PREFACE

In recent times, with the rapid development of economic, thousands of

businesses have been established due to the enormous benefits gained from
economic activities. Therefore, its essential to understand the market
structure which contains perfect competitions, monopolistic competition,
monopoly and oligopoly, in order to help your business survive in this intense
and competitive environment. We need discern the main characteristics of
those structures and how the characteristics affect each firms decision in
setting price, quantity supplied under the effect of market demand,
consumers preference and especially rivals decisions.

Understanding those crucial needs, our group decides to do research

on the market structure in which we highly focus on the oligopoly. By stating
the research question is that How oligopoly is applied in reality case?
Therefore, first, we shall bring up all the characteristics and the theories
related to oligopoly then we shall use those theories to explain 3 practical
cases which is case about P&G vs Unilever, case about Vietnams
Telecommunicating systems and finally is the case about Organization of
Petroleum Exporting Countries (OPEC).

To analyze the practical case, the method we used to collect data is

secondary data from economics book, sources on the internet relating to our
cases

0
1
TABLE OF CONTENTS:
A.MARKET STRUCTURE.
3
I.
Definition
3
II. Classification..................
..........
3
1. Determinants

3
2. Comparison

... 3

B.
OLIGOPOLY
. 5
I. Definition:

. 5
II. Key concept: Game theory
.....5
1. Overview

... 5
2. Concepts
.. 6
3. Assumptions

. 6
4. Nash
equilibrium
... 6
III.
Characteristics
. 8
1. Interdependence
... 8
a. Game theory

8

2
 b. Price stickiness (Price rigidity)
.9
2. The number of
firms
..10
c. Barrier to
entry
10
d. Market
power
10
e. Size of an
oligopoly
..11
3. Nature of
product
.11
a. Homogeneous
products
11
b. Differentiated
products
12
IV.
Modeling
..13
1. Kinked demand
mode
..13
a. Price stickiness

14
b. Non-
pricecompetition
.14
2. Cournot
model
..16
a. Assumptions
..16
b. Reaction curve & Cournot
equilibrium17

3
 3. Bertrand duopoly
model
.18
V. Classification of
olipology
.. 20
1. Basis of Product diferentiation
.20
2. Base on the agreement or collusion
.20
3. Based on the ability to entry of
firms 21
4. Based on the presence of

leadership 21

C. PRACTICAL CASES

23
I. P&G VESUS UNILEVER
..........
....23
1. Introduction
....23
2. Strategy
..24
3. Competition
.24
a. Washing powder : Omo vs
Tide24
b. Hair Care Product : Sunsilk vs
Pantene26
c. Fabric softener : Comfort vs
Downy.26
4. Oligopoly
Analysis
.................27
a. Non price competition

.27
b. Kinked demand curve

..28
c. Game theory first move advantage
........28
4
II. VIETNAMS TELECOMMUNICATION
MARKET.. 29
1. Vietnams Telecommunications
services.29
a. Mobifone

29
b. Vinaphone

.30
c. Viettel

. 30
d. Other mobile networks

30
2. Characteristics of Oligopoly in Vietnam Telecommunications
Market. 31
a. Dominant firms

..31
b. Interdependence & Kinked demand curve ( No price competition)
.31
c. Substantial barriers to entry Vietnam Telecoms market
..32
3. Could we eliminate collusion and cheating?
33
III. OPEC

34
1. Cartel Theory

.34
2. Kinked Demand
Curve
. 36
3. Stackelberg Cournot
Game
40
4. Infinitely Repeated Stackelberg Cournot
Game.42

REFERRENCES.....................................................................................................
............................44
5
6
A. MARKET STRUCTURE

I. Definition:

A market is a group of buyers and sellers of a particular good or

service. (Mankiw 2008, Principles of microeconomics, p.66). Market structure
refers to the nature and degree of competition in the market for goods and
services. The structures of market both for goods market and service (factor)
market are determined by the nature of competition prevailing in a particular
(1)
market (yourarticlelibrary.com)

II. Classification:
1. Determinants:
In order to classify market structure into 4 main types, we mostly base on
these following basis:
Number of sellers:
In a market, more sellers usually lead to more competitiveness
(because many sellers offer one type of good), and each sellers
decision has less impact on market price or market output.

Nature of product:

- Homogenous product: when the products are identical, buyers choice

substitute easily, which increase competitiveness among firms.
- Heterogeneous product: if firm offer differentiated good from other firms,
it can gain more market power of setting the prices.

Entry and exit of firms:

Barriers to entry are factors that prevent or make it difficult for new firms
to enter a market, which is one of determinant affects the number of
sellers. The more barriers are the less contestable and competitive market
is.

2. Comparison:

7
 From these determinants, we classify market structure into: Perfect
Competition, Monopoly, Monopolistic, Competition, Oligopoly as this table of
comparison:

8
 Perfect Monopolistic
Basis Monopoly Oligopoly
Competition Competition
1.
Number Very large num- Large number
Single seller Few Big sellers
of ber of sellers of sellers
Sellers
Products are
homogeneous
2. Closely related under Pure
Nature Homogeneous No Close but Oligopoly and
of Products Substitutes differentiated differentiated
Product Products under
Differentiated
Oligopoly
Entry of new
3. Entry Restrictions on
Freedom of firms and exit Freedom of
and Exit entry of new
entry and exit of old firms is entry and exit
of Firms firms
restricted
Downward slop- Downward
4.
Perfectly elastic ing demand sloping demand Indeterminate
Demand
demand curve curve (less (but more demand curve
Curve
elastic) elastic)
Firm is a price- Firm has partial
Uniform price as maker. So, control over Price rigidity
5. Price each firm is a price price due to due to fear of
price-taker discrimination product price war
is possible. differentiation.
Only
6. Huge selling
No selling costs informative High selling
Selling costs are
are incurred selling costs costs are spent
Costs incurred
are incurred
7. Level
of Perfect Imperfect Imperfect Imperfect
Knowled Knowledge Knowledge Knowledge Knowledge
ge
9
10
B. Oligopoly
I. Definition:

Oligopoly is aprevalent form of market structure in which only a

small number of firms account for most or all of total production. (Pena 2016,
Microeconomics, p.498)

For example. in Vietnam, if you ask for a mobile sim card, the cashier
will probably give only 3 choices: Vinaphone, Mobifone or Viettel. These
companies take almost all Vietnamese market share of telecommunication,
then we can consider them as oligopolists and Vietnams telecommunication
is an oligopolistic market.

II. Key concept: Game theory

1. Overview
In the modern era of economy, the profit of a firm do not only
depended on itself behavior but also the behavior of other parties in the
process of making decisions. As a result, decision makers, in order to do what
is best for the business, should take into account what strategies its
opponents choose to act, and how to deal with that scenario. To find out the
optimal strategy in the market, and Oligopoly in particular, decision makers
can apply the concept of game theory.

Game theory, firstly found in Theory of Games and Economics

Behaviour by mathematicians John von Neumann and Oskar Morgenstern in
1994 is a specific method, which is the "study of mathematical models of
conflict and cooperation between intelligent rational decision-makers". It is a
universal languagae for unification of the behavioral sciences (Gintis;
2000,20009. It is a methodology of analysis of social events and it's one of
most applicable ways of explaining human behavioral acts and their options in
the conflict and partially conflict phenomena, which is the situations that
comprise more than one member, whereas the final solution is not formed
only because of their internal factors but also the act of the opponents.

