Econ 2 Files
Econ 2 Lecture
Notes
Lecture 24: Oligopoly
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Economics 2 |
Lecture 24 Oligopoly
characteristics of oligopoly
kinked demand curve
game theory and oligopoly behavior
collusion
Characteristics of Oligopoly
- many buyers and few sellers
- identical or differentiated product
- entry is difficult to due high fixed costs
In an oligopolistic market, one firm's price and quantity decisions affect the other firms' decisions. So, firms change price and quantity after considering what other firms are likely to do in response.
Kinked Demand Curve
Strategic behavior occurs when what is best for A depends on what B does and vice versa.
What a firm's demand curve looks like depends on how their competitors respond to a price change. Suppose that your competitors will follow or copy price decreases but not price increases. If the you cut your price you do not sell much more because your competitors also lower their price. This makes the demand curve inelastic and steep. If you raise your price sales fall a lot so the demand curve is elastic and flat. Thus, the demand curve facing your firm has a kink in it at the current market price.
Because the demand curve has a kink in it, the marginal revenue curve will have a gap in it. Marginal cost can fluctuate between MC1 and MC2 without cuasing a price change. The kinked demand curve predicts infrequent price changes in oligopoly. However, neither this prediction nor the underlying assumption about how competitors react to price changes has any basis in the real world.
Game Theory and Oligopoly Behavior
- Dominant Strategy
- A dominant strategy produces better results no matter what strategy the other player follows.
A's dominant strategy is to charge a low price; since Firm B's alternatives are the same as A's, B's dominant strategy is to charge a low price. Even though both A and B would be better off if they agreed charge a high price, rational behavior dictates that they both follow their dominant strategies.
Collusion
Oligopolists are better off if they cooperate to limit production and keep the price high.
- price leadership - firms follow the pricing behavior of one firm
- collusion and cartels - eliminate profit-reducing competition
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