to carry the inquiry wherever it may lead. The fact is, that fully to understand the tariff question we must go beyond the tariff question as ordinarily debated. And here, it may be, we shall find ground on which honest divergences of opinion may be reconciled, and facts which seem conflicting may fall into harmonious relations.