11
 2. Concepts:
Game: a situation in which the participant can decide the strategies
based on the behavior of the opponents' behavior.
Players: Participants of the game.
Strategies: Set of rules and behavior made by players in a game.
Results: The value or utility equivalent to the outcome of the game.
Zero-sum game: In game theory and also economic theory, the
concept of zero-sum game, or a strictly competitive game is an
interpretation of a situation in which the amount of utility a participant
gains or losses is exactly equal the amount of losses or gains. The act
doesn't change the total amount of utility of parties, as it only changes
from one to the other.

3. Assumptions:
Homo economicus: humans are consistently rational and narrowly self-
interested who always try to achieve their personally-defined optimum.
Players get full information of game theory.

4. Nash equilibrium
The Nash equilibrium is named after a very famous mathematician,
John Nash is a concept of game theory in which the ultimate result of a game
where no one changes his mind after considering his opponents' decisions. It
refers to a condition in which every participant has optimized its outcome,
however, neither business can have the optimal outcome by any separate
attempt to gain utility. Nash equilibrium exists when there is no unilateral
profitable deviation from any of the players involved. To this point, neither
participant is willing to move because they will be worse-off than the others.

We will explain the theory by the use of pay-off matrix in an example of

Starbucks vs San Francisco Coffee in the game of deciding whether
advertising should be invested on or not.

12
 In this example, as illustrated, both parties can have a strategy called
dominant strategy. That is, regardless of what its competitor, does, if one
chooses to advertise, the profit will be better off. If SF Coffee doesn't
advertise, Starbucks will have twice as much profit as SF by advertising, the
fact is also applied by SF coffee. Therefore, both players will have incentives
to follow the dominant strategy, which is advertising, given the behavior of its
competitors. Ultimately, however, total profit that each player will receive
when they advertised is not as much as which when they did not. We
conclude that the situation in which both parties decide to advertise is a Nash
equilibrium, since neither firm has a motive to change its strategy because
they will be worse-off. On the other hand, if those 2 firms agree to negotiate
to both not advertise, and become fully loyal to that agreement, they will
increase their profit to $15 each instead of $12.

13
III. Characteristics:

The key elements of oligopolistic industries are: the recognition of the

interdependence of their actions the small number of firms, and the nature of
product. (Jones 2009, Business Economics and Managerial Decision Making,
p.174)

1. Interdependence:

The foremost characteristic of oligopoly is interdependence of firms in

the decision making. Monopolists or sellers in perfect competition have non-
strategic behavior which implies that cost and demand curves of each firm
are determined without considering their large number of competitors
behaviors. However, in oligopoly there are a few sellers compete with each
other, then each decision they make such as makes-setting price, determining
production levels, undertaking a major promotion campaign, or investing in
new production capacity will have impact on their competitors and cause
various reactions.
For example, Ford intends to lower the price by 10% to stimulate demand, it
must think carefully about the responses of its rivals. In case they will not
react at all, or they only cut their prices slightly, Ford can gain a substantial
increase in sales, largely at the expense of its competitors. Maybe they might
match Fords price cut, which makes more cars sold but with much lower
prices than initial one, then lower profits of all firms. It is even worse when
price war happens: Some firms will reduce their prices by even more than
Ford to punish Ford for rocking the boat, which leads to a dramatic fall in
profits for the entire car industry.
These following key concepts will explain further the interdependence
of oligopolistic firms and its effect on oligopoly price characteristics:

a. Game theory

In Oligopoly, there is an existence of a few firms in a single market,

with homogeneous and heterogeneous or differentiated products, therefore,
game theory becomes one of the best method to interpret the economiics
14
situations, especially for non-collusive oligopoly. Totally apart from pure
monopoly or perfect competitive situation, most of the firms running a
business will find a way to deal with the opponents' campaigns when they are
on their decision-making process, like pricing, marketing, investment
strategies...

b. Price stickiness (Price rigidity)

Price stickiness is a characteristics of oligopolistic markets by which

firms reluctant to change prices even if costs or demands change. (Pena
2016, Microeconomics, p.515). We can explain the price rigidity by both
theory and practice:

+ Theoretical explainations:
- Base on game theory: Because firms are not sure about their
competitors reaction, then implicit collusion tends to be short-lived,
they strongly desire for price stability and be unwilling to move from
Nash equilibrium.
- Base on kinked demand model: When production costs or demand
change, firms are not willing to change price. When costs or market
demand reduce, if sellers lower prices might send the wrong message
to their rivals, which may create a mutually destructive price
competition. Even if costs or demand increase, they are reluctant to
raise prices because they fear that their competitors may not increase
theirs, which takes market share away from them. We will discuss more
details in part IV - Modeling

+ Practical reasons:
Other reason why firms do not change their prices frequently is the
costs involved in changing prices such as issuing new price lists or
catalogues, informing customers, the loss of customer goodwill & loyalty
and the pricing methodology used by individual firms. For example, most
firms have price reviews only been carried out quarterly or even annually,
so that prices by custom and practice are changed only infrequently, even
if changing conditions (costs, demand, etc.) might suggest some

15
adjustment. (Jones 2009, Business Economics and Managerial Decision
Making, p.186)

16
 2. The number of firms:

a. Barrier to entry:
Oligopoly sees a few sellers dominate the whole market, they are
extremely big and their actions have large impact on the profits of all the
other sellers. Is difficult or sometimes impossible for new firms to enter,
especially in the long run.
These barriers include:

+ Natural entry barriers:

- Economics of scale enjoyed by a few large firms: big company can
produce a good at a lower unit cost than a small firm (Eg: P&G or Unilever
have lower production cost for shampoo than other firms as Sao Thi
Dng).
- It costs new firm a great deal to have brand recognition or product
reputations (advertising cost for example).
- Accessibility of expensive and complex technology (such as patents for
pharmaceutical companies) is another obstacle.
- Sometimes existing firms receive priority policies and better regulations
from government (Ministry of Defence has supported Viettel, VNPT is a
Government-owned corporation, etc.)

+ Strategic entry deterrence:

Strategic actions which caused by incumbent firms to prevent new entry.
For example, big firms can make predatory pricing (by construct excess
production capacity, drive price down), hostile takeover or product
differentiation. Big firm can also increase its advertising-to-sales ratio,
which are difficult for smaller rivals to match, to create barrier to entry
against potential entrans

b. Market power:
Because the number of firms is small, each firm has a large share of the
market, oligopolists have certain market power: higher than firms in

17
competitive market and lower than monopolist. Their monopoly power and
profitability in oligopolistic industries depend a part on how the firms interact.
If the interaction is more cooperative than competitive, firms could charge
prices well above marginal cost and earn large profits (Pena 2016,
Microeconomics, p.493). If they choose to collude explicitly as a single big
firm, they will have pure monopoly power on price. Even if they compete
aggressively, they still carefully consider how their decisions affect
competitors and end up with the output and price above than marginal cost
although not maximize profit for both firms.

c. Size of an oligopoly:
As the number of sellers in an oligopoly grows larger, an oligopolistic
market looks more and more like a competitive market (Mankiw 2008,
Principle of Microeconomics, p.370) The more firms in an industry, the. Size of
oligopoly increase leads to the decrease in magnitude of price effect (increase
the output will raise the total amount sold, which lower the price of each unit
sold and lower the profit on all sales) and remaining output effect (when price
is above marginal cost, selling 1 more unit at the going price will raise total
profit); then each individual firms production decision has less influence on
market price.

