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Oligopolies By Melanie Schmidt. Welcome to Gilladia. Life in Gilladia was once simple and peaceful. The people there had one driving interest and one primary occupation: the production of a rather marvelous fuel called Meltrol.
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Life in Gilladia was once simple and peaceful. The people there had one driving interest and one primary occupation: the production of a rather marvelous fuel called Meltrol.
Every other person one encountered in Gilladia was a producer of Meltrol, with their very own company. There were no barriers to entry, and each Metrol producer had no price setting capability.
The Gilladian Metrol producers existed in a relaxing state of perfect competition, where price was equal to demand and marginal revenue…
Where the consumer was happy to find himself the price-setter…
There were three men in perfect competition paradise who were not content with this state of affairs.
Possessed of fiery entrepreneurial spirits and some decidedly handy piles of cash, our three top-hatted gents began to invest in new, revolutionary technology and to achieve mastery over economies of scale.
Before too long, everyone came to know that if you desired cheap, quality Metrol, you had only to go to Lester’s, Alistair’s, or Wilbur’s.
Unable to keep up, the other Metrol companies either sold out to one of the three new giants or sank into the mud.
Suddenly, Gilladia had but three Metrol firms and aside from having an entirely new landscape…
…They also had a new market structure to contend with. According to the Herfindahl-Hirschman Index, they now had an oligopoly, and existed in a state of imperfect competition. MR no longer equaled MC at the demand curve, and said demand curve was now kinked, due to the three firms state of interdependence.
These new oligopolists held the majority of the Metrol industry in the palms of their hands. They possessed market power and were able to impact prices and each other through their personal actions.
One day, Alistair decided to raise his prices. Wilbur and Lester were disinclined to follow him, and he lost some of his market share.
Horrified, Alistair backpedaled, sending his prices to heretofore unimaginable lows.
Suddenly finding their market share sorely deflated, Lester and Wilbur followed suit and lowered their prices.
A price war had begun, with all three firms seeking to gain the greatest market share.
The situation had become quite desperate, but Wilbur had a cunning plan. If all three of them – Lester, Alistair, and himself – acted together, colluded, why then they could all turn a profit!
He went to Lester and Alistair, completely thrilled with his stunning idea. He suggested that they form a cartel, or a group of producers who work together to keep production low and prices high.
Little did Wilbur know, but Lester had big dreams too; big, monopolistic dreams. He wanted nothing more than to remove all competition, to be the market, instead of a third of it.
Knowing that collusion was not well regarded by the law, Lester brought with him to the meeting a rather devious device.
Poor Wilbur hardly knew what was happening when his firm was forcibly split apart.
There were now only 2 Meltrol firms in Gilladia. A duopoly had formed. Although Lester and Alistair were well aware of the risks they faced in attempting to collude, they were still locked into the vicious tango of interdependence.
Since Lester’s profits depended on the actions of Alistair and vice versa, but they weren’t allowed to communicate, they became trapped by the Prisoner’s Dilemma. This method of behaving with the actions of other players in mind is also called Game Theory.
To see how exactly their decision process worked, we can look at a payoff matrix.
If both were to collude and keep prices high, they could both turn a reasonable profit. However, if one were to cheat by lowering prices and the other to collude, the cheater would make a greater profit. If both cheat, then they will both make less than if they hadn’t.
For Lester and Alistair, no matter what the other did, cheating, or noncooperative behavior was the safest route. They had a dominant strategy, yet the ultimate result was that they both lost profits.
Years went by, and as Alistair and Lester began to understand each other better, they were able to look beyond their short-run dominant strategies and figure out how their actions would effect the other’s future actions.
Eventually, without even speaking of it, they came to realize that it was best for both of them to help each other. They formed an unspoken, or tacit, agreement.
Today in Gillandia, that agreement still exists. Alistair and Lester are fat and happy, and for the consumers price wars are but a fond memory.
Gilladia is a dreamland, Meltrol a myth; yet oligopolies do exist in the real world. The wireless network providers seem to be creating an oligopoly, much to the worry of many. http://www.northumberlandview.ca/index.php?module=news&func=display&sid=12513 Perhaps one of the most notorious oligopolies is OPEC, a cartel which controls much of the world’s oil supplies. http://tycoonreport.tycoonresearch.com/articles/344221889/oil-oligopoly-and-inflating-your-tires
http://apcentral.collegeboard.com/apc/public/repository/ap08_economics_coursedesc.pdfhttp://apcentral.collegeboard.com/apc/public/repository/ap08_economics_coursedesc.pdf Oligopolies are in Gilladia, and they are in the real world, but they are also on the Microeconomics AP test! #19 4. Which of the following best describes a strategy?1. a plan to profit maximize and ignore competitors2. a plan to drop out of an industry3. a plan to dominate an industry4. A plan that describes the actions a firm will take given the actions of other interdependent firms 1. The study of game theory is not as applicable to firms that are perfect competitors because: 1. They cannot afford to hire strategists. 2. The firms in perfect competition are too interdependent 3. Perfect competitors can sell all that they produce at the market price 4. They have to be concerned that the strategy that they would opt for would generate a reaction by their competitors
Free Response Question Question #3: http://apcentral.collegeboard.com/apc/public/repository/ap09_frq_microeconomics.pdf Answer: http://apcentral.collegeboard.com/apc/public/repository/ap09_microecon_sgs.pdf
Multiple Choice Answers 19. (A) If Bright chooses Strategy 1, it can either make $3000 which is better than $2500, or $2000, which is better than $500. If Sparkle chooses Strategy 1, it can make $6000 rather than $4000, or $3000 rather than $0. 4. (4) The definition of strategy as refers to game theory is behavior that takes into account the future actions of other players in an interdependent system. 1. (3) In perfect competition, the price and the demand are the same. Individual firms have no power over price, so cannot interact with each other to impact price.
Free Response Answer Explanation • North will be better, since Blue Mart will make $4000 instead of $1000. • South isn’t a dominant strategy for Red Shop, since they would do better to go north if Blue Mart went south. • Red Shop would go south, and Blue Mart would go north, since Red Shop can make $5000 in the south and Blue Mart can make $4000 in the north, which are the greatest profits for both of them. • Subsidies add money, so $2000 would simply be added to all of the profits in southern locations.
