Oligopoly: Firms in Less Competitive Markets

1. Oligopoly: Firms in Less Competitive Markets

2. Oligopoly • Oligopoly A market structure in which a small number of interdependent firms compete. • The approach we use to analyze competition among oligopolists is called game theory.

3. Oligopoly and Barriers to Entry 1 LEARNING OBJECTIVE 13 - 1 Examples of Oligopolies in Retail Trade and Manufacturing • Barriers to Entry Barrier to entryAnything that keeps new firms from entering an industry in which firms are earning economic profits.

4. Oligopoly and Barriers to Entry • Barriers to Entry • In addition to economies of scale, other barriers to entry include: • Ownership of a key input • Government–Imposed Barriers • Patent The exclusive right to a product for a period of 20 years from the date the product was invented.

5. Using Game Theory to Analyze Oligopoly 2 LEARNING OBJECTIVE • Game theoryThe study of how people make decisions in situations where attaining their goals depends on their interactions with others; in economics, the study of the decisions of firms in industries where the profits of each firm depend on its interactions with other firms. • Key characteristics of all games: • Rules that determine what actions are allowable. • Strategies that players employ to attain their objectives in the game. • Payoffs that are the results of the interaction among the players’ strategies. • Business strategyActions taken by a business firm to achieve a goal, such as maximizing profits.

6. A Duopoly Game: Price Competition between Two Firms Payoff matrixA table that shows the payoffs that each firm earns from every combination of strategies by the firms. Using Game Theory to Analyze Oligopoly 13 - 2 A Duopoly Game CollusionAn agreement among firms to charge the same price, or to otherwise not compete.

7. A Duopoly Game: Price Competition between Two Firms Dominant StrategyA strategy that is the best for a firm, no matter what strategies other firms use. Using Game Theory to Analyze Oligopoly Nash equilibriumA situation where each firm chooses the best strategy, given the strategies chosen by other firms. A Beautiful Mind: Game Theory Goes to the Movies 13 - 1 In the film, A Beautiful Mind, Russell Crowe played John Nash, winner of the Nobel Prize in Economics.

8. Firm Behavior and the Prisoners’ Dilemma Cooperative equilibriumAn equilibrium in a game in which players cooperate to increase their mutual payoff. Using Game Theory to Analyze Oligopoly Noncooperative equilibrium An equilibrium in a game in which players do not cooperate but pursue their own self-interest. Prisoners’ dilemma A game where pursuing dominant strategies results in noncooperation that leaves everyone worse off.

9. 2 LEARNING OBJECTIVE 13 - 1 • Is Advertising a Prisoners’ Dilemma for Coca-Cola and Pepsi? Advertising is the optimal decision for both firms, given the decision by the other firm. Is There a Dominant Strategy for Bidding on eBay? 13 - 2 On eBay, bidding the maximum value you place on an item is a dominant strategy.

10. Using Game Theory to Analyze Oligopoly 13 - 3 Changing the Payoff Matrix in a Repeated Game • Can Firms Escape the Prisoners’ Dilemma? American Airlines and Northwest Airlines Fail to Cooperate on a Price Increase 13 - 3 The airlines have trouble raising the price this business traveler pays for a ticket.

11. Cartels: The Case of OPEC Sustaining high prices has been difficult because members often exceed their output quotas. Using Game Theory to Analyze Oligopoly 13 - 4 World Oil Prices CartelA group of firms that colludes by agreeing to restrict output to increase prices and profits.

12. Cartels: The Case of OPEC The equilibrium of this game will occur with Saudi Arabia producing a low output and Nigeria producing a high output. Using Game Theory to Analyze Oligopoly 13 - 5 The OPEC Cartel with Unequal Members

13. Sequential Games 3 LEARNING OBJECTIVE 13 - 6 The Decision Tree for an Entry Game • The best decision for Wal-Mart is to build a large store to deter Target’s entry. Deterring Entry

14. 4 LEARNING OBJECTIVE 13 - 1 • Is Deterring Entry Always a Good Idea? In this case, Wal-Mart will build a small store and Target will enter. Deterrence is only worth pursuing if its costs are not too high.

15. Sequential Games 13 - 7 The Decision Tree for a Bargaining Game Bargaining

16. Barrier to entry • Business strategy • Cartel • Collusion • Cooperative equilibrium • Dominant strategy • Economies of scale Game theory Nash equilibrium Noncooperative equilibrium Oligopoly Patent Payoff matrix Prisoners’ dilemma