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UB ECO 182 - Chapter 15

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Slide 1After studying this chapter, you will be able to:Slide 3What Is Oligopoly?What Is Oligopoly?What Is Oligopoly?What Is Oligopoly?Oligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesSlide 13Oligopoly GamesSlide 15Slide 16Slide 17Slide 18Slide 19Oligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesOligopoly GamesSlide 40Slide 41Slide 42Slide 43Slide 44Slide 45Oligopoly GamesOligopoly GamesSlide 48Slide 49Slide 50Slide 51Slide 52Slide 53Oligopoly GamesSlide 55Slide 56Slide 57Slide 58Slide 59Oligopoly GamesRepeated Games and Sequential GamesRepeated Games and Sequential GamesRepeated Games and Sequential GamesRepeated Games and Sequential GamesRepeated Games and Sequential GamesRepeated Games and Sequential GamesRepeated Games and Sequential GamesRepeated Games and Sequential GamesRepeated Games and Sequential GamesAntitrust LawAntitrust LawAntitrust LawAntitrust LawAntitrust LawAntitrust LawAntitrust LawAntitrust LawAntitrust LawAntitrust LawAntitrust Law15OLIGOPOLY© 2014 Pearson Addison-WesleyAfter studying this chapter, you will be able to:¨Define and identify oligopoly¨Use game theory to explain how price and output are determined in oligopoly¨Use game theory to explain other strategic decisions¨Describe the antitrust laws that regulate oligopoly© 2014 Pearson Addison-WesleyThe chip in your laptop was made by Intel or AMD; the battery in your TV remote by Duracell or Energizer; andthe airplane that takes you on a long-distance trip was made by Boeing or the European firm Airbus. In the markets for computer chips, batteries, and big airplanes, two producers compete for market share in the pursuit of maximum profit.How does a market work when only two firms compete?The models of perfect competition and monopoly don’t predict the behavior of the firms we’ve just described.To understand how these markets work, we use the model of oligopoly.© 2014 Pearson Addison-WesleyWhat Is Oligopoly?Oligopoly is a market structure in whichNatural or legal barriers prevent the entry of new firms.A small number of firms compete.© 2014 Pearson Addison-WesleyWhat Is Oligopoly?Barriers to EntryEither natural or legal barriers to entry can create oligopoly.Figure 15.1 shows two oligopoly situations.In part (a), there is a natural duopoly—a market with two firms.© 2014 Pearson Addison-WesleyWhat Is Oligopoly?In part (b), there is a natural oligopoly market with three firms.A legal oligopoly might arise even where the demand and costs leave room for a larger number of firms.© 2014 Pearson Addison-WesleyWhat Is Oligopoly?Small Number of FirmsBecause an oligopoly market has only a few firms, they are interdependent and face a temptation to cooperate.Interdependence: With a small number of firms, each firm’s profit depends on every firm’s actions.Temptation to Cooperate: Firms in oligopoly face the temptation to form a cartel. A cartel is a group of firms acting together to limit output, raise price, and increase profit. Cartels are illegal.© 2014 Pearson Addison-WesleyOligopoly GamesGame theory is a tool for studying strategic behavior, which is behavior that takes into account the expected behavior of others and the mutual recognition of interdependence. All games have four common features:Rules Strategies PayoffsOutcome© 2014 Pearson Addison-WesleyOligopoly GamesThe Prisoners’ DilemmaIn the prisoners’ dilemma game, two prisoners (Art and Bob) have been caught committing a petty crime.RulesThe rules describe the setting of the game, the actions the players may take, and the consequences of those actions. Each is held in a separate cell and cannot communicate with the other.© 2014 Pearson Addison-WesleyOligopoly GamesEach is told that both are suspected of committing a more serious crime.If one of them confesses, he will get a 1-year sentence for cooperating while his accomplice will get a 10-year sentence for both crimes.If both confess to the more serious crime, each receives 3 years in jail for both crimes.If neither confesses, each receives a 2-year sentence for the minor crime only.© 2014 Pearson Addison-WesleyOligopoly GamesStrategiesStrategies are all the possible actions of each player. Art and Bob each have two possible actions:1. Confess to the larger crime.2. Deny having committed the larger crime.With two players and two actions for each player, there are four possible outcomes:1. Both confess.2. Both deny. 3. Art confesses and Bob denies.4. Bob confesses and Art denies.© 2014 Pearson Addison-WesleyOligopoly GamesPayoffsEach prisoner can work out what happens to him—can work out his payoff—in each of the four possible outcomes.We can tabulate these outcomes in a payoff matrix.A payoff matrix is a table that shows the payoffs for every possible action by each player for every possible action by the other player.The next slide shows the payoff matrix for this prisoners’ dilemma game.© 2014 Pearson Addison-WesleyArt’s payoff from each combination of actions is shown in the top of each payoff box, and Bob’s is shown as the bottom of each payoff box. Note that there are four possible outcomes: Bob and Art both confess (top left box), both Bob and Art deny (bottom right box), Bob confesses but Art does not (top right box), and Art confesses but Bob does not (bottom left box).© 2014 Pearson Addison-WesleyOligopoly GamesOutcomeIf a player makes a rational choice in pursuit of his own best interest, he chooses the action that is best for him, given any action taken by the other player.If both players are rational and choose their actions in this way, the outcome is an equilibrium called a Nash equilibrium—first proposed by John Nash.Finding the Nash EquilibriumThe following slides show how to find the Nash equilibrium.Bob’s view of the worldBob’s view of the worldArt’s view of the worldArt’s view of the worldEquilibriumDominant strategy equilibrium.This outcome is not the best one. If the players could have cooperated (communicated and committed) they would have chosen to deny and each get 2 years.© 2014 Pearson Addison-WesleyOligopoly GamesThe DilemmaThe dilemma arises as each prisoner contemplates the consequences of his decision and puts himself in the place of his


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