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Economics 1021A/B
Jeannie Gillmore

Chapter 15 Notes Oligopoly  natural or legal barriers prevent the entry of new firms o a legal oligopoly arises when a legal barrier to entry protects the small number of firms in a market  e/x a city might license two taxi firms or two bus companies, even though the combination of demand and economies of scale leaves room for more than two firms o a natural oligopoly arises when two (duopoly) firms can supply the whole market  small number of firms compete o interdependence  with a small number of firms in a market, each firm’s actions influence the profits of all the other firms o temptation to cooperate  when a small number of firms share a market, they can increase their profits by forming a cartel and acting like a monopoly  a cartel is a group of firms acting together (colluding) to limit output, raise price, and increase economic profit  cartels are illegal, but they do operate in some markets Oligopoly Price-Fixing Game  two firms (Trick and Gear) produce identical products o identical costs o a firms product is a perfect substitute for the other firms product o this firm is a natural duopoly, for each firm, ATC is at its minimum when production 3000 units a week  when price equals minimum ATC, the total quantity demanded is 6000 units, and the two firms can just produce this quantity  collusion o a collusive agreement is an agreement between two (or more) producers to form a cartel to restrict output, raise the price, and increase profits o two strategies that firms in a cartel can pursue: comply, cheat  a firm that complies carries out the agreement  a firm that cheats breaks the agreement to its own benefit and to the cost of the other firm  colluding to maximize profits o profit is calculated the same way is it is with a monopoly o the only thing that firms in duopoly must do beyond what a monopoly does is to agree on how much of the total output each of them will produce  one firm cheats on a collusive agreement o industry output is larger than the monopoly output, and price is lower than the monopoly price o total economic profit made by the industry is smaller than the monopoly’s economic profit o economic profit distribution is uneven, and depends on how much more one firm increased their production  both firms cheat o both firms will continue to increase production to the point when price equals marginal cost o the market operates at the point at which the market demand curve intersects the industry marginal cost curve o each firm makes zero economic profit  Nash Equilibrium in the Duopolists’ Dilemma o Nash equilibrium is for both firms to cheat  they will charge the same price and produce the same quantity as those in a competitive industry  both will make zero economic profit  John Nash claimed that he had challenged Adam Smith’s idea that we are always guided, as if by an invisible hand, to promote the social interest when we are pursuing our-self interest o Nash Equilibrium  it is in neither player’s self-interest to cooperate if the other one cooperates Economic Game of Chicken  created when R&D creates a new technology that cannot be kept secret or patented, so both firms benefit from the R&D of either firm o the chicken in this case is the firm that does the R&D  Example: Apple and Nokia o both spend $9 million developing a new touch-screen technology that would end up being able to use regardless of which of them developed it o one firm doing R&D isn’t a Nash equilibrium because one firm would be better off doing it  both firms doing R&D isn’t a Nash equilibrium because one firm would be better off not doing it  to decide which firm does the R&D, the firms might toss a coin, called a mixed strategy Repeated Duopoly Game  if two firms play a game repeatedly, one firm has the opportunity to penalize the other for previous “bad” behaviour  Example: if Gear cheats thi
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