Oligopoly is a market served by a few firms.
Game theory is the study of decision-making in strategic situations.
Concentration ratios are the percentage of the market output produced by the largest firms.
Duopoly is a market with two firms.
We’ll use a duopoly to explain the key features of an oligopoly.
Consider a duopoly in the market for air travel between two hypothetical cities.
The two airlines can use prices to compete for customers, or they can cooperate and conspire to raise prices.
Let’s assume that the average cost of providing air travel is constant, which means that marginal cost equals average cost.
A cartel is a group of firms that act in unison, coordinating their price and quantity decisions.
Price fixing is an agreement in which forms conspire to fix prices.
A game tree is a graphical representation of the consequences of different actions in a strategic setting.
A dominant strategy is an action that is best chosen for a player, no matter what the other player does.
A duopolists’ dilemma is a situation in which both firms in a key would be better off if both chose the high price, but each chooses the low price.
The Nash equilibrium is an outcome of. Game in which each player is doing the best he or she can, given the action of the other player.
The duopolists' dilemma occurs because the two firms are unable to coordinate their pricing decisions and act as one.
Firms can avoid the dilemma by low-price guarantees and repetition of the pricing game, with retaliation for underpricing.
The low-price guarantee eliminates the possibility of underpricing, so it eliminates the duopolists’ dilemma and promotes cartel pricing.
Although consumers might think that a low-price guarantee will protect them from high prices, it means they are more likely to pay the high price.
A grim-trigger strategy is a strategy where a firm responds to underpricing by choosing a price so low that each firm makes zero economic profit.
A tit-for-tat strategy is a strategy where one firm chooses whatever price the other firm chose in the preceding period.
Price leadership is a system under which one firm in an oligopoly takes lead in setting prices.
When one firm suddenly drops its price, the other firm could intercept the price cut in one of two ways:
A change in market conditions. Perhaps the first firm observed a change in demand or production cost and decided that both forms would benefit from a lower price.
Underpricing. Perhaps the first firm is trying to increase its market share and profit at the expense of the second firm.