Oligopoly

Oligopoly
Features Small number of sellers, each with large capacity relative to total market demand. In many oligopolies, competition is through advertising and product differentiation (car) In some other oligopolies, standardised products (Steel) Barriers to entry in oligopoly either due to economies of scale or due to strong product name recognition.

Collusion/collusive oligopoly
When there are small no of firms, they have a choice between co-operative or noncooperative behaviour Non-co-operation when there is no explicit or implicit agreement But when firms under oligopoly actively cooperate, it is collusion Firms jointly set their prices and divide the market among themselves.

Game theory

Game theory
The oligopolies can reach the monopoly outcome but they need to co-operate. Game theory is a study of how people behave in the strategic situations. Such a situation is the one in which each player must consider how others will react. GT is quite useful for understanding the behaviour of oligopolists.

Prisoners Dilemma
PD is two person-non-zero-sum, non-cooperative game with a dominant stategy. In zero-sum game, one players gain is others loss In non-z-g, both may gain or lose depending on the actions each chooses to take. Here opponents are not allowed to share information with each other. Two criminals captured by the police Committed minor crime of carrying an unregistered gun So one year jail Also suspecting bank-robbery for which no evidence If one confesses, he gets minimum while other gets maximum punishment. If both talk, both get moderate punishment

The Prisoners Dilemma

Suspect 1

Confess
8 years

Remain Silent
20 years free

Confess 8 years
Suspect 2

Remain Silent

free 20 years

Bonnie gets 1 year John gets 1 year

Conclusion
Thus PD describes how co-operation is difficult to maintain even though it would make both the players better off. Lack of co-operation may not always be bad for a society as a whole PD is a dilemma for the prisoners but not for the police as they can convict more criminals if there is no co-operation Invisible hand in the market is successful only when the firms do not co-operate.

Market Failures

Asymmetric information(ref. pages 567-571

Pindyck-rubinfeld-Microeconomics-7th ed.)

In most of the issues discussed so far, we have assumed that the consumers and producers have complete knowledge of the products bought and sold. But in reality, some parties in the market know more than others. This is called asymmetric information.

 AS is a market situation in which the buyers and sellers have different information while making transactions. Examples In a market for the used cars the buyer knows less about the quality of car as compared to the seller In case of an insurance company, the customer is better aware of the probability of getting ill than the insurance company In the labour market, different workers have different productivities and it is difficult for the employer to know about it

Asymmetric Information (AI)

AI leads to failure of market which means the markets can not function in the most efficient way. Market for lemons (low quality or defective goods). Eg cars. Two types of used cars for sell high quality and bad quality Price will be determined on the basis of average quality of cars. All the sellers will claim that their cars are of good quality. The buyer is not properly informed and hence ready to pay not more than the average price, even though he is buying high quality car and not a lemon.

 As a result, the owners of a good car will not get the price equal to their worth and hence they will tend to leave the market. The lemon problem implies that with AI, low quality goods can drive high quality goods out of the market. This will reduce the supply of good quality used cars Average quality of cars and hence their price will further fall. Some more good cars will be out of the market. This process will continue till only lemons are remaining in the market. This is adverse selection

Implications of AI
AI results in market failure. In ideal market, consumer would be able to choose between lowquality and high-quality cars. Some will prefer low quality cars because of the low cost while others will be willing to pay more for the good quality cars. Unfortunately consumers can not easily determine the quality until they buy the one. Market failure arises because there are owners of high quality cars who value their cars higher than the potential buyers of high quality cars.

Public Goods (Pages 557-561)

Public goods have two characteristics Non-rival A good is non-rival when for any given level of production, the marginal cost of providing it to an additional consumer is zero. For most of the goods provided privately, MC of producing goods is positive. But for some goods, additional consumers do not add cost. Eg use of highway, lighthouse, public television Most of the goods are rival in consumption. When one buys it, other can not have it.

Contd..
Non-exclusive people can not be excluded from consuming it. So difficult to charge the people. National defence Some goods are exclusive but non-rivals. TV signals. MC may be zero once a signal is broadcast. But the signals may be made exclusive by charging for the codes to unscramble them. Public goods which are both non-rival and nonexclusive, provide benefits to the people at zero marginal cost and no one can be excluded from enjoying them.

Public goods and market failure

Some services can not be provided to exclusively to a few. Mosquito abatement programme. As a result, people have no incentive to pay, though it is useful for them. People can act as free riders who enjoy the good without paying for it. The presence of free riders makes it difficult to provide goods efficiently. If a few people were involved, all of them might agree to share costs. But when many are involved, voluntary private arrangements are ineffective. Public good, so, subsidised or must be provided by governments if it is to be produced efficiently.