Principles of Microeconomics: Chapter 17Oligopoly: a market structure in which only a few sellers offer similar or identical productsAs a result of oligopoly, the actions of any one seller in the market can have a large impact on the profits of all the other sellers. They are interdependent. Game theory: the study of the behavior of people in strategic situations (predicting how others will act)Issue in oligopoly: tension between cooperation and self-interest. Oligopolists are best off when they cooperate and act like a monopolist (small q of output, price above marginal cost).Competition, Monopolies, and CartelsCollusion: an agreement among firms in a market about quantities toproduce or prices to charge. ^group of firms acting in collusion is a cartel. Once a cartel is formed,the market is in effect served by a monopoly. A cartel must agree on the total level of production and the amount produced by each member. Equilibrium for OligopolyIf members individually pursue their own self-interest when deciding how much to produce, they produce a total quantity greater than monopoly quantity, charge a price lower than monopoly price, and earn total profit less than monopoly profit. ^outcome is called Nash Equilibrium: a situation in which economic actors interacting with one another each choose their best strategies given the strategies that all the other actors have chosen.Because they pursue they own self-interest, they do not end up reaching the monopoly outcome and maximizing joint profit. Each oligopolist is tempted to raise production and capture a larger share of the market. As each of them tries to do this, total production rises and price falls. When firms in an oligopoly individually choose production to maximize profit, they produce a quantity of output greater than the level produced by monopoly and less than the level produced by competition. The oligopoly price is less than the monopoly price but greater than competitive price (which = marginal cost)As the size of a cartel increases, reaching and enforcing an agreement becomes more difficult. But if the oligopolists do not form a cartel, they must decide on their own how much to produce. At any time, each producer has the optionto raise production by one unit.2 effects:The output effect: because price is above marginal cost, selling one more unit at the going price will raise profit. The price effect: raising production will increase the total amount sold, which will lower the price of the good and lower the profit on all other units sold. If the output effect is larger than the price effect, the owner will increase production. If the price effect is larger than the output effect, the owner will not increase production. ^As the oligopoly grows in size, the magnitude of the price effect falls.The production decision of an individual firm no longer affects the market price. A large oligopoly is essentially a group of competitive firms, because competitive firms consider only the output effect when deciding how much to produce. As the # of sellers in an oligopoly grows larger, an oligopolistic marketlooks more and more like a competitive market; price approaches marginal cost, and the quantity produced approaches the socially efficient level. Prisoner's Dilemma (PD)Prisoners' dilemma: a game between two captured prisoners that illustrates why cooperation is difficult to maintain even when it ismutually beneficialDominant strategy: a strategy that is best for a player in a game regardless of the strategies chosen by other players. In PD, the players do not know what the other players will do, so they make the dominant strategy that is in their self-interest, but actually makes everyone worse off. Oligopolies as a PDIt is difficult to cooperate, even when oligopolies make agreements in advance. Sometimes producing more will lead to higher profits for an individual firm (as a dominant strategy); others might see this and do the same thing, leading to overall low profits for players involved. PD and Society's WelfareLack of cooperation a detriment to all players, sometimes society. This depends on the market/game…if it's an arms race it sucks for society. If it's a simple consumer good, the price will be driven down to maximize total surplus. SOMETIMES PEOPLE CAN COOPERATE (especially when players play the game multiple times).^can institute penalties, players concerned about future profits, etc. Public Policy toward Oligopolies:Policymakers try to induce oligopolies towards competitive, not cooperation. Policy discourages cooperation through the common law. E.g. Sherman Antitrust Law 1890, Clayton Act 1914.Most people agree that price-fixing agreements among competing firms should be illegal. But, some practice that seem anticompetitive are legitimate business practices (resale price maintenance, predatory pricing (slashing prices), tying (bundling goods at one
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