Lecture Notes Chapter 15
Oligopoly
Firms in oligopoly have only a few competitors. Their behavior can be analyzed using game theory, which shows the prisoners’ dilemma they can face.
I. What is Oligopoly?
The distinguishing features of an oligopoly are the presence of natural or legal barriers that prevent the entry of new firms and so only a small number of firms compete.
Barriers to Entry and Small Number of Firms
A natural oligopoly market occurs when the efficient scale of production allows only a few firms to meet the market demand. A duopoly is an oligopoly market with two firms.
Because there are a small number of firms, the firms in an oligopoly market are interdependent—each firm’s profit depends on its actions and the actions of its competitors. The firms have a temptation to form a cartel, which is a group of firms acting together—colluding—to limit output, raise price, and increase economic profit. Such collusion is illegal in the United States but it still occurs.
Examples of Oligopoly
Examples of oligopoly include cigarettes, batteries, and automobiles.
II. Oligopoly Games Game theory is a tool for studying strategic behavior—behavior that takes into account the expected behavior of others and the recognition of mutual interdependence. Games have rules, strategies, payoffs, and outcomes.
The Prisoners’ Dilemma
All games share four common features: rules, strategies, payoffs, and outcome
In the prisoner’s dilemma, the rules specify that each prisoner is placed in a separate room and must choose whether to confess without conferring with his accomplice.
Strategies are all the possible actions of each player.
The game’s payoff matrix, a table that shows the payoffs for every possible action by each player for every possible action by each other player, is above. In it are the payoffs from each prisoner’s strategies, which are to confess or deny involvement in the serious crime.
The choices of both players determine the outcome of the