ECON101 Unit 12

Question 1

What is an oligopoly? What are its traits

Answer 1

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

Question 2

What is a duopoly?

Answer 2

A specific type of oligopoly in which only TWO firms with large market shares compete strategically

Question 3

How do the two barriers to entry work? (Two situations of oligopoly)

Answer 3

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

Question 4

How are oligopolies interdependent?

Answer 4

There is a small number of firms and they face temptation to cooperate
- each firms profit depends on every others actions

Question 5

Why is there a temptation to cooperate? (cartel)

Answer 5

Firms in oligopoly face temptation to form a cartel

Cartel = group of firms acting together to limit output, raise price, and increase profit

Question 6

What is game theory?

Answer 6

A tool for studying strategic behaviour which s behaviour that takes into account the expected behaviour of others and the mutual recognition of interdependence

Question 7

Four main features of games:

Answer 7

1) Rules: setting, actions, consequences
2) Strategies: possible choices during turn
3) Playoffs: consequences of outcomes (utility)
4) Outcomes: what ends up occurring (result)

Question 8

What is the payoff matrix?

Answer 8

A table showing payoffs for every possible action by each player for every possible action by another player

Question 9

What is the nash equilibrium?

Answer 9

both players are rational and choose their actions like that, the outcome is this equilibrium
- each takes beset action given other players action

Question 10

Is the suboptimal equilibrium where the equilibrium is not the best outcome?

Answer 10

Yes, it is not

Question 11

What is the prisoners dilemma and how can it be used to avoid the suboptimal equilibrium?

Answer 11

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

Question 12

What is the dominant strategy equilibirum?

Answer 12

Clear strategy for each player independent of the other players actions

Question 13

What is a collusive agreement?

Answer 13

Agreement between 2+ firms to restrict output, raise price, and increase profit

Question 14

What are the four options firms can pursue?

Answer 14

1) Both comply
2) Both cheat
3) A complies B cheats
4) B complies A cheats

Question 15

What happens when firms collude in a cartel and act like a monopoly?

Answer 15

• 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

Question 16

What happens when 1 firm cheats and increases ouput?

Answer 16

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

Question 17

What happens if both firms cheat and increase output?

Answer 17

They both make 0 economic profit and achieve competitive outcome
- Same as perfect competition

Question 18

Nash equilibrium in duopolistic dilemma: What is the others best response if either cheat?

Answer 18

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

Question 19

When can a game of chicken arise?

Answer 19

When research and development creates a new technology that cannot be patented
- both firms can benefit from the technology of either firm

Question 20

What happens in a repeated duopoly game? How can a cooperative equilibrium occur?

Answer 20

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

Question 21

What are the two strategies for a duopoly game?

Answer 21

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

Question 22

When may price wars arise?

Answer 22

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

Question 23

When may price wars arise?

Answer 23

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

Question 24

What is a constable market?

Answer 24

Market where firms can enter and leave as easily that firms in the market face competition from potential entrants - firms play a sequential game

Question 25

What is less costly than a constable market?

Answer 25

Limit pricing = sets price at highest level that is consistent w keeping potential entrant out

Question 26

What is anti combine law?

Answer 26

Body of law that regulates oligopolies and prohibits them from behaving like or becoming monopolies

Question 27

What are actions that violate anti combine laws?

Answer 27

• price fixing
• bid rigging
• false advertising