Chapter+16-+Oligopoly





Oligopoly is a market structure in which only a few sellers offer similar of identical products. Oligopoly's main goal is to become a monopoly, which is illegal. We will discuss the information further in this chapter.

**Words to keep in mind:** 


 * Oligopoly** - A market structure in which only a few sellers offer similar or identical products.
 * Monopolistic Competition** - A market structure in which many firms sell product that are similar but not identical.
 * Cartel** - A group of firms acting in union.
 * Collusion** - An agreement among firms in a market about quantities to produce or prices to charge.
 * Dominant Strategy** - A strategy that is best for a player in a game regardless of the strategies chosen by the other players.
 * Game Theory** - The study of how people behave in strategic situations.
 * Nash Equilibrium** - A situation in which economic participants interacting with one another each choose their best strategy given the strategies that all the others have chosen.
 * Prisoner's Dilemma** - A particular "game" between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial 

**BETWEEN MONOPOLY AND PERFECT COMPETITION **

- An economist measures the market's domination by few firms using the concentration ratio. - The **//concentration ratio//** is measured by the percentage of total output in the market supplied by the four largest firms.

- Describes the market structure: many firms selling similar products, however not identical. - Each firm has a monopoly in the product it products, however, other firms compete for the same customers.
 * Monopolistic Competition**

- A monopoly has only one firm.
 * Monopoly**

- There are only few firms. - Due to the existence of only few firms, the tension between these firms increases. - The main goal of an oligopoly is to become a monopoly because they are better off that way. - Production of small quantities of products & Price higher than marginal cost. - //Duopoly// is an oligopoly with only two major firms. - This is the simplest form of oligopoly. - Self-interest increases the duopoly's output above the monopoly level. - Thus, does not make them reach the competitive allocation. - Oligopolists know that an increase in the amount they produce, price will decrease. - They purposely create shortage in order to produce where price equals marginal cost.
 * Oligopoly**

//Why do oligopolies want to become a monopoly?// - When they form a cartel, it produces the maximum total profit for the firms.

Since an oligopoly's main goal was to become a monopoly, in order to do that we need to learn two terms. **Collusion** and **Cartel**. - A **collusion** is when there is an agreement among firms in a market about quantities to produce or prices to charge. - A **cartel** is when a group of oligopoly firms acts as a union. - A cartel, in order to succeed must agree on the total level of production and the amount produced by each member.

//Why are oligopolies unable to form a cartel in a real economy?// 1. Antitrust laws prohibits the oligopolies from forming cartels. 2. Most of the times, it is impossible to agree upon how to divide the profits.

**EQUILIBRIUM FOR AN OLIGOPOLY**  - **Nash Equilibrium** is when the economic participants interact with one another to choose their best strategy (must consider the strategy of others). - Self-interest is not the one that drives the market to form competitive outcome.

- When making the decision of how many to produce there are two effects. 1. //Output Effect//: Since price is above marginal cost, selling 1 more gallon of a product will raise the profit at the same price. 2. //Price Effect//: Increase in production will increase the total amount sold. This decreases the price as well as the profit.
 * Size of an Oligopoly**

**GAME THEORY AND THE ECONOMICS OF COOPERATION**  - Game theory is the study of how people behave in strategic situations. - Strategic meaning when one is making a decision must consider the response of another. - We consider the response of another because: - Profit depends on how much it produces. - How much the other firms produce. - When a firm is trying to make a decision, one should consider how the decision they make will affect the decisions of production of other firms. - In a competitive market, the strategic interactions are not important. - In a monopolistic market, strategic interactions does not exist since there is only one firm.

**PRISONER'S DILEMMA:**  - This is a game that deals with prisoners confessing. - This game illustrates why cooperation is difficult to maintain although when it is mutually beneficial. - It applies to any group that tries to maintain cooperation among its members.

- The prisoner's dilemma is a story about two criminals who have been captured by the police:

 There are different years of punishments that they will have to take, depending on whether they confess or not. Here is a list of the different ways:

1. Prisoner B: Confess, Prisoner A: Confess - They both go to jail for 5 years. 2. Prisoner B: Confess, Prisoner A: Remain silent - Prisoner B is free, Prisoner A goes to jail for 20 years. 3. Prisoner B: Remains silent, Prisoner A: Confess - Prisoner B goes to jail for 20 years, Prisoner A is free. 4. Prisoner B: Remains silent Prisoner A: Remains silent - They both go to jail for 1 year.

- We can infer from this chart that the best way for both of the prisoners is when they remain silent. - When they both remain silent, they both go to jail for only one year, which is the lowest years for both of them.

A **dominant strategy** is a strategy that is best for a player in a game regardless of the strategies chosen by the other players. - In the above case, the dominant strategy for Henry is confessing that he is guilty.

//How does this apply to oligopolies?// - The game that the oligopolists play when reaching the monopolistic outcome is similar to the prisoner's dilemma. - This applies to companies when making a decision, in order to receive the highest profit for both companies, they must compare like this.



This has the same format as the above chart. The best choice for Ingrid and Edward is to work hard for both of them, since it takes the least time to finish the work.

- However, we must understand that each oligopolists has the incentive to cheat because they only want to maximize their own profits. - Self-interest makes it difficult for the oligopoly to maintain the cooperative outcome with low production, which prices and monopoly profits.

//The Prisoner's Dilemma and the Welfare of Society// - The non-cooperative equilibrium is bad for society as well as the players (companies). - Society would be better off if the two players could reach the cooperative outcome.

**CONTROVERSIES OVER ANTITRUST POLICY** <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;"> - Policymakers use the antitrust laws to prevent oligopolies from engaging in behavior that reduces competition.

- <span style="font-family: Myriad Roman,Arial,Helvetica,Sans-serif;"><span style="font-family: Verdana,Geneva,sans-serif;">This is the agreements between manufacturers and downstream distributors that set the downstream price of the product, either at a minimum price or a maximum price. - Also known as Fair Trade. - This prevents the retailers from competing on price. Thus, the court have viewed the resale price maintenance as a violation of the antitrust laws. - But without resale price maintenance, consumers will take advantage on one store and buy it at a discount. - Business practices that appear to reduce competition may in fact have legitimate purposes.
 * Resale Price Maintenance:**

- This is the measure employed by a dominant company to protect market share from new or existing competitors. - It involves temporarily pricing a product low enough to end a competitive threat. - Predatory company lowers the price, and remove the competition then becomes a monopoly.
 * Predatory Pricing:**

<span style="display: block; font-family: Verdana,Geneva,sans-serif; text-align: center;">An oligopoly simply has few firms in the market, and has a goal to become like a monopoly. This way, they are able to sell at a higher price, with more income. However, this is unlikely to happen since people have an incentive to cheat.

<span style="color: #ff005a; font-family: Verdana,Geneva,sans-serif; font-size: 108%;"> **Bibliography** <span style="font-family: Verdana,Geneva,sans-serif; font-size: 90%;">