ECON101 Unit 12 Flashcards
What is an oligopoly? What are its traits
A market structure where
- natural and legal barriers prevent entry
- a small # of firms compete
- each firm in an oligopoly market is keenly aware of the actions of the other firms and acts strategically in response
What is a duopoly?
A specific type of oligopoly in which only TWO firms with large market shares compete strategically
How do the two barriers to entry work? (Two situations of oligopoly)
1) Natural duopoly: market w two firms
- two firms can meet demand
- lowest point at ATC = efficient scale of 1 firm
2) Natural oligopoly: market w 3 firms
- three firms can meet demand
- lowest point at ATC = efficient scale of 1 firm
How are oligopolies interdependent?
There is a small number of firms and they face temptation to cooperate
- each firms profit depends on every others actions
Why is there a temptation to cooperate? (cartel)
Firms in oligopoly face temptation to form a cartel
Cartel = group of firms acting together to limit output, raise price, and increase profit
What is game theory?
A tool for studying strategic behaviour which s behaviour that takes into account the expected behaviour of others and the mutual recognition of interdependence
Four main features of games:
1) Rules: setting, actions, consequences
2) Strategies: possible choices during turn
3) Playoffs: consequences of outcomes (utility)
4) Outcomes: what ends up occurring (result)
What is the payoff matrix?
A table showing payoffs for every possible action by each player for every possible action by another player
What is the nash equilibrium?
both players are rational and choose their actions like that, the outcome is this equilibrium
- each takes beset action given other players action
Is the suboptimal equilibrium where the equilibrium is not the best outcome?
Yes, it is not
What is the prisoners dilemma and how can it be used to avoid the suboptimal equilibrium?
The prisoners dilemma describes rivalry of participants leads to the worst situation from their POV
When communication is allowed in the prisoners dilemma we can possibly avoid this suboptimal equilibrium even when communication may be deceptive
What is the dominant strategy equilibirum?
Clear strategy for each player independent of the other players actions
What is a collusive agreement?
Agreement between 2+ firms to restrict output, raise price, and increase profit
What are the four options firms can pursue?
1) Both comply
2) Both cheat
3) A complies B cheats
4) B complies A cheats
What happens when firms collude in a cartel and act like a monopoly?
- to find that profit set cartels MC = to its MR
- cartels marginal cost curve is the horizontal sum of the MC curves of the firms
- each firm agrees to produce an amount and share profit
- Price is greater than MC so if one firm increased output then profit would increase
What happens when 1 firm cheats and increases ouput?
There is an incentive to cheat if price exceeds MC
Industry output increases and price drops
For complier ATC exceeds price = economic loss
For cheat, price exceeds ATC = increases profit
What happens if both firms cheat and increase output?
They both make 0 economic profit and achieve competitive outcome
- Same as perfect competition
Nash equilibrium in duopolistic dilemma: What is the others best response if either cheat?
Best response is to cheat b/c firms will make 0 economic profit instead of 1 incurring a loss
- Nash equilibrium is both firms cheat
When can a game of chicken arise?
When research and development creates a new technology that cannot be patented
- both firms can benefit from the technology of either firm
What happens in a repeated duopoly game? How can a cooperative equilibrium occur?
If it is repeatedly played, duopolist can successfully collude and make monopoly profit
There are also additional punishment strategies that enable firms to comply and achieve a cooperative equilibrium
What are the two strategies for a duopoly game?
1) Tit for tat strategy = 1 player cooperates in this period if the other cooperated in previous but cheats in current period if the other cheated in previous (Can produce a cooperative equilibrium)
2) Trigger strategy = player cooperates if other does but plays Nash equilibrium forever thereafter if other player cheats
When may price wars arise?
From tit for tat strategy where the complication of uncertainty about changes in demand
- fall in demand might lower price and bring a tit for tat round
When may price wars arise?
From tit for tat strategy where the complication of uncertainty about changes in demand
- fall in demand might lower price and bring a tit for tat round
What is a constable market?
Market where firms can enter and leave as easily that firms in the market face competition from potential entrants - firms play a sequential game
What is less costly than a constable market?
Limit pricing = sets price at highest level that is consistent w keeping potential entrant out
What is anti combine law?
Body of law that regulates oligopolies and prohibits them from behaving like or becoming monopolies
What are actions that violate anti combine laws?
- price fixing
- bid rigging
- false advertising