4. Nature of product:
In oligopoly, products may be homogeneous or differentiated. Each
type of product has different influence on oligopoly characteristic:

c. Homogeneous products:
It hard to find any perfect homogeneous good, however, if firms
produce identical products (such as cement, steel, aluminum and chemicals)
they compete drastically in price with each other. The better a product is
substituted the greater its price is elastic, which implies each change in price
has large impact on quantity demanded (figure 2.3).

18
 Whenever a firm changes his price level, his competitors sales will be
immediately affected. As the result, they will change their pricing policy. For
the same type of good interdependence between these firms is exceedingly
significant.

d. Differentiated products:
In oligopolistic market, firms sell slightly different products (For
example all telecommunications providers offer nearly the same service, case
of P&G versus Unilever). Therefore, interdependence among them is less
significant than it does with similar products, however, if a firm can
successfully engage in product differentiation it can more easily gain market
(1)
power and dominate at least part of the industry (Source: Boundless.com)
Almost all of oligopoly models applied for differentiated products, which will
be analyzed further in case studies.

19
P1
P*
P2

Q1 Q
Q* 2

IV. Modeling:

There is no single model can fully describe the operation of an

oligopolistic market because of the variety and complexity when a few firms
competing on the basis of price, quantity, technological innovations,
marketing, and reputation. Fortunately, there are a series of models
attempting to describe oligopolistic market behavior under certain
circumstances, which are well recognized: the kinked demand model, the
Bertrand model, and the Cournot model.

5. Kinked demand model:

The kinked demand curve model is based on a price conjecture and
differentiated products. The price conjecture assesses the reactions of rivals
to a fall and an increase in price. (Jones 2009, Business Economics and
Managerial Decision Making, p.176)
In this model each firm faces a demand curve kinked at the currently
prevailing price: at higher prices demand is very elastic, whereas at lower
prices it is inelastic. (Figure 3.1)

Figure 3.1
Point X is the Oligopolists initial price (P*) and output (Q*). Each firm
believes that if it raises its price a above the current price P* (to P 1), none of
its competitors will follow suit. Therefore it will lose most of its sales (from Q*
to Q1) especially with identical products (reason why demand curve above P*
20
is very elastic). When that firm lowers price (to P 2), everyone will match the
change because no one want to lose their shares of the market, then its sales
will increase only to the extent that market demand increases (from Q* to Q 2).

As a result, the firms demand curve is kinked at point X, and its

marginal revenue curve MR is discontinuous at that point. To maximize profit,
oligopolist will charge price at which marginal revenue equal marginal cost.
Consequently, with any marginal cost curve varies from MC 1 to MC2, the firm
still produce the same output and keep the initial price.

a. Price stickiness
Although this model can not explain how initial price is set (the
following model Cournot-Nash will do) but it helps breaks down the term
price stickiness: Firms reluctant to move its price from P* (as long as the
marginal cost fluctuates bet MC1 to MC2) unless there are compelling reasons
to do so and these also apply to competitors.
(Jones 2009, Business Economics and Managerial Decision Making, p.177)

b. Non-price competition
Kinked demand model also explain why non-price competition arise: It
is hard to change price to influence demand then oligopolists are unwilling to
use price as a competitive weapon. As the results, firm prefer to distinguish
their products to others. Sellers can differentiate by:

Sales promotion activities of sellers:

Competitors can react quickly with any change of price but not easy to
respond to an advertising campaign because it takes great deal of time to
plan and carry out a good campaign to compete. Moreover, an oligopolistic
industry has relatively few competitors with differentiated good then
marketing is expected to be a significant competitive weapon compare to
monopoly and competition market (Figure 3.1.2)

21
 (Figure 3.1.2. Source: Jones 2009, Business Economics and Managerial
Decision Making, p.231)

The graph illustrates the advertising sales ratio in some different

market structures: If firm sells a homogeneous product in a perfectly
competitive market, then advertising would appear to be unnecessary,
whereas, a monopolist would likewise hardly need to advertise because
consumers would have no other choice. In oligopoly, the incentive to
advertise is to gain market share: the smaller the number of firms competing
with each other the greater the incentive for an individual firm to pursue
policies that will take sales from its rivals. (Jones 2009, Business Economics
and Managerial Decision Making, p.232)

Differences in functional features or design:

Its also difficult for rivals to copy your products specifications

Differences in availability:
If your product is less available or convenient for customers to reach in
term of timing and location, buyers are more likely to purchase your
competitors product. Hence, you have huge disadvantage in this non-price
competition.

22
 6. Cournot model:
a. Assumptions:
Cournot oligopoly model assumes that
o firms produce homogeneous good
o 2 firms cost function are identical
o each firmtreats output of competitors as fixed
o firms decide simultaneously
The most important assumption of Cournot model is that when
deciding how much to produce, each firm assumes the output level
of its competitor as fixed. In the beginning, Cournot explained his model
with the example of two profit maximizing spring of mineral water firms, with
zero costs, linear demand curve given its competitor will not change its
output. The firm can decide its own level of profit.

Assume that firm A produce and sell mineral water first. The firm will
choose to produce at quantity A, at price P where profits are maximized
(figure 9.1) and the marginal revenue equal marginal cost. Then firm B
assumes that A will keep its output fixed, its own demand curve is considered
as CD. After firm As decision, there would be only a half of the market that
has not been supplied by firm A. Therefore, firm B has only 1 choice is to
produce half the quantity AD. Under the Cournot assumption of fixed output
of the rival) at this level of output and price its revenue and profit is maxi-

mum. Bs output is a quarter of the total market.

( Trisha, Cournots Duopoly Model )

23
 Facing with this situation, firm A keep on assuming that B will retain his
quantity constant in the next period. Therefore, he will again produce one-half
of the market which is not supplied by B. This process will continue, since
firms are assumed not to learn from past patterns of reaction of their rival.
Together they cover two-thirds of the total market. Although, each firm
maximizes its profit in each period, the industry profits are not maximized.

b. Reaction curve & Cournot equilibrium.

Reaction curve is the curve illustrates the relationship between firms

profit-maximizing output and amount it thinks competitor will produce (Pena,
Microeconomics)

Cournot equilibrium. The reaction curve will tell how much each firm
will produce given the output of its competitor. The intersection between 2
curves is the Cournot equilibrium. In this equilibrium, each firm will assume
how much it produce and maximize its profit accordingly.

24
 We can see that the Cournot model has some advantages. It enables to
illustrate logical results, with the prices and quantities which are between
monopolistic and competitive levels. It also leads to a stable Nash equilibrium,
which is defined as an outcome when neither player would like to deviate
unilaterally from the Game Theory we have mentioned in previous part.

