Slide 1C H A P T E R C H E C K L I S T16.1 WHAT IS OLIGOPOLY?Slide 4Slide 5Slide 6Slide 7Slide 8Slide 10Slide 1216.2 RANGE OF OLIGOPOLY OUTCOMESSlide 14Slide 16Slide 17Slide 19Slide 21Slide 23Slide 2516.3 GAME THEORYSlide 27Slide 28Slide 29Slide 30Slide 31Slide 32Slide 34Slide 35Slide 36Slide 37Slide 38Slide 40Slide 42Slide 43Slide 44Slide 46Slide 48Slide 49When you have completed your study of this chapter, you will be able toC H A P T E R C H E C K L I S TDescribe and identify oligopoly and explain how it arises.1Explain the range of possible price and quantity outcomes and describe the dilemma faced by firms in oligopoly.2Use game theory to explain how price and output are determined in oligopoly.316.1 WHAT IS OLIGOPOLY?Another market type that stands between perfect competition and monopoly.Oligopoly is a market type in which:•A small number of firms compete.•Natural or legal barriers prevent the entry of new firms.16.1 WHAT IS OLIGOPOLY?Small Number of FirmsIn contrast to monopolistic competition and perfect competition, an oligopoly consists of a small number of firms.•Each firm has a large market share•The firms are interdependent•The firms have an incentive to collude16.1 WHAT IS OLIGOPOLY?InterdependenceWhen a small number of firms compete in a market, they are interdependent in the sense that the profit earned by each firm depends on the firms own actions and on the actions of the other firms.Before making a decision, each firm must consider how the other firms will react to its decision and influence its profit.16.1 WHAT IS OLIGOPOLY?Temptation to ColludeWhen a small number of firms share a market, they can increase their profit by forming a cartel and acting like a monopoly.A cartel is a group of firms acting together to limit output, raise price, and increase economic profit.Cartels are illegal but they do operate in some markets.Despite the temptation to collude, cartels tend to collapse. (We explain why in the final section.)16.1 WHAT IS OLIGOPOLY?Barriers to EntryEither natural or legal barriers to entry can create an oligopoly.Natural barriers arise from the combination of the demand for a product and economies of scale in producing it.If the demand for a product limits to a small number the firms that can earn an economic profit, there is a natural oligopoly.16.1 WHAT IS OLIGOPOLY?Figure 16.1(a) shows the case of a natural duopoly.A duopoly is a market with two firms.Here, where price equals minimum ATC, the lowest possible price, two firms can produce the quantity demanded in the market.16.1 WHAT IS OLIGOPOLY?Figure 16.1(b) shows the case of a natural oligopoly with three firms.Here, where price equals minimum ATC, the lowest possible price, three firms can produce the quantity demanded in the market.16.1 WHAT IS OLIGOPOLY?Identifying OligopolyIdentifying oligopoly is the flip side of identifying monopolistic competition.The borderline between oligopoly and monopolistic competition is hard to pin down.As a practical matter, we try to identify oligopoly by looking at concentration measures.An HHI that exceeds 1,800 is generally regarded as an oligopoly.16.2 RANGE OF OLIGOPOLY OUTCOMESCompetitive OutcomePrice equals marginal cost.Monopoly OutcomeThe firm would be a single-price monopoly.Possible Oligopoly OutcomesThe extremes of perfect competition and monopoly provide the maximum range within which the oligopoly outcome might lie.16.2 RANGE OF OLIGOPOLY OUTCOMES16.2 RANGE OF OLIGOPOLY OUTCOMESCollusion Versus CompetitionBy limiting production to the monopoly quantity, the firms can maximize joint profits.By increasing production, one firm might be able to make an even larger profit and force a smaller profit on to the other firm.16.2 RANGE OF OLIGOPOLY OUTCOMESJoint profits can be $72 million if the firms produce the monopoly output.16.2 RANGE OF OLIGOPOLY OUTCOMESBoeing can increase its economic profit by $4 million and cause the economic profit of Airbus to fall by $6 million.Boeing Increases Output to 4 Airplanes a Week16.2 RANGE OF OLIGOPOLY OUTCOMESAirbus Increases Output to 4 Airplanes a WeekFor Airbus this outcome is an improvement on the previous one by $2 million a week.For Boeing, the outcome is worse than the previous one by $8 million a week.16.2 RANGE OF OLIGOPOLY OUTCOMESBoeing Increases Output to 5 Airplanes a WeekIf Boeing Increases output to 5 Airplanes a week, its economic profit falls.Similarly, if Airbus Increases output to 5 Airplanes a week, its economic profit falls.16.2 RANGE OF OLIGOPOLY OUTCOMESA dilemma:•If both firms stick to the monopoly output, they both produce 3 airplanes and make $36 million.•If they both increase production to 4 airplanes a week, they both make $32 million.•If only one increases production to 4 airplanes a week, that firm makes $40 million.•What do they do?•Game theory provides an answer.16.3 GAME THEORYGame theoryThe tool used to analyze strategic behavior—behavior that recognizes mutual interdependence and takes account of the expected behavior of others.16.3 GAME THEORYWhat Is a Game?All games involve three features:•Rules•Strategies•PayoffsPrisoners’ dilemmaA game between two prisoners that shows why it is hard to cooperate, even when it would be beneficial to both players to do so.16.3 GAME THEORYThe Prisoners’ DilemmaArt and Bob been caught stealing a car: sentence is 2 years in jail.DA wants to convict them of a big bank robbery: sentence is 10 years in jail.DA has no evidence and to get the conviction, he makes the prisoners play a game.16.3 GAME THEORYRulesPlayers cannot communicate with one another.•If both confess to the larger crime, each will receive a sentence of 3 years for both crimes.•If one confesses and the accomplice does not, the one who confesses will receive a sentence of 1 year, while the accomplice receives a 10-year sentence.•If neither confesses, both receive a 2-year sentence.16.3 GAME THEORYStrategiesThe strategies of a game are all the possible outcomes of each player.The strategies in the prisoners’ dilemma are:•Confess to the bank robbery•Deny the bank robbery16.3 GAME THEORYPayoffsFour outcomes:•Both confess.•Both deny.•Art confesses and Bob denies.•Bob confesses and Art denies.A payoff matrix is a table that shows the payoffs for every possible action by each player given every possible action by the other player.16.3 GAME THEORYTable 16.5 shows the prisoners’ dilemma payoff matrix for Art and Bob.16.3