Chapter 17: Oligopoly

oligopoly focuses on…

game theory & interdependence (depending on each other)

oligopoly

a market that’s dominated by a small number of firms (cola)

the profits of a large firm depend heavily on…

the actions taken by other large firms

imperfect competition

no one firm has a monopoly, but producers can affect market prices

HHI (Herfindahl-Hirschman Index)

the sum of the squares of each firm’s share of market sales

what happens to the HHI after two companies merge?

it increases

what’s the highest HHI you can get?

10,000 (highest competition)

if there’s less firms/competition, the HHI is…

higher

HHI < 1500

strongly competitive market

HHI 1500-2500

somewhat (moderately) competitive market

HHI > 2500

oligopoly

if HHI >1500, a merger that results in a significant inc. in HHI will receive…

special scrutiny & is likely to be disallowed

we use duopoly to understand…

key issues. simplest case

duopoly

an oligopoly consisting of only 2 firms

with only two firms in the industry, each realizes that profits would be higher if…

it limited its production (& kept prices higher)

cooperation btwn firms may be profitable, but…

its unstable, & illegal in the U.S.

collusion

firms cooperating to raise each others’ profits

what is the strongest form of collusion?

cartel

cartel

an agreement by several producers to restrict output in order to inc. their joint profits

noncooperative behavior

firms ignoring the effects of their actions on each others’ profits (ex. expanding output)

firms acting in self-interest, driving down everyone’s profits

game theory

the study of behavior in situations of interdependence; a way of predicting outcomes in strategic situations like oligopolies.

dominant strategy

a strategy that’s a player’s best action regardless of the action taken by the other player

does a player always have a dominant strategy?

no

nash equilibrium (AKA noncooperative equilibrium)

the result when each player in a game chooses the action that maximizes their payoff given the actions of others, ignoring the effects of their action on the payoffs received by those other players

self-interest

if a game is played repeatedly, players may engage in strategic behavior, sacrificing…

short-run profit to influence future behavior

tit for tat

a strategy of playing cooperative at first, then doing whatever the player did in the previous period.

tacit collusion

implicitly working with each other to raise joint profits

in game theory, the players can make themselves better off by…

making a choice based on the other player’s choice

even if one/both players don’t have a dominant strategy, you can still…

use game theory

does nash equilibrium need dominant strategy?

no.

how is nash equilibrium used in game theory?

each player must have an optimal choice for the optimal choice of the other player (not just for every strategy of the other player as dominated strategies approach requires)

when using game theory and there’s no dominant strategy (after checking), the pair of best responses becomes…

the nash equilibrium