Oligopolies

In any scenario where both partners are involved in a decision-making process, there is often a lack of incentive for either party to deviate from their chosen strategy.
Attempting to divert from the set strategy can lead to negative outcomes for oneself.
Each participant possesses a dominant strategy which indicates that they will choose a particular outcome regardless of the action taken by the other party.
- Example: Thomas has a specific strategy he adheres to strictly.

The discussion revolves around game theory, specifically the Prisoner's Dilemma.
- In a Prisoner's Dilemma, the primary question is to identify whether a dominant strategy exists and what that strategy entails.
Central to the analysis within game theory is the concept of Nash Equilibrium:
- A situation where no player has an incentive to change their strategy because they are already at an optimal outcome given the other players' strategies.

The focus of the discussion relates to oligopolies.
- Oligopolies consist of a market structure where a few firms dominate the market space.
- The defining feature of oligopolies is interdependence among firms:
- The outcome or decision-making of one firm significantly depends not only on their own actions but also on the actions of other firms in the market.
Firms must strategize based on potential reactions from the competition, making their decision-making process more complex.

Under oligopolies, firms may operate at different quantities and pricing strategies compared to perfectly competitive industries.
- Example: A non-competitively priced firm will establish production where Marginal Revenue (MR) = Marginal Cost (MC).
- This results in a lower quantity produced (denoted as $Q<em>{MC}$ ) than a perfectly competitive firm, which produces at a higher output (denoted as $Q</em>C$ ).
Pricing strategies differ distinctly between competitive firms and oligopolies:
- Competitive firms function efficiently at the lowest point of the Average Total Cost (ATC) curve, leading to productive efficiency.
- In contrast, firms within monopolistic competition do not operate at this lowest efficiency point, leading to decreased output levels and higher pricing.

Perfect competition is characterized by:
- Allocative efficiency: resources are distributed in a way that maximizes total welfare.
- Productive efficiency: production occurs at the lowest average total cost.
Monopolistic competition, on the other hand, does not achieve this efficiency and operates generally to the left of the ATC curve:
- Resultantly less efficient than perfectly competitive markets.

There are specific methodologies to differentiate between market structures, notably through concentration ratios:
- Four-firm concentration ratio (CR4): Measures the total market share held by the four largest firms.
- If greater than 40%, the market is classified as an oligopoly. Less than this suggests a competitive market.
- A more comprehensive method involves assessing all firms in a market, but this is more complex and costly.

Consider an industry composed of 10 firms:
- Two firms possess 14% market shares each, while the remaining eight firms have 9% each.
- Calculation of market shares provides insight into the market landscape and competitive dynamics.

Historical context involves consumer behavior in retail settings, such as shopping malls, leading to changes in price strategies:
- In the market, firms must consider potential outcomes when adjusting prices (both up and down).
- An increase in price by one firm may not be matched by competitors, leading to a loss of customers for the raising firm.
- Conversely, lowering prices could lead to losses as well due to the inelastic demand response.
As a result, firms often choose price stability, avoiding significant deviations from their original pricing.

A model describing firm behavior in oligopoly markets is the kinked demand curve:
- Reflects that firms ignore price increases from competition but match any price decreases:
- This leads to a kink at a specific price point (the red dot symbolizing 'You are here').
- The demand curve is illustrated as having a kink:
- Above the point, demand is elastic (consumers reduce quantity demanded with higher prices).
- Below, demand is inelastic (consumers increase quantity demanded with lower prices).
The kink leads to price stability since firms do not want to disrupt their sales by adjusting prices.

The intersection of the kink demand curve with the marginal cost (MC) creates a unique pricing strategy:
- Changes in MC do not significantly affect the price or output for firms in this model until a large change occurs.

In contrast, when firms work together (e.g., forming a cartel), they act as a collective monopoly:
- This creates a central opportunity to set higher prices collectively and restrict outputs to optimize profits.
Price leadership occurs when a dominant firm sets a price level and other firms in the market follow suit to avoid competitive losses.
- This cooperation, while effective, is typically illegal under competition laws in many jurisdictions.