Module 12 Study Guide Flashcards
What are the characteristics of oligopoly?
An oligopoly only has a few firms that saturate the market. There are barriers to entry.
Examples: Breakfast cereal market
The big barrier to entry of breakfast cereal is super market shelf space.
Each firm has a large market share.
The firms are interdependent. One firms decisions affect the other firms. If Kellog lowers their prices, that’s going to affect General Mills’ profits.
Firms have incentive to collude (work together). So Kellog is not going to lower their prices because then the other big brands would lower their prices, and they would all lose money.
What is the 4-firm concentration ratio and the Herfindahl-Hirschman Index (HHI)?
We try to figure out which market system is going on for a specific market (monopoly, perfect competition, oligopoly, or monopolistic competition) using the 4 - firm concentration ratio.
This determines what percentage of the total industry revenue is accounted for by the 4 largest firms. (4 largest breakfast cereal companies make up 78% of the market)
For a monopoly, it obviously has to be a one firm concentration ratio of 100%. For a perfect competition market, it has to be close to zero. It’s an oligopoly if it’s greater than 60% and it’s a monopolistic competition if it’s less than 40% with some grey area between those two.
US cell phone companies are another oligopoly. 4 largest make up 98.8% of the market.
Another way to measure is the HHI.
The HHI tell us a little bit more information and we calculate that by the square of the percentage of the firm’s market share. We add up the square of all the firm’s market share. So for a monopoly, it’s one hundred percent squared (or 10,000). We usually say 1,500 or less for monopolistic competition and 2,500 or more for oligopoly (which makes it uncompetitive). This is specifically to square all of the firms in a market (limit to top 50).
Define collusion and name two types of collusion.
Tacit which is hidden. (The only one that happens in the US because it’s illegal to collude due to Anti-Trust laws.)
Overt which is not hidden (open, spoken, traceable, etc.)
What is the difference between Nash equilibrium and dominant strategy?
Dominant strategy is when it’s the best thing for you to do no matter what the other person is doing. Each player doing the best they can given what the other one is doing is the Nash equilibrium. It’s equilibrium because it’s a place of rest.
Nash equilibrium definition: Stable state of a system involving different participants in which no participant can gain from a unilateral change in strategy while the other participant’s strategies remain unchanged
- “Each player chooses the best possible strategy, given the other player’s action”
- “But it’s not the best outcome for either player”
How can we apply the lesson of the Prisoner’s Dilemma to the oligopoly market?
Firms aren’t supposed to collude. “Duopolist’s Dilemma”
A firm will use a dominant strategy to pick the option that will give them the most profits given what the other firm may do. Then the other firm will make a decision based off that knowledge and meet Nash Equilibrium.
But most likely, they will collude and get the collusion one that’s actually the best outcome for both of them.
Anti-trust laws in the US say it’s illegal for firms to collude. They’re trying to protect the consumer.