And of course, the model also has some drawbacks based on its
assumptions which are seemed like to be unrealistic in the real world.

o The responsiveness: Even though Cournot model assumes that

the 2 firm decisions are independently made, in reality, the less
firm the more responsive to each other.
o Collusion dilemma: Cournot shows collusion could bring higher
profit but the Game theory shows that a cartel would not be in
equilibrium, since each firm cannot come to a agreed output (for
proof, one need look no further than OPEC in later part).

o Product differentiation: the Cournot model assumes that product

is the same in every market with no differentiating factors which
would be hard-pressed to find such homogeneity in the products
which are offered by different suppliers.

7. Bertrand duopoly model:

Developed in 1983, Bertrand model differs from Cournots in the

assumption that while Cournot cares about the quantity, Bertrand assume
each firm expects that the rival will keep its price constant, which means they
focus more on the price. Therefore each firm faces the same market demand
and same target of maximizing its own profit given the price of the competitor
remains constant. The model examines the decision of price between two
oligopoly firms.

In general, we can understand from Bertrand model that if firm A or B is

the first to set price, it will try to set the price below the other firm's expected

25
price with the purpose to capture the whole market. You can imagine that, in
a market with homogenous goods for example in a neighborhood, there are 2
gas stations offering the same kind of gasoline, then the one offer cheaper
price will attract all the consumers. Therefore, 2 firms in turn, will try to lower
the price to the point that profits of both firms are zero which mean when
there price equal marginal cost. This can happen because one of the most

important assumptions of Bertrand is MC of both firm equal.

(Jones 2009, Business Economics and Managerial Decision Making, p179)

However, this Bertrand model still has some disadvantage, which makes it
seem not releastic:
Capacity constraints: a firm in normal do not own enough capacity to
supply the whole market, so that even it offer lower price, it cannot
serve the whole demand and a number of consumers will have to buy
from the other firm even though they will be charged with higher price.
Product differentiation: in reality there are many kinds of products,
once products are not identical then the higher price product will not
lose its market to the cheaper one due to customers' preference.
Long-run competition: in the long run firms will realize collusion will
bring higher benefits.

26
 Other competitive weapons: with the same price, and firms then will try
to use other kind of marketing tools to win the market especially
advertising.

V. Classification of olipology
Oligopoly scenarios can be classified on different characteristics and bases.

1. Basis of Product diferentiation:

Pure oligopoly indicates market in which firms only sells homogeneous
products Given the complete information, buyers will consider the products as
perfect substitue for one another and will have no personal preference
towards any of the products. In this situation, rational buyers will find a
product with the relatively lower price. Vegetable, wheat, grain are perfect
examples of non-differentiated products, and the buyers will probably go with
the cheaper one. If the firm tries to increase the price of the goods, the
customers will eventually buy the competitors' output.

On the other hand, differentiated oligopoly is a case in which firms

produce heterogeneous products. Linderman (2002, p.86) stated that
"differentiated product exists where you can tell a difference between a
different firms' products within the industry". The products may be similar to
one another, however, they are not identical like the homogeneous ones. In
order to get sales from customer, A firm attempts to differentiate products by
slightly altering what it actually produces, adding extras or using different
design. Besides, they will also take advantages of different advertising and
marketing campaign with different messages to create a different intangible
value in the mind of the customers.

2. Base on the agreement or collusion

The oligopoly market can be classified into Collusive and Non-collusive
on the basis of agreement among firms in the market.

Collusive Oligopoly is the situation when different firms in the oligopoly

market negotiate and have some types of agreement about output, price,

27
market share, division of market,etc either informal or formal. The occurance
of the arrangement is called cartel, where there is a mutual objective among
members in the market, which is the act of assembling the organization and
members in a same branch in order to control a certain type of business. The
principle of cartel is unanimous and equal amount of profit share. The two
main factors of this oligopoly that cartel tries to control is price and quantity.
In a cartel, every member firm would choose the same price and each firm
would set its production quantity such that every firm expense the relatively
similar marginal cost. For the same reason that monopolies are considered
harmful, cartels are usually not tolerated by governments for the regions in
which those markets operate. Even the collusion is in some place illegal.
However, although cartels could act with the same power as a monopolist,
there is a potential instability that can destroy the arrangement, Individual
member may see an opportunity to defect, assuming they can do so without
being easily detected. They could profit individually by increasing their own
production. Of course, the discovery of the other participants can change the
whole situation, as they will increase their volumes as well. Consequently, the
result could be a lower market price and lower profits for all members when
they try to maximize their personal profits. A perfect example of cartel is
OPEC - the Organization of Petroleum Exporting Countries, which will be
further analyzed in this paper.

Alternatively, non collusive oligopoly is the model when the firms in an

oligopoly do not agree or collude with one another, so they have to be very
aware of the behavior and reactions of other firms when making decision.

3. Based on the ability to entry of firms

In oligopoly, firms can decide whether to accept or restrict the number
of new competitors to the market. For open oligopoly, it's free for new firms to
enter the industry. On the contrary, the industry will be a dominated by few
large firms with certain blockade to the entry of the newcomers under closed
oligopoly. The boundary may be formed with the help of technological, natural
or legal factors.

28
4. Based on the presence of leadership:
In oligopoly, the existence of dominance of a single firm will be a
situation of partial oligopoly. In this case, this firm will become superior to its
competitors and also perform the act of fixing the price of a product. They will
be called Price leader and the other smaller firms in the market follow the
price by the leader firm. Under the full oligopoly, no firm actually enjoys the
dominant position in the industry and the right of a price leader. They will
receive a relatively tantamount amount of profit in this type of market. The
firms may be engaged in price comeptition.

29
C. PRACTICAL CASE

I. P&G VESUS UNILEVER

4. Introduction
In the fast moving consumer goods sector (FMCG), Unilever and P & G
(Procter & Gamble) are always two of the biggest names in the world, and
also two of the names soon invested in Vietnam from early. These two giant
corporations own many famous brands, familiar to consumers not only in
Vietnam but also many other countries in the world.

Unilever
Unilever is a multinational corporation founded by the UK and the
Netherlands. Unilever produces four main product groups:
1. Food: soup, salt, snack, mayonnaise, butter
2. Personal care products: beauty products, shower gel, shampoo,
conditioner, toothpaste
3. Home care products: detergent, soap, dishwashing liquid
4. Beverage products: ice cream, tea
Unilever has more than 400 brands but only focuses on 14 of the most
famous brands with annual sales of more than 1 billion euros for example
OMO, Dove, Sunsilk, Lifebouy, LUX, Rexona, Ponds

P&G
P&G (short for Procter & Gamble) is an American consumer goods
corporation founded in 1837. The company provides cleaning and personal
care products in four key areas (before selling Pringles to Kellogg Company,
which also operates in the food and beverage sector).
1. Beauty Products: skincare products, hair care products, cosmetics for
spa
2. Family and baby products: diapers, diapers, toilet paper
3. Cleaning products: detergent, fabric softener, floor cleaner
4. Health care products: toothbrush, razor
P & G claims to cut about 100 brands, focusing on the remaining 80
brands (which account for about 95% of total revenue) such as Tides, Ariel,

30
Downy, Rejoice, Olay, Pantene It was in top Fortune 500 elected annually by
Fortune magazine based on annual revenue.
Working together in a field, these two co-own many brands directly
compete with each other in the market. For instance, Omo vs Tide, Downy vs
Comfort, Clear vs Head&Shoulder, Sunsilk vs Rejoice, Dove vs Pantene, Pond
vs Olay, P/S vs Crest.

