OLIGOPOLY Chapter 14

INTRODUCTION

An oligopoly is an industry with only a small number of producers.

A producer in such an industry is known as an oligopolist.

Economists refer to a situation in which firms compete but also

possess market power—which enables them to affect market
prices—as imperfect competition.

There are actually two important forms of imperfect competition:

oligopoly and monopolistic competition.
 UNDERSTANDING OLIGOPOLY

 An oligopoly consisting of only two firms is a duopoly.

 Each firm is known as a duopolist.

 Sellers engage in collusion when they cooperate to raise

their joint profits.

 A car tel is an agreement among several producers to

obey output restrictions in order to increase their joint
profits.

 When firms ignore the effects of their actions on each

others’ profits, they engage in noncooperative behavior.
 GAMES OLIGOPOLISTS PLAY

 When a firm’s decision significantly aff ects the profits of

other firms in the industry, the firms are in a situation of
interdependence.

 The study of behavior in situations of interdependence is

known as game theor y.

 The reward received by a player in a game, such as the profit

ear ned by an oligopolist, is that player’s payoff.

 A payoff matr ix shows how the payoff to each of the

participants in a two - player game depends on the actions of
both. Such a matrix helps us analyze situations of
interdependence.
 GAME THEORY
THE PRISONERS’ DILEMMA
 Game theory deals with any situation in which the reward
to any one player—the payoff—depends not only on his or
her own actions but also on those of other players in the
game.

 In the case of oligopolistic fir ms, the payoff is simply

the fir m’s profit.

 Prisoners’ dilemma is a game based on two premises:

(1) Each player has an incentive to choose an action that
benefits itself at the other player’s expense.
(2) When both players act in this way, both are worse off
than if they had acted cooperatively.
THE PRISONERS’ DILEMMA
 GAME THEORY

 A Nash equilibr ium , also known as a noncooperative

equilibr ium, results when each player in a game chooses the
action that maximizes his or her payoff given the actions of other
players, ignor ing the eff ects of his or her action on the payoffs
received by those other players.

 A firm engages in strategic behavior when it attempts to

influence the future behavior of other firms.

 An action is a dominant strategy when it is a player’s best action

regardless of the action taken by the other player.\

 A strategy of tit for tat involves playing cooperatively at first, then

doing whatever the other player did in the previous per iod.

 When firms limit production and raise pr ices in a way that raises
one anothers’ profits, even though they have not made any f ormal
agreement, they are engaged in tacit collusion.
 GAME THEORY

How Repeated Interaction Can Support Collusion

 GAME THEORY

 A pr ice war occurs when tacit collusion breaks down and

prices collapse.

 Product differentiation is an attempt by a firm to

convince buyers that its product is different from the
products of other firms in the industry.

 In pr ice leadership, one firm sets its price first, and other
firms then follow.

 Firms that have a tacit understanding not to compete on

price often engage in intense nonpr ice competition,
using advertising and other means to try to increase their
sales.
 OLIGOPOLY EXAMPLES

Automobile Industry

Technology Industry

Media Industry

Pharmaceutical Industry