Oligopoly - Game Theory

• Oligopoly

  A market structure with a small number of firms that are interdependent
• Game theory

  A framework for analysing the strategic interactions between interdependent firms
• Game theory

  Can give more nuanced and detailed conclusions than the kinked demand curve model
• Prisoner's dilemma


  A game theory model where two players have an incentive to defect from cooperation, even though cooperation would provide a better outcome for both
• Applying the prisoner's dilemma to oligopoly

  1. Identify the pricing decisions and payoffs for the firms

  2. Determine the dominant strategy for each firm

  3. Identify the Nash equilibrium

  4. Analyse the implications for price rigidity and non-price competition
• The Nash equilibrium in the prisoner's dilemma for oligopoly is where both firms charge the low price
• The Nash equilibrium is not the best outcome for the firms combined, as they could earn higher profits by colluding and charging the high price
• Collusion

  Provides an incentive for firms to cheat and undercut the agreed price
• Competition authorities may detect and punish collusion, providing an additional incentive for firms to cheat
• Oligopoly behaviour is complex and can go in many different directions, requiring further analysis