4 Chapter

• An oligopoly is an industry with small numbers of sellers.

• Entry is often limited by legal restrictions (e.g. banking in most of the world).

• In an oligopoly

  • firms know that there are only a few large competitors;

  • competitors take account of the effects of their actions on the overall market.

  • interdependence among firms

• Duopoly – only two firms that control the market

• The Game theory - the study of the behavior of rational agents (players) in settings for which each agent’s best action depends upon what other agents are expected to do.

• The strategic form of a game describes an economic setting by three elements:

1) A list of agents who are making decisions

2) A list of the possible decisions that each agent can make

3) A description of the way in which each agent evaluates different possible outcomes.

• A strategy – the decision rule of a player, tells a player how to behave

• A player’s payoff function describes the player’s state of well-being from players having played strategies

• Rate of advertising, a format – player’s strategy; payoff - profit

• If each player has chosen a strategy and no player can benefit by changing his or her strategy while the other players keep theirs unchanged, then the current set of strategy choices and the corresponding payoffs constitute a Nash equilibrium.

• Each strategy in a Nash equilibrium is a best response to all other strategies in that equilibrium

• An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists).

• Interdependence among firms

• Basic Oligopoly Models:

1. Competition in quantities: Cournot Model

2. Competition in prices: Bertrand Model

3. Stackelberg leadership Model

4. Collusive oligopoly

• Bertrand competition is a model of price competition in oligopolistic markets used in economics, named after Joseph Louis François Bertrand (1822-1900).

It describes interactions among firms (sellers) that set prices and their customers (buyers) that choose quantities at that price --- MC=P like in competitive markets

• The Stackelberg leadership model is a strategic game in economics in which the leader firm moves first and then the follower firms move sequentially.

• In game theory terms, the players of this game are a leader and a follower and they compete on quantity.

• Firms may engage in Stackelberg competition if one has some sort of advantage enabling it to move first. More generally, the leader must have commitment power. Moving observably first is the most obvious means of commitment: once the leader has made its move, it cannot undo it - it is committed to that action. Moving first may be possible if the leader was the incumbent monopoly of the industry and the follower is a new entrant.

• Cartel is a group of producers that typically creates a formal written agreement specifying how much each member will produce and charge

• If oligopolies can limit the entry of other firms and form a cartel, they can increase the profits going to the firms in the cartel

• Coordination of price and quantity levels

• Imperfect monitoring

• Cheating problem

• Potential entry

• Price leadership – the price leader (might be the largest or lowest-cost firm) openly announces its intention to change its price, and the other firms normally follow with similar price changes.

• Markup pricing – all firms in an industry become accustomed to calculating prices with the same formula, then pricing changes that reflect industry-wide cost changes are more likely to be understood and accepted

• A basing point system of pricing – used in some industries where freight costs are relatively large and consumers are located at various distances from producers.

The Herfindahl Index can be close to zero if there are many, very small firms in an industry.

• A market is considered concentrated if H > 1800.

• A market is considered unconcentrated if H < 1000.