Economics Chpt. 10

Game Theory

considers the optimum strategy that a firm could undertake in the light of different possible decisions by rival firms. In a duopoly, we assume that the firms have equal costs, identical products and share the market evenly, so the initial demand for their goods are the same. If one considers the worst possible outcomes (pessimistic or cautious), the best option is to lower prices. The firm is maximizing minimum profit options, known as the 'maximin' strategy. If one considers the best possible scenarios If firm A lowers its price and firm B does not lower its price, best option remains to lower price. The strategy of trying to make the maximum profit available is known as a "maximax" strategy. In both strategies the best option is to lower the price, it is the dominant strategy.The more firms the more complex determining strategies becomes.

Tacit Collusion

exists when firms in an oligopoly charge the same prices without any formal collusion. A firm may charge the same price as another by looking at the prices of a dominant firm in the industry, or at the prices of the main competitors.

Collusive Oligopoly

exists when the firms in an oligopolistic market collude to charge the same prices for their products, in effect acting as a monopoly, and so divide up any monopoly profits that may be made. Offers an explanation of price rigidity, if firms are colluding (tacitly or formally), they are making their share of long-run monopoly profits, then they may try to keep prices stable in order that the situation continues.

Non-Collusive Oligopoly

exists when the firms in an oligopoly do not collude, and so have to be very aware of the reactions of other firms when making pricing decisions.

Strategic Behavior

in a non - collusive oligopoly, firms develop strategic behavior as they must develop strategies that take into account all possible actions of rivals.

Oligopoly

where a few firms dominate; a large proportion of the industry's output is shared by just a small number of firms.

Kinked Demand Curve in Relation to Price Rigidity and Non-Collusive Oligopoly

1.) Firms are afraid to raise prices above the current market price because other firms will not follow and so they will lose trade, sales, and probably profit. 2.) Firm are afraid to lower their prices below the current market price, because other firms will follow, undercutting them, and creating a price war the harms all involved participants. 3.) The shape of the MR curve means that if the marginal coasts were to rise, then it is possible that MC would still equal MR, and so the firms, being profit maximizers, would not change their price or outputs.

Oligopoly Characteristics

1.) May be very different in nature, some produce identical products (petrol - brand names = only difference), some highly differentiated products (cars), some slightly differentiated products (shampoo - huge budgets to persuade people that their product is better) 2.) Most examples have distinct barriers to entry, usually large-scale production of strong branding of dominant firms. Some examples may be low barriers to entry. 3.) All oligopolies are interdependent. There is a small number of large firms dominating the industry, each firm needs to take notice of the other's actions. Some wish to collude and so avoid unexpected outcomes and maximize industry profits while other compete vigorously to gain greater market share. 4.) Price rigidity, unchanging, even when production cost increases.

Kinked Demand Curve

Assumption: in reality a firm only knows one point on its demand curve, the present. If the firm raises its price then it it unlikely that its competitors would raise theirs and so a lot of demand would be lost to other firms. This implies that above a point demand would be relatively elastic since a small increase in price would lead to large fall in quantity demanded. If the firm were to lower its price more firms are likely to follow. It is likely that they would undercut the price of the first firm in order to regain any lost sales. This implies that demand would be less elastic below a point since a decrease in price is unlikely to lead to a noticeable increase in quantity demanded.

Formal Collusion

also called a cartel, takes place when firms openly agree on the price that they will all charge. Since this results in higher prices and less output for consumers, this is usually deemed to be against the interest of consumers and so collusion is generally banned by governments and is against the law. *Formal collusion between government may be permitted (e.g. OPEC).

Concentration Ratio

indicates the concentration in an industry. CR(X) = % where X represents the number of the largest firms. 0% = Perfect Competition 0%-50%= Monopolistic Competition 50% = Oligopoly 100% = Monopoly. 0-50% = low concentration 50%-80% = medium concentration 80%-100%= high concentration

Non-Price Competition

since firms in an oligopoly tend to not compete in terms of price, they implement brand names, packaging, special features, advertising, sales promotion, personal selling, publicity, sponsorship deals, and special distribution features (free delivery etc.). Oligopoly is characterized by very large advertising and marketing expenditures as firms try to develop brand loyalty and make demand for their product less elastic. Very large advertising and marketing expenditures as firms try to develop brand loyalty and make demand less elastic, may result in more choice for consumers. Some try to increase barriers to entry.