Chapter 10. 2: Oligopoly Flashcards
4 characteristics of an oligopoly
- Few large firms
- Identical or differentiated products
- Price setter
- Mutual interdependence: decisions like output, price, and advertising depend on other firm’s decisions.
*
What happens if oligopolists compete? What happens if oligopolists collude?
- They drive down costs and earn zero profits (like perfect competition).
- They work together to reduce output, keep prices high, and earn high levels of profit (like monopoly).
Game Theory
a branch of mathematics that analyzes situations in which players must make decisions and then receive payoffs based on what other players decide to do.
Collusion
when oligopolies work together to reduce output, keep prices high, and earn high levels of profit.
What is a cartel?
A group of firms that have a formal agreement to produce at monopoly output and sell at monopoly price; illegal; a form of collusion.
Kinked Demand Curve
See table 10.2
Explains price stability in oligopoly; perceived demand curve that arises when competing firms commit to match price cuts, but not price increases.
Explain the kinked demand curve
Fig. 10.4
Left side:
* If a firm increases the price, then it becomes more expensive than rivals and consumers will switch to its rivals.
* Likely to be a fall in demand and increasing price firm will lose TR because demand isprice elastic.
* The percentage fall in demand is greater than the percentage rise in price.
Right side:
* In the short term, if a firm cuts price it would cause a big increase in demand and a rise in TR. Firm would gain market share.
* But other firms will not want to see this fall in market share and so they will respond by cutting price to follow the 1st firm.
* The net effect is that if all firms cut price, firm will only see small increase in demand, and TR will fall demand is price inelastic – there is a smaller percentage rise in demand.
What happens when oligopolist reduces or increases price?
Reduce:
* Other firms will also cut prices.
* Other firms will also expand output.
Increase:
* Other firms will not follow price increase.
* Output falls for the firms that increases price.
*
Total revenue and elasticity
Price inelastic: price and TR have a direct relationship.
Price elastic: price and TR have a indirect relationship
Price elasticity of demand, formula
% change in quantity divided by % change in price:
* % change in quantity > % change in price = elastic.
* % change in quantity < % change in price = inelastic.
Elasticity of demand
Measures the responsiveness of one economic variable to a change of another.
Elasticity along the demand curve
see fig. 10.5
Types of barriers to entry
- Economies of scale
- Government granted: patents, licensing etc.
Game Theory to watch out for
Sometimes, there’s no dominant strategy, or the nash equilibrium is also the collusion (profit-maximizing) option.
