What did you study last time?

1. CRC Microeconomics

2. What did you study last time? what is meant by monopolistic competition? the special features of monopolistic competition? 8/15/2014 CRC Microeconomics 2

3. Do you know … • what is meant by an oligopoly? • what is meant by a duopoly? • how game theory is applied to oligopoly? • how governments deal with oligopoly? CRC Microeconomics

4. 1a. Oligopoly—Main characteristics A market with • few sellers (firms); • similar (or identical) products; • a key feature: the tension between cooperation and self-interest. CRC Microeconomics

5. 1b. Oligopoly—Main Ideas • An oligopoly is a price maker/setter. • Firms in oligopoly are interdependent. • The actions of one firm tend to affect all other firms. CRC Microeconomics

6. 1b. Oligopoly—Main Ideas • They have the tendency to collude, i.e. to form a cartel. • A collusion is an agreement among firms in a market about quantities to produce and prices to charge. • A cartel is a group of firm acting in unison, like a monopolist. CRC Microeconomics

7. 1b. Oligopoly—Main Ideas • The market outcome is inefficient • Qo < Qc; Po > Pc; and • P > MC. • As the number of firms in an oligopoly grows larger • Qo rises toward Qc; and Po falls toward Pc. • Oligopolies would like to act like monopolies, but self-interest drives them closer to competition. CRC Microeconomics

8. 1b. Oligopoly—Main Ideas • The equilibrium in an oligopoly is called a Nash equilibrium. • A situation in which economic actors interacting with one another each choose its best strategy given the strategies that all the other actors have chosen. CRC Microeconomics

9. 2. A Duopoly • An oligopoly with two firms, e.g. Coke and Pepsi. • Possible outcome: collusion or cartel. • If they pursue their own self-interest, the outcome will be a Nash equilibrium. CRC Microeconomics

10. 3. Game theory • Game theory: the study of how people behave in strategic situations • Each person, in deciding what action to take, must consider how others might respond to that action. CRC Microeconomics

11. 3. Game theory • An example: The prisoners’ dilemma • A particular “game” between two captured prisoners that illustrates why cooperation is difficult to maintain when it is mutually beneficial. CRC Microeconomics

12. The prisoners’ dilemma • The prisoners: Bonnie and Clyde, who are suspected of robbing a bank. • The deal, offered by the police: • If both confess, each would get 8 years in jail; • If both remain silent, each would get 1 year; • The one who confesses and implicates his/her partner will get free, and the other who remains silent will get 20 years. • The question: What would they do? CRC Microeconomics

13. The prisoners’ dilemma Bonnie’s decision Confesses Remains silent Clyde’s decision Confesses Bonnie gets 8 years Clyde gets 8 years Bonnie gets 20 years Clyde goes free Remains silent Bonnie goes free Clyde gets 20 years Clyde gets 1 year Bonnie gets 1 year If Clyde confesses, then what would Bonnie do? then Bonnie would also confess. If Clyde remains silent, then Bonnie would confess. then what would Bonnie do? CRC Microeconomics Regardless of what Clyde does, Bonnie would choose to confess.

14. The prisoners’ dilemma • The answer: Bonnie and Clyde would both confess. They would take the dominant strategy. • A strategy that is best for a player in a game regardless of the strategies chosen by the other player(s). • The final outcome: In the end, both spend 8 years in jail. CRC Microeconomics

15. The prisoners’ dilemma • Why? The logic of self-interest takes over and lead them to confess. Cooperation between them is difficult to maintain, because cooperation is individually irrational. CRC Microeconomics

16. 3. Game theory • Self-interest makes it difficult for the oligopoly to maintain a cooperative outcome with low production, high prices, and monopoly profits. CRC Microeconomics

17. 3. Game theory • Other examples of game theory: • Oil production, Iraq vs. Iran • Arms race, U.S. vs. U.S.S.R • Advertising, Marlboro vs. Camel • Oil drilling, Exxon vs. Texaco CRC Microeconomics

18. 4. Dealing with an oligopoly • Anti-trust laws prevent oligopolies from engaging in behavior that reduces competition. • It is illegal to restrain trade or to attempt to monopolize a market. • The laws: • Sherman Antitrust Act of 1890 • Clayton Act of 1914 CRC Microeconomics

19. 4. Dealing with an oligopoly • Some controversies over the antitrust policy • Some business practices that may seem to reduce competition may in fact have legitimate business purposes. • A few examples CRC Microeconomics

20. 4. Dealing with an oligopoly • Resale price maintenance (fair trade)—when suppliers (e.g. wholesalers) require the retailers to charge customers a specific amount. This practice may be illegal. CRC Microeconomics

21. 4. Dealing with an oligopoly • Predatory pricing—when a large firm cuts the price of its product with the intent to drive its competitors out of the market. This practice may be illegal. CRC Microeconomics

22. 4. Dealing with an oligopoly • Tying—when a firm offers two (or more) of its products together at a single price, rather than separately. This practice may be illegal. CRC Microeconomics

23. Now you know … • what is meant by an oligopoly. • what is meant by a duopoly. • how game theory is applied to oligopoly. • how governments deal with oligopoly. CRC Microeconomics

24. What will you study next time? The labor market. The markets for other factors of production (land and capital). 8/15/2014 CRC Microeconomics 24

25. See You! Take Care! CRC Microeconomics