Module 1 - Ch 10.2 Flashcards
What is an oligopoly?
Oligopoly arises when a small number of large firms have all or most of the sales in an industry.
it is a situation where a few firms sell most or all of the goods in a market
What is a natural monopoly?
will arise when the quantity demanded in a market is only large enough for a single firm to operate at the minimum of the long-run average cost curve.
In such a setting, the market has room for only one firm, because no smaller firm can operate at a low enough average cost to compete, and no larger firm could sell what it produced given the quantity demanded in the market.
What is an example of how monopolies are created?
when a government grants a patent for an invention to one firm, it may create a monopoly.
What is an example of how oligopolies are formed?
When the government grants patents to, for example, three different pharmaceutical companies that each has its own drug for
reducing high blood pressure, those three firms may become an oligopoly
What is collusion?
When oligopoly firms in a certain market decide what quantity to produce and what price to charge, they face a temptation to act as if they were a monopoly.
By acting together, oligopolistic firms can hold down industry output, charge a higher price, and divide the profit among themselves.
What is a cartel?
A group of firms that have a formal agreement to collude to produce the monopoly output and sell at the monopoly price
Why is collusion hard to prove?
The problem of enforcement is finding hard evidence of collusion. Cartels are formal agreements to collude.
Because cartel agreements provide evidence of collusion, they are rare in the United States.
Instead, most collusion is tacit, where firms implicitly reach an understanding that competition is bad for profits.
Why does prisoner’s dilemma apply well to oligopolies?
because the gains from cooperation are larger than the rewards from pursuing self-interest.
Because collusion is illegal, oligopolists cannot sign a legally enforceable contract to act like a monopoly, what tools can they use to increase profits?
the firms may instead keep close tabs on what other firms are producing and charging.
competing oligopoly firms commit to match price cuts, but not price increases.
What happens when competing oligopoly firms commit to matching prices or competitors?
If the oligopoly decides to produce more and cut its price, the other members of the cartel will immediately match any price cuts—and therefore, a lower price brings very
little increase in quantity sold.
if oligopolists always match price cuts by other firms in the cartel, but do not match price increases, then none of the oligopolists will have a strong incentive to change prices, since the potential gains are minimal.
What type of graph does this represent?
a Kinked Demand Curve
It is the result of price matching with competing oligopolies.
If one company drops their price to increase their sales, the other companies will also drop their prices resulting in more sales than what they had, but not as many as they were projecting.
If one company increases their price, the other companies will not increase their prices which results in less sales.
Sometimes oligopolies in the same industry are very different in size. Suppose we have a duopoly where one firm (Firm A) is large and the other firm (Firm B) is small, as the prisoner’s dilemma box shown.
Assuming that both firms know the payoffs, what is the likely outcome in this case?
Firm B reasons that if it cheats and Firm A does not notice, it will double its money. Since Firm A’s profits will decline substantially, however, it is likely that Firm A will notice and if so, Firm A will cheat also, with the result that Firm B will lose 90% of what it gained by cheating. Firm A will reason that Firm B is unlikely to risk cheating. If neither firm cheats, Firm A earns $1000. If Firm A cheats, assuming Firm B does not cheat, A can boost its profits only a little, since Firm B is so small. If both firms cheat, then Firm A loses at least 50% of what it could have earned. The possibility of a small gain ($50) is probably not enough to induce Firm A to cheat, so in this case it is likely that both firms will collude.
Does each individual in a prisoner’s dilemma benefit more from cooperation or from pursuing self-interest?
each individual benefits more from cooperation if both cooperate. However, if trust is lacking, individuals may choose to pursue self-interest, fearing that the other will defect, leading to suboptimal results for both.
This is the core of the dilemma.
What stops oligopolists from acting together as a monopolist and earning the highest possible level of profits?
- Incentive to Cheat
- Lack of Trust and Coordination Issues
- Legal and Regulatory Barriers
- Fear of Government Intervention
- Market Uncertainty and Changing Conditions
- Potential Entry of New Competitors
- Consumer Backlash
Would you expect the kinked demand curve to be more extreme (like a right angle) or less extreme (like a normal demand curve) if each firm in the cartel produces a near-identical product like OPEC and petroleum?
If firms produce near-identical products (like OPEC and petroleum), the kinked demand curve is more extreme, approaching a right angle, because of sharp differences in price elasticity above and below the kink.
Mary and Raj are the only two growers who provide organically grown corn to a local grocery store. If they cooperate they will each earn $150. What is the best choice for Raj if he is sure that Mary will cooperate?
To cooperate
Mary and Raj are the only two growers who provide organically grown corn to a local grocery store. If they cooperate they will each earn $150. If Mary thinks Raj will cheat, what should Mary do and why?
Mary should defect and keep producing independently if she thinks Raj will cheat. Here’s why:
By cooperating, Mary risks earning nothing ($0) if Raj defects.
By defecting, Mary guarantees herself $100, even if Raj also defects.
Mary and Raj are the only two growers who provide organically grown corn to a local grocery store. If they cooperate they will each earn $150. What is the prisoner’s dilemma result?
To both work independently.
They would both obtain a suboptimal amount of $100 each.
Jane and Bill are apprehended for a bank robbery. They are taken into separate rooms and questioned by the police about their involvement in the crime. A = Confess; B = Stay Silent. (Each results entry lists Jane’s sentence first (in years), and Bill’s sentence second.)
If Jane trusts Bill to stay silent, what should she do?
If Jane trusts Bill to stay silent, she should stay silent.
Jane and Bill are apprehended for a bank robbery. They are taken into separate rooms and questioned by the police about their involvement in the crime. A = Confess; B = Stay Silent. (Each results entry lists Jane’s sentence first (in years), and Bill’s sentence second.)
If Jane thinks that Bill will confess, what should she do?
If Jane thinks that Bill will confess, she should stay silent
Jane and Bill are apprehended for a bank robbery. They are taken into separate rooms and questioned by the police about their involvement in the crime. A = Confess; B = Stay Silent. (Each results entry lists Jane’s sentence first (in years), and Bill’s sentence second.)
Does Jane have a dominant strategy?
Yes. She should stay silent regardless of what Bill does.
Jane and Bill are apprehended for a bank robbery. They are taken into separate rooms and questioned by the police about their involvement in the crime. A = Confess; B = Stay Silent. (Each results entry lists Jane’s sentence first (in years), and Bill’s sentence second.)
Does Bill have a dominant strategy?
Yes, Bill should stay silent regardless of what Jane says.
