4.5 - Oligopoly & Game Theory

  • Only a few firms

    • large market shares

  • Control over price

    • mutual interdependence - based on what other’s in the market are doing

    • strategic behavior

    • price war

  • Entry barriers

    • economies of scale

    • Control of Resources

Collusive Oligopoly

  • If a few firms face similar demand and costs they will act like a monopoly

    • teaming up and both rise prices a lot and cut back on output

    • Monopoly graph

    • Split monopoly profits

Overt (in the open) Collusion

  • Cartel

    • OPEC

Covert (hidden) Collusion

  • Illegal in the U.S.

    • Tacit Understandings - “Gentlemen’s Agreements”

    • No contracts involved

Obstacles to Collusion

  • Demand or Cost Differences (having more demand or efficiency than another firm so it would not be to one’s benefit to collude)

  • Number of firms (more firms makes collusion more difficult)

  • Cheating

  • Potential Entry

  • Antitrust Law

  • Not Productively Efficient

    • P does not = Minimum ATC

  • Not Allocatively Efficient

    • P does not = MC

Game Theory:

Payoff Matrix

2 strategies - high price or low price

high

low

high

A - $12/$12

B - $15/$6

low

C - $6/$15

D - $8/$8

  • Greatest combined profit

  • Independent actions stimulate response (where one cheats)

  • Dominant strategies - better off going low

  • Both gravitate towards the worst case - D

Nash equilibrium - worse case (D) - what they will do

no dominant strategy for both - no nash equilibrium

Collusive outcome (both are guaranteed/trust that the other business will raise the price) - best case (A)