Oligopolies & Game Theory

Oligopoly

A market structure dominated by a few large firms, leading to interdependent decision-making.

Duopoly

A specific type of oligopoly with only two firms, such as coke/pepsi or boeing/airbus.

Collusion

An agreement among firms to limit competition, often by setting prices or output levels.

Cartel

A formal organization of firms that collude to act as a monopoly.

Interdependence

Firms must consider the potential reactions of rivals when making decisions in an oligopoly.

Non-Price Competition

Competition through advertising and product differentiation rather than price.

Purpose of Collusion

To maximize joint profits by reducing competition.

Nash Equilibrium

A situation where no player can benefit by changing their strategy while the other players keep theirs unchanged.

Dominant Strategy

A strategy that is the best for a player, regardless of the strategies chosen by other players.

Prisoners' Dilemma

A game theory scenario where mutual cooperation leads to the best outcome, but individual incentives often result in betrayal.

Incentive to Cheat in Cartels

Firms in a cartel may lower prices or increase production secretly to increase their individual market share and profits.

Short-Term Gain from Cheating

Immediate benefits to a firm that lowers prices or increases output, leading to increased sales.

Long-Term Problems of Cheating

Cheating can destabilize the cartel, causing a collapse of agreed prices and output levels.

Instability of Cartels

Cartels are unstable due to firms' temptation to cheat, which can lead to price wars.

Mutual Betrayal in Oligopolies

When one firm's cheating encourages others to cheat, reducing overall profits.

Lack of Enforcement in Cartels

Illegality of collusion complicates enforcement and trust among firms.