Oligopolies

Question 1

What are the characterisitics of an oligopoly?

Answer 1

Small number of large sellers so firms have to act strategically
Offer similar or homogenous products
High barriers to entry and exit
Interdependant

Question 2

What is collusion?

Answer 2

An agreement between 2 or more firms to form a cartel to restrict output, raise price and increase industry profits.

Question 3

What is the risk with collusion?

Answer 3

Firms may cheat on agreement and cause industry profits to fall as industry output increases which causes the industry price to fall until it reaches the price andquantity that would be ahceived in perfect competition and potential of whistleblowers.

Question 4

How is output determined in a collusive oligopoly?

Answer 4

Act as a monopolist supplying output at the profit max point where MC=MR and the collusive oligopolies agree how to share profit and output between themselves.

Question 5

What factors favour collusion?

Answer 5

Few firms so less parties can disagree
Homogenous products so similar prices to agree to
Similar production methods so similar costs
High barriers to entry so a new entrant cant come in and undercut
Stable market which makes it eaiser to reach an agreement

Question 6

What is tacit collusion?

Answer 6

Collusion that has not been explicitly agreed to, it may take the form of price leadership whereby the price leader sets the market price and followers copy this resulting in the market having a perfectly elastic demand curve.

Question 7

What is a cournot duopoly?

Answer 7

2 identical firms producing homogenous products which compete on quantity.

Question 8

What is a reaction function?

Answer 8

How the optimal actions (output) of one player varies with assumed actions (output) of the other player.

Question 9

How would firm A react if Firm B was expected to decrease output by one unit?

Answer 9

Firm A would increase output by less than one unit as this will decrease total industry output raising the price of all the previous units (demand falls by more than the marginal revenue).

Question 10

What is Nash equilibrium in terms of a reaction function?

Answer 10

Where assumptions about both players are correct - doesnt necessarily give the best pay-off for both.

Question 11

Why might firm A’s reaction function shift right?

Answer 11

If firm A’s MC curve shifts downward as now making more at the assumed output of firm B.

Question 12

What is the results in comparison to other market structures when cournot equilibrium is acheived?

Answer 12

Profits will be lower than a monopoly or cartel as prices will be lower but will be better off than in PC.

Question 13

What is the kinked demand curve and what are the 2 assumptions?

Answer 13

Useful to show price rigiditys and why price doesnt change when costs change.
1. If a firm increases price, rivals will not follow (AR elastic above kink)
2. If a firm decreases the price, rivals will follow (AR inelastic below kink)

Question 14

Why can price and output remain the same when costs change on the kinked demand curve?

Answer 14

Because MR becomes discontnued at the profit max quantity. No incentive to change price as TR will fall either way.

Question 15

What is a normal form game in game theory?

Answer 15

Firms play simultaneously without knowing the strategy of the other.

Question 16

What is nash equilibrium?

Answer 16

Each player plays the best strategy given the strategy of the other players. Neither player has incentive to deviate.

Question 17

What is a dominant strategy?

Answer 17

A players best strategy regardless of what the other players strategies are.

Question 18

How does game theory show the temptation to cheat in a cartel and why it wont be effective?

Answer 18

If firm A produces high output and the B produces low then A can maximise their profits but they cant risk this in case B also produces high output so by colluding both produce low output which is a better payoff than both producing low. If one party cheats on agreement and produces high the other will follow and they will both be worse off.

Question 19

What are the benefits of game theory?

Answer 19

Helps identify the right strategy
shows consequences of interdependence
used to show clear reasoning behind a strategy
used to predict and analyse behaviour

Question 20

What are the drawbacks to game theory?

Answer 20

Can become complex and too difficult to solve ( too many players)
General principles abandoned in favour of local modelling.

Question 21

What is a Bertrand duopoly?

Answer 21

Both firms produce identical goods but set price reflecting what it assumes the other firm will do.

Question 22

Where is nash equilibrium in a Bertrand duopoly?

Answer 22

Where both firms price is equal to MC (perfect competition outcome). This is because if firm A increases their price then B will set price just below and above MC so they will supply the whole market and eventually both return back to setting price equal to MC.

Question 23

What is Bertrand paradox?

Answer 23

A perfect competition outcome arising in an imperfect market.