etp econ lecture chapter 16

8/22/2019 ETP Econ Lecture Chapter 16

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Oligopoly and Game Theory

ETP Economics 101


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Imperfect Competition

Imperfect competition refers to those marketstructures that fall between perfectcompetition and pure monopoly.

Imperfect competition includes industries inwhich firms have competitors but do notface so much competition that they are price

takers.


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Types

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 notidentical.


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Copyright 2004 South-Western

Tap waterCable TV

Monopoly(Chapter 15)NovelsMovies

MonopolisticCompetition(Chapter 17)

Tennis ballsCrude oil

Oligopoly(Chapter 16)

Number of Firms?

Perfect

Wheat Milk

Competition(Chapter 14)

Type of Products?

IdenticalproductsDifferentiatedproductsOnefirm Fewfirms

Manyfirms


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Key Feature

Because of the few sellers, the key featureof oligopoly is the tension betweencooperation and self-interest.


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Characteristics

Characteristics of an Oligopoly Market

Few sellers offering similar or identical products

Interdependent firms

Best off cooperating and acting like amonopolist by producing a small quantity ofoutput and charging a price above marginal cost


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Simple Type: Duopoly

A duopoly is an oligopoly with only twomembers. It is the simplest type of oligopoly.


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Collusion and Cartel

The duopolists may agree on a monopolyoutcome.

Collusion

An agreement among firms in a market aboutquantities to produce or prices to charge.

Cartel

A group of firms acting in unison.


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Is Cartel Possible?

Although oligopolists would like to formcartels and earn monopoly profits, often thatis not possible. Antitrust laws prohibit

explicit agreements among oligopolists as amatter of public policy.


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The Equilibrium for an Oligopoly

A Nash equilibrium is a situation in whicheconomic actors interacting with oneanother each choose their best strategy

given the strategies that all the others havechosen.


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The equilibrium for an Oligopoly

When firms in an oligopoly individually chooseproduction to maximize profit, they producequantity of output greater than the level produced

by monopoly and less than the level produced bycompetition.

The oligopoly price is less than the monopoly pricebut greater than the competitive price (which

equals marginal cost).


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Size of an Oligopoly

How increasing the number of sellers affectsthe price and quantity:The output effect: Because price is above

marginal cost, selling more at the going priceraises profits.

The price effect: Raising production willincrease the amount sold, which will lower the

price and the profit per unit on all units sold.


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Size of an Oligopoly

As the number of sellers in an oligopolygrows larger, an oligopolistic market looksmore and more like a competitive market.

The price approaches marginal cost, andthe quantity produced approaches thesocially efficient level.


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Strategic Action

Because the number of firms in anoligopolistic market is small, each firm mustact strategically.

Each firm knows that its profit depends notonly on how much it produces but also onhow much the other firms produce.


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Game Theory

Game theoryis the study of how peoplebehave in strategic situations.

Strategic decisions are those in which eachperson, in deciding what actions to take,must consider how others might respond tothat action.


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Prisoners Dilemma

Theprisoners dilemma provides insight into thedifficulty in maintaining cooperation.

Often people (firms) fail to cooperate with one

another even when cooperation would makethem better off.

The prisoners dilemma is a particulargamebetween two captured prisoners that illustrateswhy cooperation is difficult to maintain even whenit is mutually beneficial.


17/38Copyright2003 Southwestern/Thomson Learning

Bonnie s Decision

Confess

ConfessBonnie gets 8 years

Clyde gets 8 years

Bonnie gets 20 years

Clyde goes freeBonnie goes free

Clyde gets 20 years

gets 1 yearBonnie

Clyde gets 1 year

Remain Silent

RemainSilent

ClydesDecision


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Dominant Strategy

The dominant strategyis the best strategy for aplayer to follow regardless of the strategieschosen by the other players.

Dominant strategies in Prisoners dilemma:

_ Clyde: Confess

_ Bonnie: Confess


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Nash Equilibrium & BestOutcome

Nash Equilibrium (self-interest):

_ Clyde: Confess & Bonnie: Confess

Best Outcome (cooperation):

_ Clyde: Silent & Bonnie: Silent

Cooperation is difficult to maintain, becausecooperation is not in the best interest of theindividual player.


