This preview shows pages 1–5. Sign up to view the full content.
4/2/2008
1
Chapter 16
Game Theory and Oligopoly
•
Oligopoly
is a market structure characterized by:
•
 A few large firms that each have some
market power.
•
 Products that are homogeneous.
•
 Firms are pricesetters.
•
 Examples include steel, oil, sugar etc.
•
Let’s consider a market that is a
duopoly
: 2
firms.
Example
•
Market demand is given by
p = 100 – y
•
Each firm can produce at a constant cost of $40
per unit, that is
MC = 40
•
And thus
ATC = 40
•
$40 is the firm’s
unit cost of production
.
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document 4/2/2008
2
•
We also assume that there are no other relevant
costs and the oligopolists are established firms.
•
First, let’s find the standard monopoly solution if
there was only 1 firm serving the market:
•
MR = 100 – 2y.
Setting MR = MC,
100 – 2y = 40
y = 30
•
p = 100 – y = 100 – 30 =
70
•
Π
= TR – TC = 70(30) – 40(30) = $
900
•
Now, let’s suppose that each firm either chooses
to produce a small quantity of output, S = 15 or
a large quantity of output, L = 20.
•
If each firm chooses S = 15, total market output
will be 15 + 15 = 30, the monopoly outcome.
•
The firms will split the monopoly profit, each
making a profit of $450.
4/2/2008
3
•
If each firm chooses to produce L = 20, total
output will be 40, price will be p = 100 – 40 = 60.
•
Total profit will be
Π
= 60(40) – 40(40) = 800
•
The firms will each make a profit of $400
•
If one firm chooses S = 15 and the other
chooses L = 20, total market output will be 35,
price will be p = 100 – 35 = 65
•
The firm producing S = 15 makes a profit of
Π
= 65(15) – 40(15) = $375
•
The firm producing L = 20 makes a profit of
Π
= 65(20) – 40(20) = $500
•
We can set this situation up as a prisoner’s
dilemma:
500, 375
400, 400
450, 450
375, 500
•
Regardless of what Firm 1 does, Firm 2’s best
response is to produce L = 20.
•
Its profit will be either $500 ( > $450) or $400
(> $375).
•
Firm 1 has the same dominant strategy,
•
The outcome is a Nash equilibrium at
(L , L) and profit = (400, 400).
•
Yet, if they could agree to restrict their individual
outputs to 15 units apiece, each could earn
$450.
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document 4/2/2008
4
•
Oligopolists have a clear incentive to collude or
cooperate.
•
If they agreed to both produce S, their profits
would be maximized.
•
However, oligopolists have a clear incentive to
cheat on any simple collusive or cooperative
agreement.
•
If they agreed to produce S, either firm could
cheat and produce L and increase its profit.
•
Any agreement they make is not selfenforcing.
•
When an agreement is a Nash equilibrium, it is
selfenforcing: there’s a clear incentive to follow
through.
The Cournot Duopoly Model
•
Now, let’s assume that our firms can produce
any level of output.
The Cournot model assumes:
This is the end of the preview. Sign up
to
access the rest of the document.
This note was uploaded on 06/18/2011 for the course ECON 2X03 taught by Professor Jamesbruce during the Fall '10 term at McMaster University.
 Fall '10
 JAMESBRUCE
 Game Theory, Oligopoly

Click to edit the document details