5. Strategy
In the US market PG dominates absolutely, while in the Asian market,
Unilever has strong growth. So it can be seen that Unilever's strategy is at
any cost to hold P & G's development in Asia especially in Vietnam.

But taking into account the global strategy, P & G is far superior to
Unilever with its superior positioning and dominance in many key industries
and markets. By focusing on your strategic items, P & G will continue to
expand. Unilever seems to be more advanced when it comes to marketing
and advertising because Unilever seems to be quite capturing the style and
lifestyle of the Vietnamese.
In terms of revenue, P & G is still a lot better. Considering strategic
positioning, P & G is clearer and Unilever is more diversified.

In Vietnam, the strategy of the two sides is different: P&Gs is cherry-

picking, choosing segments, premium and urban areas while Unilever chooses
to spread. Unilever took the advantage of first mover better than P & G in the
case of Vietnam. Unilever's growth has come courtesy of a healthy mix of
volume and pricing gains while P&G had to rely entirely on higher prices.
Procter & Gamble seems to be slower in developing products for poor
customers, Unilever started this strategy many years ago with small packages
of shampoo.

6. Competition
Though each corporation has their own business strategy but they
share similar brands which compete directly, here are some examples :

31
 d. Washing powder : Omo vs Tide
Omo is one of the main products of Unilever in Vietnam, this brand of
detergent came into Vietnam quite early, earlier than Tide which appeared
from 1995. That day, when it comes to high-class detergent, people often
think of Omo. Today Omo has an important position in market, annual revenue
is always increasing rapidly. According to an online survey, Omo brand
accounts for about 60% of the domestic laundry detergent market, Tide
Omos biggest competitor accounts for 30%, and the remaining 10% for
other brands of detergent. The confrontation between the two brands is
extremely fierce, both businesses are very cautious in each step and always
keep track of competitor moves.

With both brands, the target market is large and densely populated
cities, in which people have medium to high income levels.

Brand
Tide
Weight Omo
0.4kg 14.500 15.500
0.8kg 27.000 30.500
3.5kg 99.000 125.000
3.5kg 139.000 147.000

Above is the price lists of 2 brands, it can easily be seen that there is
just slight differences between them. They directly compete with each other.
Tide is slightly cheaper but the sales of Omo is higher because Unilever
promotes wide distribution and sales network, appearing 100% in villages,
cities through 180 distributors throughout the country. P & G does not have
the ambition to build a nationwide distribution network, it depends on regions
and groups so that P&G decises to build strong or weak distribution networks.
This makes the difference between Tide and Omo. When entering a small
shop we can see very few of the Tide, Omo almost always overwhelm.
However, the distribution of Tide is well suited to the current context of Tide,
helps this brand to maintain market share and take best care of its customers.

32
 e. Hair Care Product : Sunsilk vs Pantene
P & G's Pantene is one of the early shampoo brands that have been
successful in the market. In 2004, Pantene's sales increased by an average of
10% over the same period of the previous year.

Sunsilk - one of Unilever's most profitable product lines- is the market

leader in several geographies. It is very strong in Asia, Middle east and Latin
America and it is number 1 in India, Pakistan, Brazil, Argentina, Bolivia,
Bangladesh, Sri Lanka, Indonesia and Thailand. In essence, it is the top brand
positioned in the mind of billions of people.

P&G's brand success comes from the implementation of a creative,

innovative and unique media campaign across multiple media channels:
television advertising, newspaper advertising, funding for TV game. Unilever
shampoos promotion is very simple, easy to understand and suitable for
customers in many classes. However, for high-end customers, this style of
advertising will not work out significantly.

Brand
Pantene Sunsilk
Kind
100ml 21.000 18.000
200ml 40.000 34.000
400ml 67.000 55.000

Sunsilk of Unilever is slightly cheaper. The budget for marketing,

advertising of Sunsilk is about 4.32million USD while Pantenes is 3.7 million
USD. Sunsilk accounts for about 14% market shares, Pantenes is 10.8%. So, it
can be understood that though price of Sunsilk is cheaper and it also spends
more money on marketing, the result is that the revenue is higher than
Pantenes.
The price war between two brands is intensified with P&G slashing the
prices of its shampoo brand Pantene in 2004.

33
 It cut the prices of Pantene bottles by 15-20 percent and intended to
announce the launch of a new variant under the Pantene brand. A fortnight
ago, Unilever had announced a promotional offer of a free bottle with every
bottle of Sunsilk, in other words it cut down 50 percent. Both products
decreased price at the same time to compete.

f. Fabric softener : Comfort vs Downy

Comfort aims to use the advertising campaign named world of cloth
with cloth angels and they successfully achieved 40% of the market share,
overcoming Downy of P&G. On the contrary, Downy aims to fabric conditioner
which can be mosquitoes-resistant for children. Comfort aims to medium-
income households. However, Downy choose high-income households.

Taking into account pricing strategy: Comfort tries to find small

businesses in local areas to find materials more conveniently instead of
importing. They created national distribution in Northern, Southern and
Central Vietnam, from countryside to city. However, Downy seems to focus
more on the big cities.

Comfort advertise on national channels like VTV 1,VTV3 and local

channels like HTV1, HTV 7, HN1,while Downy spend less for ads and seems
not to appear on national channels.

Comfort Downy

One rinse product oil

48200 dong 49500 dong
perfume 800ml
Concentrated one
49500 dong 52000 dong
rinse product 800ml
One rinse 1.8l 109000 dong 115000 dong

7. Oligopoly Analysis:

a. Non price competition:

34
 It involves advertising and marketing strategies to raise consumer demand
and boost brand loyalty.

- Variation in style, quality, design of the product and customer service

- Advertising
Actually, P&G and Unilever are very interested in non-price war to
increase their sales. This can be explained in terms of sales revenue
maximization to a minimum profit constraint. The effect of price cut on
total revenue is uncertain because if they cut the price, total revenue
will increase. However, a rise in price will result in a fall in sales or total
revenue so they will consider non-price competition as an
advantageous choice.

b. Kinked demand curve:

Firms in a oligopoly wants to protect their market share and rivals in

oligopoly immediately react to the change in price of other firms.

If Unilever raises their price and P&G make theirs constant, there will
be a large substitution effect because both of the 2 companies products are
homogeneous and that results in making price elastic. Unilever would lose
their market share and then a fall in total revenue. On the contrary, if Unilever
decrease its price and P&G follow too, the relative price change is smaller and
demand would be inelastic. Reducing price when demand is inelastic causes a
fall in revenue with very little effect on market share. That boosts the
importance of non-price competition presented above, price is sticky in
oligopoly markets.

c. Game theory first move advantage:

There are three benefits of being first- mover : technology leadership,

control of resources, and buyer switching costs.

