OLIGOPOLY

Chapter 16
 The Spectrum of Market
Structures
Number of Firms?

Many Firms
Type of Product?
One Few
Firm Firms
Differentiated Identical

Monopolistic Perfect
Monopoly Oligopoly
Competition Competition
 Tap water  Tennis balls  Novels  Wheat
 Cable TV  Crude oil  Movies  Milk
Imperfect Competition

• Market structures that fall between

perfect competition and pure monopoly.
• Industries in which firms have
competitors but do not face so much
competition that they are price takers.
Types of Imperfectly
Competitive Markets
• Oligopoly
 Only a few sellers, each offering a similar
or identical product to the others.
• Monopolistic Competition
 Many firms selling products that are
similar but not identical.
 Characteristics of an Oligopoly
Market
• Few sellers offering similar or identical
products
• Interdependent firms
• Best off cooperating and acting like a
monopolist by producing a small quantity of
output and charging a price above marginal
cost
Because of the few sellers, the actions of any one
seller in the market can have a large impact on
the profits of all the other seller
Duopoly Example

• A duopoly is an oligopoly with only two

members. It is the simplest type of
oligopoly.
• Oligopolies pay attentions to rival firms
behaviour
• Each firm can influence the price, and
hence affect rival firms.
Outcome from Duopoly \
Oligopoly
• They may agree on a monopoly
outcome.
 Collusion
 The two firms may agree on the quantity
to produce and the price to charge.
 Cartel
 The two firms may join together and act
in unison.
Nash Equilibrium

• Nash equilibrium is a situation in which

economic actors interacting with one
another each choose their best strategy
given the strategies that all the others
have chosen.
Game Theory and the
Economics of Cooperation
• Game theory is the study of how people behave
in strategic situations.
• Strategic decisions are those in which each
person (firm) in deciding what actions to take,
must consider how others (firms) might
respond to that action.
• Because the number of firms in an oligopolistic
market is small, each firm must act
strategically.
Game Theory and the
Prisoners’ Dilemma
• The prisoners’ dilemma illustrates the
difficulty in maintaining cooperation.
 Often people (firms) fail to cooperate
with one another even when cooperation
would make them better off.
The Prisoners’ Dilemma
• The dominant strategy is the best strategy for a
player to follow regardless of the strategies
pursued by other players.
• Cooperation is difficult to maintain, because
cooperation is not in the best interest of the
individual player.
• Self-interest makes it difficult for the oligopoly
to maintain a cooperative outcome with low
production, high prices, and monopoly profits.
• The monopoly outcome is jointly rational for
the oligopoly, but each oligopolist has an
incentive to cheat.
Example of the Prisoners’
Dilemma
Prisoner A’s Decision
Prisoner B’s Decision
Confess Confess Deny

3 years each A gets 6 years

B gets 2 years

A gets 2 years 1 year each

Deny

B gets 6 years
Other Examples of the
Prisoners’ Dilemma
U.S.’ Decision
Arm Disarm
USSR’s Decision
Arm

U.S. at risk and weak

Both countries
USSR safe and
at risk
powerful

U.S. safe and

Disarm

powerful Both countries

USSR at risk and safe
weak
Other Examples of the
Prisoners’ Dilemma
Marlboro’s Decision
Advertise Don’t Advertise
Camel’s Decision
Advertise

Marlboro gets £2
£3 billion profit
billion profit
for each
Camel gets £5 billion
profit
Advertise

Marlboro gets £5
billion profit £4 billion profit
Don’t

Camel gets £2 billion for each

profit
Why People Sometimes
Cooperate
• Firms in oligopolies have a strong
incentive to collude in order to reduce
production, raise prices, and increase
profits.
• Firms that care about future profits will
cooperate in repeated games rather than
cheating in a single game to achieve a
one-time gain.
Public Policy Toward
Oligopolies
• Cooperation among oligopolists is
undesirable.
 It leads to production that is too low.
 It leads to prices that are too high.