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Unformatted text preview: Chapter Introduction Oligopoly If you go to a store to buy tennis balls, you will probably come home with one of four brands: Wilson, Penn, Dunlop, or Spalding. These four companies make almost all the tennis balls sold in the United States. Together these firms determine the quantity of tennis balls produced and, given the market demand curve, the price at which tennis balls are sold. The market for tennis balls is an example of an oligopoly. The essence of an oligopolistic market is that there are only a few sellers. As a result, the actions of any one seller in the market can have a large impact on the profits of all the other sellers. Oligopolistic firms are interdependent in a way that competitive firms are not. Our goal in this chapter is to see how this interdependence shapes the firms' behavior and what problems it raises for public policy. The analysis of oligopoly offers an opportunity to introduce game theory, the study of how people behave in strategic situations. By "strategic" we mean a situation in which a person, when choosing among alternative courses of action, must consider how others might respond to the action he takes. Strategic thinking is crucial not only in checkers, chess, and tic-tac-toe but in many business decisions. Because oligopolistic markets have only a small number of firms, each firm must act strategically. Each firm knows that its profit depends not only on how much it produces but also on how much the other firms produce. In making its production decision, each firm in an oligopoly should consider how its decision might affect the production decisions of all the other firms. Game theory is not necessary for understanding competitive or monopoly markets. In a market that is either perfectly competitive or monopolistically competitive, each firm is so small compared to the market that strategic interactions with other firms are not important. In a monopolized market, strategic interactions are absent because the market has only one firm. But, as we will see, game theory is useful for understanding oligopolies and many other situations in which small numbers of players are interacting with one another. Game theory helps explain the strategies that people choose, whether they are playing tennis or selling tennis balls. 17-1 Markets with Only a Few Sellers Because an oligopolistic market has only a small group of sellers, a key feature of oligopoly is the tension between cooperation and self-interest. The group of oligopolists is best off cooperating and acting like a monopolistproducing a small quantity of output and charging a price above marginal cost. Yet because each oligopolist cares only about its own profit, there are powerful incentives at work that hinder a group of firms from maintaining the monopoly outcome....
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This note was uploaded on 07/14/2011 for the course ECO 1001 taught by Professor Barcia during the Spring '08 term at CUNY Baruch.
- Spring '08