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Oligopoly
Characteristics of an oligopoly marketFew producers
offering differentiated products
High barriers to entry
Interdependent firms React to competitors actions
GAME THEORY
Game theory is the study of how firms behave in
strategic situations.
When setting price and quantity, oligopolies are
constantly playing a “game” with their
competitors….
Let’s play a little game
theory…
The Story of X vs. O
The Game
Take out a full sheet of paper
You are going to vote on who you support, “X” or “O”
You will either write an “X” or an “O” in the direct middle of the paper.
Then, fold the paper 4 times
But…..are you asking yourself, “What happens if I write an X or if I write an O?
Classroom Possibilities
You will have potential
to win free candy. It all
depends on how the
class as a group votes.
Candy Breakdown
# of “X” votes Reward
1 15 pieces of candy
2 7 pieces of candy
3 4 pieces of candy
4+ NO ONE GETS CANDY
Entire class votes “O” Everyone gets 1 piece of candy
The Game
Take out a full sheet of paper
You are going to vote on who
you support, “X” or “O”
You will either write an “X” or an
“O” in the direct middle of the
paper.
Then, fold the paper 4 times
Oligopolies and Game
Theory
Its best if oligopoly firms work together and don’t
cheat
However, there is an incentive to cheat
A firm could benefit more than its competitor
Collusion
Agreement among
producers to divide
market, set prices, or limit
production
Illegal in the United States
(antitrust laws)
Payoff Matrix/Prisoners
Dilemma
Payoff Matrix
Matrix that shows the possible
payouts for interdependent firms
Pepsi and Coke’s Payoff
MatrixCoke’s Decision
High
Production
High Production: 40 Gal.
Coke gets $1,600 profit
Pepsi gets $1,600 profit
Coke gets $1,500 profit
Pepsi gets $2,000 profit
Coke gets $2,000 profit
Pepsi gets $1,500 profit
Coke gets $1,800 profit
Pepsi gets $1,800 profit
Low Production: 30 gal.
Low
Production
Pepsi’s
Decision
40 gal.
30 gal.
Different Options
Dominant Strategy
The firm makes the same decision no matter
what the other firms do
Nash Equilibrium
The equilibrium that results when all firms
choose the action that maximizes their benefit
given the actions of the other firms
Pepsi and Coke’s Payoff
MatrixCoke’s Decision
High
Production
High Production: 40 Gal.
Coke gets $1,600 profit
Pepsi gets $1,600 profit
Coke gets $1,500 profit
Pepsi gets $2,000 profit
Coke gets $2,000 profit
Pepsi gets $1,500 profit
Coke gets $1,800 profit
Pepsi gets $1,800 profit
Low Production: 30 gal.
Low
Production
Pepsi’s
Decision
40 gal.
30 gal.
Pepsi and Coke’s Payoff
MatrixCoke’s Decision
High
Production
High Production: 40 Gal.
Coke gets $1,600 profit
Pepsi gets $1,600 profit
Coke gets $1,500 profit
Pepsi gets $2,000 profit
Coke gets $2,000 profit
Pepsi gets $1,500 profit
Coke gets $1,800 profit
Pepsi gets $1,800 profit
Low Production: 30 gal.
Low
Production
Pepsi’s
Decision
40 gal.
30 gal.
An Arms-Race Game
Decision of the United States (U.S.)
Arm
Arm
U.S. at risk
USSR at risk
U.S. at risk and weak
USSR safe and powerful
U.S. safe and powerful
USSR at risk and weak
U.S. safe
USSR safe
Disarm
Disarm
Decision
of the
Soviet Union
(USSR)
How the Size of an Oligopoly
Affects the Market Outcome
As the number of sellers in an oligopoly grows
larger, an oligopolistic market looks more and more like a competitive market.
The price approaches marginal cost, and the
quantity produced approaches the socially
efficient level.
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