Principles of Microeconomics: Oligopoly
Principles of Microeconomics - Chapter 14: Oligopoly
14.1 Market Structure in an Oligopoly
Definition of Oligopoly:
Oligopoly is a form of industry structure characterized by a small number of dominant firms.
Products in an oligopoly may be either homogeneous (identical) or differentiated (varied).
Competition in Oligopoly:
Oligopolists compete with each other not just on price but also in innovation, product development, marketing, and advertising strategies.
Five Forces Model:
This model, developed by Michael Porter, assists in understanding the competitiveness of an industry by analyzing five forces that impact competition and profitability:
Rivalry among existing firms
Threat of new entrants
Bargaining power of suppliers
Bargaining power of buyers
Threat of substitute products
14.2 Oligopoly Models
Collusion Models:
Cartel: A coalition of firms that coordinate to make collective price and production decisions to maximize their combined profits.
Tacit Collusion: Occurs when firms implicitly agree to limit competition; contrasted with explicit collusion, which involves formal agreements.
Price Leadership Model:
In this model, a dominant firm sets prices that other smaller firms in the industry follow.
Cournot Model: illustrates that firms independently choose output levels. It demonstrates that total industry output under a duopoly is higher than under a monopoly but still less than under perfect competition.
Duopoly: A special case of oligopoly involving two firms.
Description of Cournot Model dynamics:
14.3 Game Theory
Game Theory:
An analytical framework that evaluates the strategic interactions between rival firms, individuals, or governments aiming to maximize their benefits while anticipating opponents' decisions.
Dominant Strategy:
A strategy that yields the best outcome for a player, regardless of the opponent's choice.
Prisoners' Dilemma:
A scenario where individual decision-makers act according to their own interests, leading to a worse outcome for both than if they cooperated.
Nash Equilibrium:
The point in a game where all players are using their best strategy considering the strategies of others, resulting in none having a reason to deviate from their current strategy.
Maximin Strategy:
A strategy that maximizes the minimum gain that can be derived to minimize losses.
Tit-for-Tat Strategy:
A strategy in repeated games whereby a player replicates the opponent's previous action to foster mutual cooperation.
14.5 The Role of Government
Mergers and Government Regulation:.
Herfindahl-Hirschman Index (HHI): Quantitative measure of market concentration that is calculated by summing the squares of the market share percentages of firms in the industry.
Regulatory Approaches:
The Department of Justice and FTC evaluate potential mergers based on whether they enhance firms' abilities for “coordinated interaction,” defined as actions that yield profits only through collective accommodating actions.
Debate on Government Role:
Government regulation is controversial; some believe government intervention is crucial to combat inefficiency and promote competition, while others argue that it could create barriers to entry and induce inefficiencies.
Dominant firms in one market may heavily compete in international markets, altering regulatory considerations.