WEEK 8 - Chapter 17: Oligopoly and Business Strategy Flashcards
What is game theory?
The analysis of oligopoly offers an opportunity to introduce game theory.
Game theory is the study of how people behave in strategic situations.
By ‘strategic’ we mean a situation in which a person, when choosing among alternative courses of action, must consider how others might respond to the action he takes.
Markets with only a few sellers.
With few sellers, the key feature of oligopoly is the tension between cooperation and self-interest.
Oligopolistic make STRATEGIC decisions about price and quantity p, taking into account the expected chives of their rivals.
Characteristics of an oligopoly market.
. Few sellers offering similar or identical products
. Interdependent firms
. Best off cooperating and acting like a monopolist by producing a smaller quantity of output and charging a price above magical cost
A key lesson from oligopolies.
Conflict between individual self-interest and collective well-being.
Social incentives to COOPERATE and private interest to DEFECT (act in self-interest).
The oligopolists are best off when they cooperate and act like a monopolist–producing a small quantity of output and charging a price above marginal cost. Yet because each oligopolist cares about only its own profit, there are powerful incentives at work that hinder a group of firms from maintaining the monopoly outcome.
What is a duopoly?
An oligopoly with only two members. It is the simplest type of oligopoly.
Competition, monopolies and cartels.
The duopolies may agree on a monopoly outcome:
. COLLUSION is an agreement among firms in a market about quantities to produce or prices to charge.
. CARTEL is a group of firms acting in unison.
Why can’t collusion and cartels work?
Oligopolists would like to form cartels/collude and earn monopoly profits, but that is often impossible.
Competition laws prohibit explicit agreements among oligopolists as a matter of public policy.
In addition, squabbling among cartel members over how to divide the profit in the market can make agreement among members difficult.
What is the Nash equilibrium?
A situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen.
In a Nash equilibrium no player has an incentive to deviate from his or her chosen strategy after considering an opponent’s choice.
What is the prisoner’s dilemma?
A particular ‘game’ between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial.
In many situations, people fail to cooperate with one another even when cooperation would make them all better off. An oligopoly is just one example. The story of the prisoners’ dilemma contains a general lesson that applies to any group trying to maintain cooperation among its members.
Eg. Two people in custody: C = Cooperate (stay quiet) band D = Defect (admit)
CC - both stay quiet, gets 1 year
CD - one goes free and the other gets 20 years
DC - one goes free and the other gets 20 years
DD - both get 8 years
What is dominant strategy?
A strategy that is best for 1 player in a game regardless of the strategies chosen by the other players.
Eg. Prisoners dilemma - regardless of what the Ned decides does, Kelly is better off confessing.
Now consider Ned’s decision. He faces exactly the same choices as Kelly and he reasons in much the same way. Regardless of what Kelly does, Ned can reduce his time in jail by confessing. In other words, confessing is also a dominant strategy for Ned.
In the end, both Ned and Kelly confess and both spend eight years in jail. This outcome is a Nash equilibrium, each criminal is choosing the best strategy available, given the strategy the other is following. Yet, from their standpoint, the outcome is terrible.
If they had both remained silent, both of them would have been better off, spending just one year in jail on the gun charge. By each pursuing his or her own interests, the two prisoners together reach an outcome that is worse for each of them.
Why people sometimes cooperate?
The prisoners’ dilemma shows that cooperation is difficult. But is it impossible? Not all prisoners, when questioned by the police, decide to turn in their partners in crime.
Cartels sometimes do manage to maintain collusive arrangements, despite the incentive for individual members to defect. Very often, the reason that players can solve the prisoners’ dilemma is that they play the game not once but many times.
. Firms that car about future profits will cooperate in INFINITE GAMES rather than cheating in a single game to achieve a ONE-TIME GAIN.
. Betrayal/defection destroys trust.
. Can enforce cooperation using other methods, eg. Violence, religious beliefs, peer group pressure etc.
The equilibrium for an oligopoly.
When firms in an oligopoly choose production to maximise profit, they produce quantity of output greater than the level produced by monopoly and less than the level produced by competition.
The oligopoly price is less than the monopoly price, but greater than the competitive price.
Possible outcome if oligopoly firms pursue their own self-interest.
. Joint output is greater than the monopoly quantity but less than the competitive industry quantity
. Market prices are lower than monopoly price but greater than competitive price
. Total profits are less than the monopoly profit
How the size of an oligopoly affects the market outcome?
How increasing the number of sellers affects the price and quantity:
. The OUTOUT EFFECT: because price is above marginal cost, selling is more at the going price raises profits.
. The PRICE EFFECT: raising production will increase the amount sold, which will lower the price and the profit per unit on all units sold.
What happens when the number of sellers in an oligopoly grows larger?
An oligopolistic market looks more and more like a competitive market.
. Price approaches MC and
. Quantity produced approaches the social efficient level.
