Chapter 15 Oligopoly

Oligopoly
a market structure in which a small number of firms compete with each other and the market barrier prevents the entry of new firms

Characteristics of an oligopoly
– Small number of firms (2, 3, 4, etc.)
– Very similar or identical products (crude oil, tennis ball,
cigarettes, soft drinks, etc.)
– Interdependence : one firm’s profit depends on other firms
– Natural or legal market barriers

Interdependence
one firm’s profit depends on other firms

Duopoly
An oligopoly with only two firms

Strategic Behavior
– Behavior that takes into account the expected behavior of
others.
– A firm’s decisions about P or Q will affect other firms and cause them to react.

Game Theory
The study of how people/firms behave in strategic situations.

The recognition of mutual interdependence.

All games share four components: Rules, Strategies, Payoffs, and Outcome.

Rules
describe the setting of the game, the actions the players may take, and the consequences of those actions.

Strategies
are all the possible actions of each player

Payoffs
are what the players will get after they both choose their strategies. We can tabulate these payoffs in a payoff matrix.

payoff matrix
is a table that shows the payoffs for every possible action by each player for every possible action by the other player

outcome
The rational choices made by players will decide the outcome of the game

Nash equilibrium for prisons dilemma is called
dominant strategy equilibrium

Collusive agreement
agreement between two or more producers to form a cartel to restrict output, raise the price, and increase profits

dominant strategy
A strategy that is best for a player in a game regardless of the strategies chosen by the other player.

Nash Equilibrium
– A situation where each player choose the best strategy given the strategy the other has chosen.
– A stable outcome in a non-cooperative game.
– No gain by moving away from a Nash Equilibrium if the
other player keeps unchanged.
• Both players have no incentive to move away from Nash equilibrium.

Cartel
a group of firms acting together – colluding – as a monopoly to limit Q, raise P, and increase profit.

Advertising Wars
Two firms spend millions on advertising to steal business from each other. Each firm’s effort cancels out the effects of the other, and both firms’ profits fall by the cost of the advertising.

Predatory Pricing
A pricing war. Firm cuts price drastically in order to drive the competitor out of the market. If the competitor reacts by cutting price too, both will bear huge cost.

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