In this case of Unilever and P&G , I wan to consider the buyer switching
costs advantage in Vietnam of Unilever for launching earlier than P&G. If it is
inconvenient for a customer to switch to a new brand, Unilever will have an
advantage. Switching costs comprise the adaption to a new product and
penalties if breaking a long-term contract. Unilever has the chance to shape

35
consumer preferences more than P&G and brand loyalties may be earned by
the first company who can offer fine quality. Satisfied consumers have a
tendency not to spend time finding information about other products, and to
avoid the risk of being dissatisfied if they switch. These brand preferences are
likely to be more important for products bought by consumers than for
products bought by businesses. Businesses often buy products in larger
volume and obviously have more incentives to seek information about choices
which are cheaper.

II. VIETNAMS TELECOMMUNICATION MARKET

4. Vietnams Telecommunications services.

Telecommunications has always played a vital role in national socio-
economic development. It not only helps to speed up communication, but it is
also the most important and convenient channel in supporting people in
terms of education and training, contributing to national economic recession
and the process of international integration. And Vietnam is no exception.

Vietnam has been regarded as one of the world's most up-to-date

telecommunications networks and ranked among the top 10 developed
telecom countries by the International Telecommunication Union (ITU) .
Although Vietnam is classified as a developing country with income per capita
of less than US $ 2,000 per person per day, our citizens still benefit from using
modern telecommunications and information technology services.
Contributing to that achievement is the contribution of Vietnam Posts and
Telecommunications (VNPT) - mobile telecommunications.

Currently, there are three major mobile operators in Vietnam's mobile

telecommunications market , namely Viettel, Mobifone and Vinaphone.

a. Mobifone
Mobifone, which is known as Vietnam Mobile
Telecom Services Company (VMS), is a Limited Liability
Company belong to. Since June 2014, VNPT has

36
officially transferred the company VMS Mobifone to the Ministry of Information
and Communications in accordance with Decision No. 888 / QD-TTg dated
10/06/2014 of the Prime Minister, and the Decision No. 877 / QD-BTTTT and
878 / QD-BTTTT dated June 27, 2014 of the Minister of Information and
Communications.

b. Vinaphone
Founded on 26 June 1996, as a GSM (Global
System for Mobile Communications) launcher,
Vinaphone, also a subsidiary of VNPT Group, is
the second network (after MobiFone) and
currently the second largest provider in Vietnam. VinaPhone was the first
network to cover service in 100% of districts nationwide, and also the first
operator to launch 3G services nationwide. The year 2009 marked the
important development of Vinaphone with total net revenue reached
approximately VND 21,000 billion and the number of postpaid subscribers
grew to the total number of a ten-year-period ( about 36 million real
subscribers).

c. Viettel
Viettel Telecom Company was established on April 5, 2007. It
is a special one, owned by Ministry of National Defence.
Viettel Group is among the 100 largest telecommunications
brands in the world and is currently the largest
telecommunications group in Vietnam with 76 million customers. The group
consists of more than 20 subsidiary companies running different types of
business including telecom, investment, real estates, foreign trade and
technical services. In 2014, Viettel Group reached US$9.8 billion revenue and
US$2 billion profit, ranking among the top largest enterprises of Vietnam in
term of revenue.

d. Other mobile networks

Besides the three big operators: Vinaphone, Mobifone and Viettel, there
are also some mobile operators such as S-fone, EVN telecom, Beeline and
37
Vietnamobile. However, these operators face the risk of being held up, even
bankruptcy. By the end of 2011, EVN Telecom was belonged to Viettel after a
long time of losses. By the end of 2013, S-fone admitted their insolvency. The
Beeline brand completely terminated its business after three years of entry
into the telecommunications market, replaced by G-mobile.

38
 5. Characteristics of Oligopoly in Vietnam Telecommunications
Market
a. Dominant firms
According to Vietnams ICT White Book statistics, in 2015,Viettel's
mobile phone subscriber market share is 40.67% (including 0.22% of EVN
Telecom), followed by VinaPhone with 30.07%, MobiFone with 17.90%,
Vietnamobile with 8.04%, Gtel with 3.21% and SPT with 0.1%.

The 3 major firm accounts for up to 88% of market share and four-
company concentration ratio is 96%. Telecommunication market in Vietnam
has had the appearance of an oligopolistic one.

b. Interdependence & Kinked demand curve ( No price

competition)
These 3 majors company are evidently interdependence:

- If an operator increase its price, it will obviously lose its market shares
but in the other direction, if an oligopolistic company decrease the price,
others will follow and it eventually leads to the loss for all competitors. That
may explain why there were up to 9 times of decrease price over the course
of 10 years from 2000 to 2010. However since then to now, when the market
share had been distributed, the price has been quite stable and even increase

39
simultaneously. Kinked curve model and cartel idea may well explain this
situation
- Inversely, in this time, the other version of price competition,
promotion war, was very eventful. In fact, when Viettel launches postpaid or
prepaid packages, Tomato package for the low-income, Ciao package for
students, Happy zone package for family..; Mobifone also launched the
package with similar features:Mobi gold, Mobi card, Mobi 4U, Mobi Q, Mobi
365 and Vinaphone with Vina card, Vina Daily ....
Another evidence is in the Student packages of Viettel and Mobifone:
Targeting students, Viettel has launched the package with the cheapest
charge rate with only 1390d / min for on-net calls, VND 1590 /minute for out-
net calls, SMS rate of VND 100 / SMS, extra VND 25,000 monthly on-net and
many other good deals. Mobifone also launched a Q-student package for
students of all age groups:middle, college and university level with a wide
range of incentives: VND 99 /SMS , VND1380 / min for on-net calls, 1580d /
min for out-net calls...

On-net calls Out-net calls SMS

Viettel 1390/min 1590/min 100/SMS

Mobifone 1380/min 1580/min 99/SMS

Segment pricing strategy seem to be effective and highly appropriated

in this case. The reason is about an interesting feature of Telecommunication
Market that new or potential customers are mostly low-income or students,
who will be attracted by an economical feature. On the other hand, old users
less likely to change their carrier due to the potential troubles or
inconvenience they get if their numbers change. The demand is just price-
inelastic.

c. Substantial barriers to entry Vietnam Telecoms market

Naturally, Telecommunication market requires a high amount of capital
and technology so as to infrastructure. Furthermore, laws in Vietnam much or
little have protected the cartel of existing oligopolies and trammeled entries.

40
Last but not least, the lock-in effect of an completely distributed market is
another barrier.

The failure of Beeline is a typical example for this matter. Beeline is a

big company in the world with significant strengths in technology, capital and
even marketing. It has invest total nearly a half of billion dollars in Vietnam
and its can offer extremely cheap price and attractive packages such as Big
Zero, Billionaires In marketing, it has an unique corporation identity with a
lovely appearance. As a result, Beeline got some really impressive progresses
mentioning a 400% growth rate ( averagely about 15000 new users per day)

However, the barriers seemed to be too harsh for Beeline. Firstly, it was
not provided an own appropriate ratio band for 3G service. It had to work with
1800 MHz radio frequency while other companies one was between 800 and
900 MHz, meaning that Beeline need about 2 times more base transceiver
stations than others. Although Beeline had made some significant effort with
adventurous packages such as Billionaire 1, Billionaire 2.... , it encountered
the forbidden from Ministry of information and communication due to
underselling service, according to competition law. In addition, that
Vietnamese policy did not allow foreign companies to own the major share in
a cooperation discouraged the investment. Finally, as we mentioned above,
old users may not willing to change their contacts due to working or
networking purposes while keeping it without changing carrier is impossible in
Vietnam. Eventually, Beeline did not archive its expected effect and accept
the failure in Vietnam in 2012.

