Understanding Oligopoly: Collusion, Game Theory, and Market Efficiency

1. Oligopoly Microeconomics What is Marketing? Principles of Marketing

2. Oligopoly • Oligopolistic markets are those dominated by a small number of firms • Oligopolies are characterized by high barriers to entry with firms choosing output, pricing, and other decisions strategically based on the decisions of the other firms in the market • Oligopolistic firms face two conflicting temptations: to collaborate as if they were a single monopoly, or to individually compete to gain profits by expanding output levels and cutting prices

3. Oligopoly Models In oligopolistic industries any one firm’s demand and marginal revenue curves are influenced by what the other oligopolistic firms are doing

4. Collusion • Oligopolistic firms can collude to hold down industry output, charge a higher price, and divide up the profit among themselves • A group of firms that have a formal agreement to collude to produce the monopoly output and sell at the monopoly price is called a cartel

5. Anti-trust Law and Collusion In the United States, as well as many other countries, it is illegal for firms to collude since collusion is anti-competitive behavior, which is a violation of antitrust law

6. Collusion or Competition? • Even when oligopolists recognize that they would benefit as a group by acting like a monopoly, each individual oligopoly faces a private temptation to produce just a slightly higher quantity and earn slightly higher profit—while still counting on the other oligopolists to hold down their production and keep prices high. • If at least some oligopolists give in to this temptation and start producing more, then the market price will fall. • Indeed, a small handful of oligopoly firms may end up competing so fiercely that they all end up earning zero economic profits—as if they were perfect competitors.

7. Monopoly through Collusion

8. Game Theory in Oligopolies

9. How Can Oligopolies Enforce Cooperation? • Formal agreements (cartels) are not usually enforceable in court due to anti-trust laws • Kinked demand curves

10. Kinked Demand Curve Competing oligopoly firms commit to match price cuts, but not price increases

11. Efficiency • Oligopolies are inefficient for the same reasons that monopolies are—in order to reap economic profits, they produce too little output so they create deadweight losses to society • The more like a monopoly a given oligopoly is, the higher their profits and the greater the deadweight loss • This is why strong oligopolies usually generate antitrust action by the government

12. Practice Question Why is game theory a useful tool for predicting the behavior of firms in an oligopoly?

13. Quick Review • What are the characteristics of oligopolies? • Why can collusion occur in oligopolistic industries? • How does game theory help economists understand the behavior of oligopolies? • Why are oligopolies inefficient?