CHAPTER 14: Oligopoly Flashcards
Oligopoly is a market in which…..
small # of firms compete
Produces an identical product and compete only on price, or they might produce a differentiated product and compete on price, product quality, and marketing
Has natural or legal barriers that prevent entry of new firms
What is a duopoly?
oligopoly market w/ 2 firms
Firms in oligopoly are ______ & face _______ to cooperate to increase their joint economic profit
○ Interdependence - each firms actions influence the profit of all other firms
○ Temptation to cooperate - When a small number of firms share a market, they can increase their profits by forming a cartel and acting like a monopoly
What is a cartel?
is a group of firms acting together—colluding— to limit output, raise the price, and increase economic profit
□ Illegal
What is game theory in oligopoly?
- Game theory - set of tools for studying strategic behaviour— behaviour that takes into account the expected behaviour of others and the recognition of mutual independence
○ seeks to understand oligopoly as well as other forms of economic, political, social, and even biological rivalries by using a method of analysis
What is prisoners dilemma?
Used to understand price fixing, price wars, and other aspects of the behaviour of firms in oligopoly
○ Two prisoners acting in their own self-interest harm their joint interest
○ An oligopoly (duopoly) price-fixing game is prisoners dilemma in which the firms might collude or cheat
What is a natural oligopoly?
Occurs when two firms can produce this good at a lower cost than either one firms or three firms can
What is a collusion agreement?
agreement between two or more products to form a cartel to restrict output, raise the price, and increase profits
○ Illegal in Canada
○ Cartel firms can pursue two strategies: Comply or cheat
A firms that complies carries out the agreement.
A firm that cheats breaks the agreement to its own benefit and to the cost of the other firm
In a collusion agreement, what are the four possible combinations of actions based on the two strategies pursued in a cartel?
i. Both firms comply
ii. Both firms cheat
iii. Trick complies and Gear cheats
iv. Gear complies and Trick cheats
Colluding to maximize profit
the firms in the duopoly agree to restrict output to the rebate that makes the industry marginal cost and marginal revenue equal
outcome of this is the two firms collide to produce the monopoly profit-maximizing output and divide that output equally between themselves.
One Firm Cheats on a Collusive Agreement
industry output is larger than the monopoly output and the industry price is lower than the monopoly price
total economic price made by the industry is also smaller than the monopoly’s economic profit
Both firms cheat
each firms tells each other that it is unable to sell its output at the going price and that it plans to cut the price.
- As long as price exceeds marginal cost, each firm has an incentive to increase its production to cheat.
- Only when price equals marginal cost is there no further incentive to cheat
Nash Equilibrium in the Duopolists Dilemma
- Nash equilibrium of the duopoly game is that both firms cheat
- The industry has only two firms, they charge the same price and produce the same quantity as those in a competitive industry
- Each firm makes zero economic profit
A Game of Chicken
- The Nash equilibrium for the prisoners dilemma is unique. Both players cheat. Not all games have a unique equilibrium and one that doesn’t is a game called chicken
- An Economic Example of Chicken - An economic game of chicken can arise when research and development (R&D) creates a new technology that cannot be kept secret or patented, so both firms benefit from the R&D of either firm.
Repeated Games & Sequential Games
- Players move simultaneously - however the play is sequential (one moves 1st & then the other)
- Large # of possible outcomes