6. Could we eliminate collusion and cheating?

The question is: whether or not the oligopolists implicitly collude and
cheat customer? Recently suspicion arises when Viettel, MobiFone and
VinaPhone simultaneously increased 3G service charges monthly by 20% and
unlimited service charge by 40% with the consent of Ministry of Information
and Communications.
Although the investigation found that these companies did not violate
Competition Law due to the agreement among them, this collaboration
41
harmed customers interests as raising prices without qualitative
improvement.

The potential solution is diversification service supplier. As we

discussed above the top three big operators in the country Viettel, MobiFone,
and VinaPhone account for 88% of market share. Its hard for foreign
enterprises to make high profits because they not receive governmental
subsidization. Another factor that equally affected is the fierce price
competition in telecoms market.
Goverment seperated MobiFone from VNPT Group, which creates
chance in equitization for foreign investors to invest in MobiFone and
contributes to a significant change for the telecommunications industry. This
action from government is expected to break oligopoly existing in the industry
and turn into a competitive market, in which consumers will benefit most as
there are more choices, products with cheaper price and service.
In conclusion, the government should keep releasing more policies to
lift its barriers, allowing stakeholders to participate in market structuring and
encouraging both private and foreign companies to enter the market.

II. OPEC

OPEC is the intergovernmental organization (Organization of the Crude

oileum Exporting Countries) consisting of 12 oil producing and exporting
countries across America, Asia and Africa continents. The members are
Algeria, Angola, Ecuador, the Islamic Republic of Iran, Iraq, Kuwait, the
Socialist People's Libyan Arab Jamahiriya, Nigeria, Qatar, Saudi Arabia, United
Arab Emirates & Venezuela.

A report states that it was formed on September 14, 1960 in Baghdad,

Iraq, by five Founder Members: Iran, Iraq, Kuwait, Saudi Arabia and Venezuela.
It was registered with the United Nations Secretariat on November 6, 1962.

5. Cartel Theory

A cartel is defined as an organization of firms that gets together by a

formal agreement to make output and price decisions. When there are few

42
firms in the market and each firm has a significant share in the market, they
tend to act as a monopoly in order to manipulate or regulate prices. Although
in the U.S., cartels are illegal, there are no restrictions on cartel formation
internationally.

The Organization of the Petroleum Exporting Countries or OPEC is an

example of a cartel, which is dominated by the Arab oil producers as they
hold the maximum amount of oil refineries. Its purpose is to control the supply
of petroleum to so that it can set the price on the world market and avoid
fluctuations that might affect the economies of both producing and exporting
countries.

It has been criticized that OPEC has a great influence on the market.
Because its member countries hold the vast majority of crude oil reserves
and nearly half of natural gas reserves in the world, the organization has
significant power in these markets. As a cartel, OPEC members have a strong
incentive to keep oil prices as high as possible, while maintaining their shares
of the global market.
A fall in oil price as a result of the breakdown of OPEC will impact on
many countries both inside and outside OPEC. This is because some countries
outside the organization realize the benefits to negotiate with OPEC, they
offer to support OPECs control over the market.

The figure below will illustrates the case of OPECs pricing

43
 Total demand is the total world demand for crude oil, and is the

competitive supply curve. The demand for OPEC oil is the difference

between total demand and competitive supply, and is the

corresponding marginal revenue curve. is the OPECs marginal cost

curve; as you can see, OPEC has much lower production costs than do non-
OPEC producers. OPECs marginal revenue and marginal cost are equally at

44
quantity , which is the quantity that OPEC will produce. We see from

OPECs demand curve that the price will be P*, at which competitive supply is

Suppose the petroleum-exporting countries had not formed a cartel but

had instead produced competitively. Price would then have equaled marginal
cost. We can therefore determine the competitive price from the point where

OPECs demand curve intersects its marginal cost curve. That price, labeled

, is much lower than the cartel price P*. Because both total demand and

non-OPEC supply is inelastic, the demand for OPEC oil is also fairly inelastic.
Thus the cartel has substantial monopoly power, and it has used that power
to drive prices well above competitive levels.

Distinguishing between short run and long-run supply and demand is

important here. The total demand and non-OPEC supply curve in the figure
apply to a short- or intermediate run analysis. In the long run, both demand
and supply will be much more elastic, which means that OPECs demand
curve Will also be much more elastic. We would thus expect that in the long
run OPEC would be able to maintain a price that is so much above the
competitive level. Indeed, during 1982-1918, on prices fell in real terms,
largely because of the long-run adjustment of demand and non-OPEC supply.

2. Kinked Demand Curve

With cartels like OPEC, firms within are interrelated. As such, they act in
accordance with others behaviors and watch out each other closely to
preserve their standing. In this case, OPEC members also face a kinked
45
demand curve. This is a typical characteristic of an oligopoly market. It
explains why price in this type of market stay quite rigid and more often than
not fluctuate simultaneously.

Let examine it in the case of OPEC. Price for a barrel of oil between
members of OPEC stay quite the same and pretty much rigid except for when
there are sudden and dramatic changes in output like political events or
fluctuations in demand.

In 1974, due to output restraint, OPEC pushes oil price well above what
they should be. During 1979-1980, oil price shot up as the Inranian revolution
and the outbreak of Iran-Iraq has considerably reduce oil demand from these
2 countries. Price remain relatively stable during 1988-2001, except for a
temporarily spike in 1990 following the Iraqi invasion of Kuwait. For the
following time, price continues to go up and down according to political
outbreaks like the strike in Venezuela or the Iraq war.

We will examine why the oil war between the OPEC members will stay
rigid during the politically stable period and how it will change according to
the change in marginal cost or change in demand.

During the time from 2009-2011the price for oil is $80 dollars per barrel
and it is charged by all members of OPEC. Now we assume that one member
has the incentive to raise their price to $85. There are two possible outcomes:
Firstly, all the remaining nations would raise their price accordingly to the first
46
nation. Otherwise, they would remain theirs at the current level in order to
yield the regressor out of the market. Rationally saying, by keeping the price
stay put, the rest members of OPEC stand a good chance of getting the bigger
market share and higher volume of customers due to the lower price.
Therefore, they hardly have any incentive to move along.

The price-raising country, consequently, will go through a dramatic

plunge in sales which is more than proportionate to the price rise. The
demand for price over $80 is defined as very elastic.

In the contrary, what is the scenario for a price cut? The cheaper seller
would gain the advantage as they get more customers. A price war between
sellers will ensue as the remaining countries will also lower their prices to
protect their profit. However, the market do not expand too much over a short
timespan. So a huge drop in price may do not accompany with a
proportionate rise in demand. The revenue for the sellers, hence, go down
following a price war. The demand curve for under $80 dollars per barrel is
pretty inelastic. The war would eventually put all the members in jeopardy.

All OPEC members face a kinked Demand curve which kinks at $80. It is
flatter for the part above 80 and steeper towards the tail (below $80). This
presents a case where members will refrain from acting out of the rest and
keep their price in conjuntion with others or the leader.

