Oligopoly Chapter 16

Adam Smith said in 1776 …. “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

Oligopoly Temptations –Collusion »An agreement among firms in a market about quantities to produce or prices to charge. –Cartel »A group of firms acting in unison.

Diamond Cartel

GAME THEORY AND THE ECONOMICS OF COOPERATION Game theory is the study of how people behave in strategic situations. Strategic decisions are those in which each person, in deciding what actions to take, must consider how others might respond to that action.

Duopoly Example

Table 1 The Demand Schedule for Water Copyright©2004 South-Western

Equilibrium for an Oligopoly Price lower than monopoly price and higher than competitive price. Quantity higher than monopoly quantity and lower than competitive quantity.

Nash Equilibrium A situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen.

The Prisoners’ Dilemma The prisoners’ dilemma is a particular “game” between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial.

Figure 2 The Prisoners’ Dilemma Copyright©2003 Southwestern/Thomson Learning Bonnie’ s Decision Confess Bonnie gets 8 years Clyde gets 8 years Bonnie gets 20 years Clyde goes free Bonnie goes free Clyde gets 20 years gets 1 yearBonnie Clyde gets 1 year Remain Silent Remain Silent Clyde’s Decision

Figure 3 An Oligopoly Game Copyright©2003 Southwestern/Thomson Learning Iraq’s Decision High Production High Production Iraq gets $40 billion Iran gets $40 billion Iraq gets $30 billion Iran gets $60 billion Iraq gets $60 billion Iran gets $30 billion Iraq gets $50 billion Iran gets $50 billion Low Production Low Production Iran’s Decision

Actual phone call by one airline president to another ROBERT : I think it’s dumb as hell … to sit here and pound the --- out of each other and neither one of use making a --- dime. HOWARD: Do you have a suggestion for me? ROBERT : Yes, I have a suggestion for you. Raise your --- fares 20%. I’ll raise mine the next morning. HOWARD : Robert, we … ROBERT : You’ll make more money, and I will, too. HOWARD : We can’t talk about pricing! ROBERT: Oh ---, Howard. We can talk about any --- thing we want to talk about.