Oligopoly Characteristics of an oligopoly market Few producers offering differentiated products High barriers to entry Interdependent firms React to competitors actions

GAME THEORY Game theory is the study of how firms behave in strategic situations. When setting price and quantity, oligopolies are constantly playing a “game” with their competitors….

Let’s play a little game theory…

The Story of X vs. O

The Game Take out a full sheet of paper You are going to vote on who you support, “X” or “O” You will either write an “X” or an “O” in the direct middle of the paper. Then, fold the paper 4 times But…..are you asking yourself, “What happens if I write an X or if I write an O?

Classroom Possibilities You will have potential to win free candy. It all depends on how the class as a group votes.

Everyone gets 1 piece of candy Candy Breakdown # of “X” votes Reward 1 15 pieces of candy 2 7 pieces of candy 3 4 pieces of candy 4+ NO ONE GETS CANDY Entire class votes “O” Everyone gets 1 piece of candy

The Game Take out a full sheet of paper You are going to vote on who you support, “X” or “O” You will either write an “X” or an “O” in the direct middle of the paper. Then, fold the paper 4 times

Oligopolies and Game Theory Its best if oligopoly firms work together and don’t cheat However, there is an incentive to cheat A firm could benefit more than its competitor

Collusion Agreement among producers to divide market, set prices, or limit production Illegal in the United States (antitrust laws)

Payoff Matrix/Prisoners Dilemma

Payoff Matrix Matrix that shows the possible payouts for interdependent firms

Pepsi and Coke’s Payoff Matrix Decision High Production: 40 Gal. Low Production: 30 gal. Coke gets $1,600 profit Pepsi gets $1,600 profit Coke gets $1,500 profit Pepsi gets $2,000 profit High Production 40 gal. Pepsi’s Decision Coke gets $2,000 profit Pepsi gets $1,500 profit Coke gets $1,800 profit Pepsi gets $1,800 profit Low Production 30 gal.

Different Options Dominant Strategy Nash Equilibrium The firm makes the same decision no matter what the other firms do Nash Equilibrium The equilibrium that results when all firms choose the action that maximizes their benefit given the actions of the other firms

Pepsi and Coke’s Payoff Matrix Decision High Production: 40 Gal. Low Production: 30 gal. Coke gets $1,600 profit Pepsi gets $1,600 profit Coke gets $1,500 profit Pepsi gets $2,000 profit High Production 40 gal. Pepsi’s Decision Coke gets $2,000 profit Pepsi gets $1,500 profit Coke gets $1,800 profit Pepsi gets $1,800 profit Low Production 30 gal.

Pepsi and Coke’s Payoff Matrix Decision High Production: 40 Gal. Low Production: 30 gal. Coke gets $1,600 profit Pepsi gets $1,600 profit Coke gets $1,500 profit Pepsi gets $2,000 profit High Production 40 gal. Pepsi’s Decision Coke gets $2,000 profit Pepsi gets $1,500 profit Coke gets $1,800 profit Pepsi gets $1,800 profit Low Production 30 gal.

An Arms-Race Game Arm Disarm U.S. at risk USSR at risk Decision of the United States (U.S.) Arm Disarm U.S. at risk USSR at risk U.S. at risk and weak USSR safe and powerful Arm Decision of the Soviet Union U.S. safe and powerful USSR at risk and weak U.S. safe USSR safe (USSR) Disarm

How the Size of an Oligopoly Affects the Market Outcome As the number of sellers in an oligopoly grows larger, an oligopolistic market looks more and more like a competitive market. The price approaches marginal cost, and the quantity produced approaches the socially efficient level.