Lecture notes week 10

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University of Toronto Scarborough
Economics for Management Studies
Gordon Cleveland

ECMA04 Week 10 OLIGOPOLY Oligopoly is a market in which there are only a few sellers. How many? So few that they feel the effects of each others decisions. (cigarette companies, the banks, oil producers, steel producers, car companies, insurance companies, cereal producers, electronics, etc) When top four firms control large % of sales Four-firm concentration ratio = share of sales in hands of top four firms in industry. In Canada: Four firm concentration ratio is over 50% for tobacco products, petroleum and coal products, transportation equipment, primary metals, beverages, metal mining N broadly defined industries Suppose we have two firms competing in a given market, producing identical output (homogeneous, standardized product - just like perfect competition). The decision each firm has to make is: How much output should I try to sell, given what I think the other producer might try to sell? Firm #1 decides on q 1 Firm #2 decides on q 2 Each firm has MC = AC = $2, no matter how much they produce (that is, TC 1= 2q 1ndTC = 22 ) 2 The key to this problem is that each firm chooses its own output, but price depends on BOTH firms decisions TC 1 2q 1 and TC 2 2q 2 and P = 14 - Q T and Q T q +1q 2 For example, if firm #1 chooses q 1= 2 then if q2= 2, P = 10 if q = 3, P = 9 2 if q2= 4, P = 8 On the other hand, if firm #1 chooses q1 = 3 then if q2= 2, P = 9 if q2= 3, P = 8 if q2= 4, P = 7 So, to repeat, the outcome (your profits, if you are one of the firms) depends not only on your decision but also on the other firms decision How to model this kind of decision? Economists use a concept known as Prisoners Dilemma Story: A robbery is committed, and police catch two ex-cons whom they strongly suspect of the crime. There is some evidence, but not enough to convict them of the robbery itself. Without more evidence, the best the prosecutor can do is convicting them of minor things that will earn TWO YEARS in jail. So police separate the two suspects and offer each of them the following offer: If you will confess, and if your partner denies the crime, we will let you off with 6 months in jail, and your partner will get 10 years in jail. If you both confess, you will both get 5 years. So, each prisoner has a problem (a dilemma). You dont know what your partner will do, but whatever he does, you are better off confessing: N If your partner denies the crime, you can get off with 6 months (instead of 2 years) by confessing N If your partner confesses, you are going to jail, but you end up with 5 years (instead of 10 years) by confessing So you confess, as does your partner (he faces the same dilemma), and you end up with 5 years each (instead of 2 years if you both deny the crime) Economists think of the Prisoners Dilemma as a classic Game Theory situation your payoff in the game depends on both your decision and the other persons decision. We treat this as a game and look at outcomes based on decisions. Collective well-being vs. individual well-being So lets construct a payoff matrix representing outcomes based on decisions: www.notesolution.com
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