{"lesson":{"ID":"1835172219587657758","description":"","name":"4.5 Oligopoly and Game Theory","objectives":[],"sections":[{"content":"|Oligopoly| is a market structure characterized by a small number of large firms that dominate an industry. Unlike monopolistic competition, where many firms compete with differentiated products, oligopolies are defined by high barriers to entry and significant interdependence among firms. This interdependence means that the actions of one firm directly impact the decisions and outcomes of others, leading to strategic behavior that can be analyzed using |game theory|.\n

\nUnderstanding oligopoly and game theory provides insight into how firms in highly concentrated markets compete, cooperate, and influence market outcomes. These concepts are especially relevant in industries such as telecommunications, automotive manufacturing, and airlines, where a few key players dominate the landscape.\n","header_size":1,"name":"Oligopoly and Game Theory","section_type":0},{"content":"|Oligopolistic markets| are defined by a few key features. First, there are only a small number of firms, each with significant |market power|. While these firms are not as dominant as monopolists, their size and influence allow them to shape prices and output in the industry.\n

\nSecond, products in an oligopoly may be either |homogeneous| or |differentiated|. For example, the oil industry, dominated by a few global producers, offers a largely standardized product. In contrast, the automobile industry competes on brand, features, and quality, leading to product differentiation.\n

\nThird, oligopolies are marked by |barriers to entry|, which prevent new firms from entering the market and disrupting the balance of power. These barriers include economies of scale, control over key resources, and substantial capital requirements.\n

\nFinally, the most distinctive feature of oligopoly is |interdependence|. Each firm\u2019s pricing, production, and marketing decisions are influenced by the anticipated responses of its competitors. This dynamic often leads to strategic behavior, as firms must consider not only their own interests but also the potential reactions of their rivals.","header_size":1,"name":"Characteristics of Oligopoly","section_type":0},{"content":"|Game theory| is a tool used to study strategic decision-making in situations where the outcome for one participant depends on the actions of others. In an oligopoly, game theory helps explain how firms behave when they must account for their competitors\u2019 responses.\n

\nOne of the simplest models of game theory is the |prisoner\u2019s dilemma|, which illustrates how rational decision-making can lead to suboptimal outcomes for all participants. In the context of an oligopoly, this can be seen in pricing decisions:\n

\nSuppose two competing firms are considering whether to lower their prices to attract more customers. If both firms reduce their prices, they erode their profits. However, if one firm lowers its price while the other maintains a higher price, the firm with the lower price gains market share. The fear of losing customers often leads both firms to lower prices, resulting in reduced profits for both\u2014a scenario neither wanted. This concept is called a |dominant strategy|, where both \"players\", or in this case, firms, find that the strategy of lowering prices is the best choice they can make for themselves, no matter the opponent's choice.\n\n| `Firm A, Firm B` | Same price | Lower price |\n|:--------------:|:----------:|-------------|\n| Same price | `$300, $300` | `$100, $500` |\n| Lower price | `$500, $100` | `$200, $200` |\n\n\nSimilarly, they reach a |nash equilibrium| by choosing to lower their prices, as no individual firm is able to earn more by changing their choice now that both have decided to lower prices.\n

\nGame theory also explains |collusion| and |cartels|. In some cases, firms may attempt to cooperate by setting prices or limiting output to maximize joint profits. However, these arrangements are often unstable because individual firms have an incentive to cheat by undercutting their partners to gain a larger market share. In many countries, collusion is illegal due to its anti-competitive nature.","header_size":1,"name":"Strategic Behavior and Game Theory","section_type":0},{"content":"Oligopolies can take different forms based on the nature of competition and cooperation among firms:\n- |Non-Collusive Oligopoly|: In a non-collusive oligopoly, firms act independently and compete against one another. Strategic decision-making is critical, as each firm must anticipate and react to the actions of its rivals. Price rigidity often occurs in non-collusive oligopolies, where firms avoid frequent price changes to prevent destabilizing the market.\n- |Collusive Oligopoly|: In a collusive oligopoly, firms cooperate to set prices, limit production, or divide markets to maximize collective profits. Formal agreements, known as |cartels|, are an extreme example of collusion. However, most collusion is informal and secretive, as it is illegal in many jurisdictions. The |Organization of Petroleum Exporting Countries (OPEC)| is a well-known example of a cartel that coordinates oil production among member countries.\n- |Duopoly|: A duopoly is a special case of oligopoly where only two firms dominate the market. The interdependence between these firms is particularly pronounced, often leading to intense rivalry or implicit cooperation. Examples include the competition between Boeing and Airbus in the aircraft manufacturing industry.","header_size":1,"name":"Types of Oligopoly","section_type":0},{"content":"- Impact on Firms: Oligopolistic firms benefit from their market power, allowing them to earn significant profits, especially when barriers to entry prevent competition. Strategic behavior enables these firms to influence prices and maintain a stable position in the market.\n- Impact on Consumers: The effects on consumers are mixed. On the one hand, competition among a few firms can lead to innovation, better quality products, and non-price benefits such as improved service. On the other hand, reduced competition can result in higher prices and limited choices, particularly when firms engage in collusion.\n- Impact on Efficiency: Oligopolies often fall short of allocative efficiency, as prices exceed marginal cost, leading to a loss of consumer surplus. Productive inefficiency may also arise, as firms do not operate at the lowest point on their average total cost (ATC) curve. However, the innovation driven by competition within oligopolies can partially offset these inefficiencies.\n","header_size":1,"name":"Economic Effects of Oligopoly","section_type":0}],"unit_id":"1835172219583463449"},"status":"success"}

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