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Game Example: OPEC

Iraq and Iran: Members of OPEC

Their decisions on oil production.

Decisions: High Production or LowProduction



Iraqs Decision

HighProduction

High ProductionIraq gets $40 billion

Iran gets $40 billion

Iraq gets $30 billion

Iran gets $60 billionIraq gets $60 billion


Iraq gets $50 billion


Low Production

LowProduction

IransDecision


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Nash Equilibrium

Dominant strategies:_ Iran: High Production_ Iraq: High Production

Nash Equilibrium (self-interest):_ Iran: High Production & Iraq: High Production

Best Outcome (cooperation):_ Iran: low production & Iraq: low production


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Game Example: Arm Race

Game Players: USA & Russia

Decisions: Arm or Disarm



Decision of the United States (U.S.)

Arm

ArmU.S. at risk

USSR at risk

U.S. at risk and weak

USSR safe and powerfulU.S. safe and powerful

USSR at risk and weak

U.S. safe

USSR safe

Disarm

Disarm

Decision

of the

Soviet Union

(USSR)


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Nash Equilibrium

Dominant strategies:_ USA: Arm_ Russia: Arm

Nash Equilibrium (self-interest):_ USA: Arm & Russia: Arm

Best Outcome (cooperation):_ USA: Disarm & Russia: Disarm


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Game Example: Advertising

Players: Camel & Marlboro

Decisions: Advertise or Dont advertise



Marlboro s Decision

Advertise

AdvertiseMarlboro gets $3

billion profitCamel gets $3billion profit Camel gets $5billion profit

Marlboro gets $2billion profit

Camel gets $2billion profit


Camel gets $4billion profit


Dont Advertise

DontAdvertise

CamelsDecision


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Nash Equilibrium

Dominant strategies:_ Camel: Advertise_ Marlboro: Advertise

Nash Equilibrium (self-interest):_ Camel: Advertise_ Marlboro: Advertise

Best Outcome (cooperation):_ Camel: Dont Advertise_ Marlboro: Dont Advertise


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Game Example: CommonResource such as Oil

Players: Texaco & Exxon

Decisions: Drill Two Wells or Drill one Well


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Copyright2003 Southwestern/Thomson Learning

Exxons Decision

Drill TwoWells

Drill Two WellsExxon gets $4

million profit

Texaco gets $4million profit Texaco gets $6million profit

Exxon gets $3million profit

Texaco gets $3million profit


Texaco gets $5million profit


Drill One Well

Drill OneWell

TexacosDecision


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Nash Equilibrium

Dominant strategies:_ Texaco: Drill Two Wells_ Exxon: Drill Two Wells

Nash Equilibrium (self-interest):_Texaco: Drill Two Wells_ Exxon: Drill Two Wells

Best Outcome (cooperation):_ Texaco: Drill One Well_ Exxon: Drill One Well


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Game Example: Where toAdvertise?

Players: Competitor.com or We.com

Decisions: NBA and NHL


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No Nash equilibrium in pure strategies

Competitor.com

NBA NHL

NBA W: 4,C: 3

W: 3,C: 4

We.comNHL W: 3,

C: 4

W: 4,

C: 3

Where to advertise?


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No Nash Equilibrium

Dominant strategies:_ We.com: none_ Competitor.com: none

Nash Equilibrium (self-interest):_ We.com: none_ Competitor.com: none


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Game Example: Evening News

Players: ATV and TVB

Decisions: 7:30 pm or 8:00 pm


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Evening News:

TVB

7:30pm 8:0pm

7:30pm A: 1,

B: 1

A: 3,

B: 4

ATV 8:0pm A: 4,B: 3

A: 2.5,B: 2.5


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Nash Equilibrium

Dominant strategies:_ ATV: none_ TVB: none

Two Nash Equilibria (self-interest):

_ ATV: 7:30pm & TVB: 8:00pmor

_ ATV: 8:00pm & TVB: 7:30pm

Wh P l S ti


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Why People SometimesCooperate

Firms that care about future profits willcooperate in repeated games rather thancheating in a single game to achieve a one-

time gain.

etp econ lecture chapter 16

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