Oligopolies and Game Theory

Strategic independence is a concept observed in sports where teams adapt in real-time to their opponents. This concept parallels oligarchies, where firms and nations operate strategically to benefit their own interests.

Collusion and Cartels
- Instead of competing against each other, firms within an oligopoly can choose to collaborate by forming a cartel.
- Definition of a Cartel: A cartel is a group of firms that agree to work together to control prices and limit competition.
- While this may be initially profitable, individual firms may ultimately decide to undercut prices to increase their own profits by selling outside the agreement.
Impact of Increased Supply
- If a firm increases supply by selling outside the cartel, prices will generally decrease, causing other firms to also lower their prices to remain competitive.
- This leads to a scenario where consumers face higher prices due to limited choices, if firms agree on high prices.

Predatory Pricing
- In contrast to collaboration, firms can engage in predatory pricing, which involves aggressively lowering prices to drive competitors out of business.
- The firm engaging in predatory pricing is termed the "predator," while its competitors are the "prey."
- This strategy can lead to temporary lower prices for consumers but is unsustainable for long-term business practices.

Price Dynamics
- Firms may enter a price war, which can push prices below average total costs (ATC).
- In a perfectly competitive market, prices are typically set at the minimum ATC, benefitting consumers.
Demand Sensitivity
- The cross price elasticity of demand indicates how the demand for one good is affected by the change in price of another good.
- If the cross price elasticity is 3 or more, the two firms are likely in the same industry, suggesting potential oligopolistic behavior.

North American Industry Classification System (NAICS)
- NAICS provides a method for categorizing various industries down to specific segments by analyzing sales revenue.
- A more detailed collection often reveals limited market competition for specific services within broad categories (e.g., information industry).
Four-Firm Concentration Ratio
- A measure to determine market control by the four largest firms in an industry.
- A concentration ratio of 80% indicates significant market control, hinting toward an oligopolistic structure.
- This measurement can alert regulators to potential anti-competitive practices.
Herfindahl-Hirschman Index (HHI)
- Calculated by summing the squares of the market shares of each competing firm in an industry.
- A higher HHI indicates greater market concentration.
- Example: If the HHI for breakfast cereals is 78%, deeper investigation into the competition landscape is necessary, despite apparent choices available to consumers.

Foundational Concepts
- Game theory, developed in the 1940s, analyzes strategic interactions among players, including individuals, companies, or nations.
- Dominant strategies emerge when a single course of action yields the highest payoff irrespective of what others do.
Backwards Induction
- A strategy for solving games by identifying the end outcomes and working backwards to determine the most effective means to achieve those outcomes.

Definition of Nash Equilibrium
- Achieved when no player has an incentive to change their strategy given the strategies of others.
- An example scenario involves two players, Thelma and Louise, who can either confess or remain silent.
- Their decisions impact their jail time, creating a situation where mutual decisions can lead to optimal or suboptimal outcomes based on strategic choices.

When games are played repeatedly, player reputations can influence outcomes, allowing for strategies based on trust and cooperation, known as "tit for tat".
In repeated settings, firms can mimic each other's strategies, impacting pricing and advertising behaviors over time.

When discussing decisions like advertising campaigns, firms weigh potential revenue gains against competitor responses, creating strategic decisions that may redefine their market positions.

Key concepts from the lecture can serve as guides for solving problems on exams.
- Understanding how market equilibrium, competition, and pricing strategies function within economic models is critical.
Examples include utilizing supply and demand graphs to analyze consumer behavior and profit maximization strategies in competitive environments.
Homework and practice exercises reinforce comprehension of the relationships between competition, consumer surplus, and price elasticity, setting a solid foundation for future economic analysis.