SC ECON 221 - Oligopolies (4 pages)

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This lecture discusses the market concept of oligopolies. The lecture also covered specifics of oligopolies such as: game theory, profit maximization, and tacit collusion.

Lecture number:
Lecture Note
University Of South Carolina-Columbia
Econ 221 - Prin of Microeconomics
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ECON 221 Lecture 19 Outline of Last Lecture I Monopolistic Competition II Short Run effects III Long Run effects IV Efficiency and Implications Outline of Current Lecture I Oligopoly characteristics II Game theory a Strategic Interaction b Dominant Strategy III Maximizing Profits IV Tacit Collusion Current Lecture Oligopolies Lecture 20 Commonly there are just a few firms in an industry o Operating systems phone providers airplane manufacturers airlines o Lands somewhere between the two extremes of perfect competition and monopolies Perfect competition competition but no market power Monopoly complete market power no competition o What do we mean by market power PC because there are thousands of firms no matter how much one produces they have no impact on market level supply or price Monopoly only firm in the market so changes in quantity affect market level Q s and price These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute Oligopoly One of a handful of firms so many actions impact the market just as other firms actions impact the market Game Theory o Oligopolies engage in Strategic Interaction Strategic Interaction Any situation where my best action depends on what you are doing and vice versa Prisoner s dilemma Not strategic interaction How many donuts to buy how much to produce in a perfectly competitive market Game Theory is the study of strategic interaction o Terms and Ideas Strategy specifies a plan for what to do conditional on what the other guy is doing Ex Prisoner s dilemma best strategy is RAT OUT PARTNER when he rats me out and RAT OUT PARTNER when he stays quiet Dominant Strategy if one action is better regardless of what the other guy does it is a dominant strategy Nash Equilibrium a situation where no one has an incentive to change their strategy given what others are doing In P D the situation where both players play ALWAYS RAT OUT OTHER PLAYER strategy Equilibrium Outcome 5 5 John Nash won Nobel Peace Prize in Economics in 1994 o Another example Stag Hunt Game Only one best outcome Two equilibrium outcomes both rabbit or both stag Stag Rabbit Stag 5 5 0 3 Rabbit 3 0 3 3 Game Theory o Both games mentioned are one shot games they happen once and that s it Maximizing profits The problem o Remember how monopolies maximized profits Sold less than would be sold under perfect competition Why With complete control of the market lower quantity implied higher prices Like a monopolist large market power implies that increasing output decreases prices and therefore eventually decreases profit An oligopolist prefers less total output in the market Unlike a monopolist an oligopolist is not in total control of market output and therefore prices o If another firm increases output it decreases my revenue due to lower price so I suffer price effect but do not enjoy quantity effect o But if I respond by increasing my quantity price goes down even further Maximizing profits A potential Solution o The fact that there are few firms provides the opportunity to cooperate Not possible in PC or MC too many firms o Firms can agree to collude or form a cartel to act as though they are a monopolist limiting total output to the profit maximizing level o But will this work Ex Assume there are two firms and MC ATC 0 so both firms just care about maximizing revenue Revenue in the market is maximized when total output Q 1 Q2 is 60 So suppose the two firms agree to each produce 30 and share the profits TR 180 for each However eventually one firm will realize that it can produce more q 1 40 Q 70 and increase profit Drives price down to 5 Firm one revenue 5 x 40 200 Firm two revenue 5 x 30 150 Oligopoly profits and game theory o It seems that incentives make collusion impossible a self interested firm would never hold up their end of the agreement o Prisoner s dilemma parallel Tacit Collusion o This sort of repeated interaction can and does occur without any formal agreement firms simply monitor each other s behavior and punish each other if deviation occurs In summary o The analysis of oligopolies is very different than other market structures due to the possibility of strategic interaction o Cooperating to maintain a low output and therefore high price is useful to both producers but there is no incentive to maintain that arrangement in a one shot game o However when repeated cooperation can occur which is of course very good for the sellers and very bad for the buyers Perf Comp Monopoly Mono Comp Oligopoly of sellers Many One Large Number A few Identical Products Yes No close substitutes irrelevant No slight differentiation Maybe but not a defining characteristic Long run outcome for firms Zero profits firms enter shifting market supply up reducing price Positive profit Zero profit firms enter shifting firm demand down reducing price at Q Complicated Long run outcome for society Efficient Inefficient Deadweight loss Ambiguous Complicated

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