47
 This diagram illustrates the revenue curves. The Demand curve (the
AR-Average Revenue) has a kink at A. For price over $80, the demand is more
elastic so the curve is flatter, a small increase in price would lead to a large
portion of sale lost. In contrast, for price below $80, demand curve is steeper,
a sharp fall in price only account for a marginal increase in sales. As the
revenue stumble, the marginal revenue breaks at point B and relocates to
point C. That justifies the kink in the AR curve.

In this kind of model, the equilibrium point is exactly the kink point.

You can explain the price rigidity by using the traditional profit-
maximizing formula: MR = MC. Take marginal cost curve MC1 and MC2 for
examples. The optimal quality will be at Q1 where the MC cuts MR curve, that
leads to the price of $80 (point A). The same rationale applies to all the
marginal curves between Mc1 and MC2. Therefore, for the majority of curve
structure, the maximizing profit equilibrium will be at point A, with the price of
$80 and quality of Q1.

48
What if the marginal cost rise above the kink point, or higher than MC2? In
that case, the equation MC = MR holds at a lower output and higher price.
The price for oil would eventually go up.

This is the same case when demand for crude oil go up (especially in
times of wars). The steeper demand curve with higher inelasticity allows OPEC
to reach to the profit-maximizing point by restraining output and charge a
higher price as in the case in 2002-2003 when the Asian demand for oil got
higher or in between 2009 and 2011, buoyed by the growth of China.

Likewise, in the case of competitive non-OPEC rose or political turmoil

which lowers the demand for oil. The flatter demand curve (which indicates
more elasticity) will be followed by a flatter Marginal curve. The profit-
maximizing point MC=MR would hold at a higher quality of oil produced and a
lower price. This accounts for the plunge in OPEC crude oil during the 1980s
and the economic recession 2008.

3. Stackelberg Cournot Game

In the Stackelberg Cournot game, firms compete each other based on
quantities of an identical product, and one firm is able to credibly commit to
its production level first. As explained by Fattouh and Mahadeva, Gately, and
Huppmann and Holz, Saudi Arabia is the leader in this case, setting its crude
oil output based on predicted reactions from the other countries.
Multiple payoff matrices can be constructed to model this type of situation,
but for this example, Saudi Arabia is given the strategies of cooperating with
other OPEC countries to act as a cartel or using its reaction function to
increase its output. The other OPEC countries are grouped together and given
the strategies of cooperating with Saudi Arabia or increasing output to
Cournot levels.

Fattouh and Mahadeva (2013) suggest that OPEC can achieve greater
than Cournot profits as long as there is a way to enforce punishment for those
who diverge substantially from production quotas. Saudi Arabia, which holds
the largest reserve base and is known as the dominant producer among OPEC
49
countries, has often taken responsibility for punishing the cheaters by
employing a tit-for-tat strategy
If cheating becomes flagrant, Saudi Arabia, using its excess production
capacity, will increase output until all producers profits are reduced to
Cournot levels.

Saudi Arabias relatively strong ability to adapt its production levels

allows it to be the most independent of the OPEC countries. In this view, it
acts as the Stackelberg leader, and the other OPEC leaders are left to react
accordingly. Huppmann and Holz (2012) recognize the possibility that Saudi
Arabia is a Stackelberg leader, and they design several models forecasting
output and price for various market scenarios. They then compare actual
prices with estimated prices for years 2005 to 2009 in cases of perfect
competition, simultaneous Cournot equilibrium, OPEC successfully operating
as a cartel, and Saudi Arabia acting as Stackelberg leader of a non-
cooperative oligopoly. As expected, they found that estimated cartel prices
were the greatest, followed by Cournot prices. Real world prices recorded
from 2005 to 2009 were above projected perfect competition levels and below
Stackelberg Cournot. With the Stackelberg models estimates falling closest to
observed prices, Huppmann and Holz concluded that the oil market is best
described by this game. They find additional supporting evidence that Saudi
Arabia is the Stackelberg leader by analyzing actual production totals; they
show that the country is producing an amount greatly exceeding what it
would supply in the Cournot equilibrium.
Monopoly Stackelberg

50
 Monopoly
Stackelberg

The numbers for each outcome on the diagram represents relative

payoffs and are not exact calculations of profits or utilities. Rather, they show
that total utility is maximized when Saudi Arabia and the rest of OPEC can
successfully collude with monopoly (or cartel) output, and total utility is
minimized when they settle on Stackelberg output. Each country always has
the incentive to increase output to the Stackelberg level, resulting in an
inefficient Nash equilibrium {Stackelberg, Stackelberg} where total utility is
minimized considering the available strategies. This situation qualifies as a
Prisoners Dilemma game; the unique Nash equilibrium is inefficient and
occurs when each player plays its strictly dominant strategy. Even though this
result does not maximize the payoff for either player, neither has the
incentive to change its strategy in this one-shot equilibrium.

4. Infinitely Repeated Stackelberg Cournot Game

While the solution of this game played once is inefficient and results in
Saudi Arabia and its fellow OPEC members cheating by increasing their
output, the oil market operates much differently. With millions of barrels of
crude oil produced each day and updated production projections released
each month (OPEC, 2014), the oil industry represents an infinitely repeated
Prisoners Dilemma, simply modeled by the above payoff matrix. Unlike in the
one-shot version of this game, in the infinitely repeated Prisoners Dilemma,
cooperation can be sustained if there are appropriate discount factors and

51
sufficient trigger strategies. A grim trigger strategy may be effective, but it is
not likely to be used in this situation. Considering two players in this simplified
Stackelberg game, Saudi Arabia and all of the other countries, each would
have the same trigger strategy:
1. Collaborate with Monopoly output in the first round.
2. Continue to produce Monopoly output as long as the previous
round resulted in {Monopoly, Monopoly}. If the result was any other
outcome, produce Stackelberg output forever.

As Fattouh and Mahadeva (2013) explained, however, cheating is

common and even expected of the OPEC countries. When this overproduction
has prompted Saudi Arabia to react, the leader has employed more of a tit-
for-tat strategy for punishment, as seen in 1986 and 1998, for example. This
trigger strategy for Saudi Arabia is loosely described as follows:

1. Collaborate with Monopoly output.

2. Continue to collude if the other countries cooperated with
Monopoly output; produce Stackelberg output if the other countries
cheated in the previous round.
3. Return to Monopoly output.

Another trigger strategy would need to be developed for the other

countries to punish Saudi Arabia in the instance of excessive cheating, but
this would be more complicated to develop due to Saudi Arabias higher
production capacity (Huppmann and Holz, 2012:10). If a strategy could be
developed to stably maintain cooperation in the long run, OPEC could
maximize total profits and better achieve their mission of [securing] an
efficient, economic and regular supply of crude oileum (OPEC, 2014).
However, non-OPEC players and their growing presence in the global oil
industry present additional complications that cannot be forgotten. The
analysis required to develop strategies and models that take into
consideration the implications of non-OPEC production and pricing go beyond
the scope of this paper, and as previous studies have explained, the decisions

52
of OPEC countries cannot be consistently explained by a single model (Fattouh
and Mahadeva, 2013).

53
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