GAME THEORY AND

OLIGOPOLY
Identification of product market
• Traditionally trivial
• e.g. market for potato, sugar or egg
• Complicated in presence of technology
• e.g.: a) phone and camera, phone and
MP3 player same market?
b) mobiles: android vs. non android
different market?
• Complicated due to branding and
differential
• e.g.: i phones and Mi phones
Way out?
￮ Check cross price elasticity
￮ High -> same market, e.g. desktop, laptop
￮ Low-> different market ,e.g. camera and phone
￮ Caveat
• No clear threshold for the cross-price elasticity to
determine the boundary of the market.

￮ Role of economic analysts and subjective judgment

of managers
Market Power: Concept
￮ Market power
￮ The power of a firm to raise price
￮ Instruments to measure power
￮ Demand substitutability
￮ Supply substitutability
￮ Demand for market power: shows boundary of power to
increase revenue and profit by raising price.
￮ Caveat
￮ High market power harmful from welfare point of view
￮ The regulatory authority (CCI ?) is concerned about
market power as high market power adversely affects
the consumers.
 Types of Markets: Distinctive Features
Number of
Firms?

One Firm Few Firms Many Firms

Type of Products?
Monopoly Oligopoly
• Electricity • Soft Drinks Differentiated Products Identical Products
• Railways • Automobiles
Monopolistic Competition Perfect Competition
• Retail Trade / Garments • Wheat
• Soaps • Vegetables
Example: Domestic Airline Market

• Manager’s Perspective: Can you explain the present scenario?

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Lerner’s Index
￮ Lerner’s Index: Monopoly Power
￮ 𝐿= =
￮ Therefore, High Elasticity=> low
market concentration and vice
versa
Caveats
￮ Threat to entry
￮ Strategic factors
￮ Product differentiation:
￮ High in low concentration can lead
to low competitiveness
￮ Low and in high concentration can
lead to high competitiveness
OLIGOPOLY
Snapshot
￮ No market form is as important as oligopoly.
￮ Modern firms operate in oligopolistic market.
￮ Learning of Economics and Management is never complete without
understanding of oligopoly market.
￮ Various issues of oligopoly market –
￮ how firms compete?
￮ can firms collude?
￮ why do firms differentiate?
￮ what is the implication of leadership etc.?
What is oligopoly?
￮ Oligopoly is the common market form
￮ A few sellers market, selling either homogeneous(e.g. petrol) or
differentiated product(e.g. LCD TV).
￮ Strong mutual interdependence between sellers
￮ The action of one firm critically depends on the actions of other firms
￮ Firms interact strategically, make possible guesses causes for
conjectural variation
Duopoly
￮ The simplest form of oligopoly, called duopoly
Coke and Pepsi

￮ Firm A’s behaviour depends on firm B’s behaviour and vice versa
proverbial egg chicken problem

￮ If two firms behave simultaneously: decisions on the basis of conjecture about others’ behavior.

￮ If they move sequentially: second mover firm observes first mover firm’s behaviour and decide.
Conjectural
Variation
￮ Adjustment in output level of the firm 1 corresponding to
changes in output level of firm 2 as perceived by firm 2
￮ Profit function of Firm 1

￮ FOC

Conjectural Variation
Cournet Model
￮ Cournot’s model of oligopoly is the oldest model of oligopoly (1838)
￮ It is the foundation model of Nash equilibrium concept (Game Theory)
￮ It is demonstrated that under conditions, duopoly can lead determinate
outcome
Assumptions
￮ Two firms producing homogenous
product

￮ Conjectural variable of each firm is

zero

￮ Firms have identical cost structures

￮ Seller vary output; not price

Cournot equilibrium
￮ Cournot equilibrium with a very simple demand function

￮ Assume :
￮ Best response output of firm 1:
￮ Best response output of firm 2:
￮ Solving
Diagrammatic Representation

q2
R1

R2

q2* C

O q 1* R1 R2 q1
Concept: Nash Equilibrium

￮ Nash Equilibrium: All players’ actions are optimal given the

other’s actions.

￮ No player will have an unilateral incentive to deviate from

a Nash equilibrium.

￮ Look at the Pure Strategy Nash Equilibrium (Equilibria) of

the above mentioned game.