Oligopoly

• Oligopoly


  • Few large producers
  • Homogeneous or differentiated product
  • Control over price, but Mutual Interdependence
  • Entry Barriers
  • Mergers
• Game theory


  • Basic elements: players, available strategies, payoff to each player for each possible action
  • Dominant strategy: yields higher payoff no matter what the other player does
  • Dominated strategy: any other strategy available to a player who has a dominant strategy
• Oligopoly scenario


  • American and United Airlines
  • Jasper and Horace (prisoner's dilemma)
• Nash equilibrium


  Any combination of strategies in which each player's strategy is their best choice, given the other player's strategies
• Prisoner's dilemma


  Has a dominant strategy, but the resulting payoffs are smaller than if each had stayed silent
• Oligopolies display strategic pricing behavior, mutual interdependence, and depend on own strategy and rival's strategy
• Collusion can benefit the firm, but there is an incentive to cheat which can result in more revenues for the cheater
• Kinked-demand theory


  • Assumptions: Match price reduction, Ignore price increase
  • Demand is elastic above the kink, inelastic below the kink
  • Equilibrium occurs when marginal cost intersects the marginal revenue at the kink point
• Price rigidity


  Explains the behaviour of an oligopoly firm which has no incentive to either increase or decrease the price of its products
• Cartels


  • Illegal group of firms acting together to limit output, raise price, and increase profit
  • Conditions for successful cartels: Small number of sellers, Similar cost conditions, Minimal product differentiation, High barriers to entry
  • Weaknesses: Cheating on the agreement, Recession, New entrants, Legal obstacles
• Price leadership model


  • Dominant firm initiates price changes, Other firms follow the leader
  • Tactics: Infrequent price changes, Possible price war, Communication, Use limit pricing to block entry of new firms
• Oligopolies are inefficient: Productively inefficient (P > min ATC), Allocatively inefficient (P > MC)
• Qualifications: Increased foreign competition, Limit pricing, Technological advance