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Lecture 21

Economics 1021A/B Lecture Notes - Lecture 21: Oligopoly, Game Theory, Strategic DominancePremium

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ECON 1021A/B

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Economics 1021 Khan Lecture 21
What Is Oligopoly?
Oligopoly is a market structure in which
Natural or legal barriers prevent the entry of new firms
A small number of firms compete
Barriers to Entry
Either natural or legal barriers to entry an create oligopoly
In part (a), there is a natural duopoly a market with two firms.
In part (b), there is a natural oligopoly market with three firms
A legal oligopoly might arise even where demand and costs leave room for a larger
number of firms
Small Numbers of Firms
Because an oligopoly market has only a few firms, they are interdependent and face a
temptation to cooperate
Interdependence: With a small number of firms, each firm’s profit depends on every
firm’s actions
Temptation to Cooperate: Firms in oligopoly face the temptation to form a cartel
A cartel is a group of firms acting together to limit output raise price, and increase profit.
Cartels are illegal.
Oligopoly Games
What Is a Game?
Game theory
A tool for studying strategic behavior
Strategic behavior considers the expected behavior to others and the mutual
recognition of interdependence
All games have four common features:

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The rules describe the setting of he game, the actions the players may take, and the
consequences of those actions
Strategies are all the possible actions of each player
Each player can take two possible actions:
With two players and two actions for each player, there are four possible outcomes:
1. Both confess
2. Both deny
3. Art confesses and Bob denies
4. Bob confesses and Art denies
Each player can consider their respective payoffs in each of the four possible outcomes
We can tabulate these outcomes in a payoff matrix
A payoff matrix is a table that shows the payoffs for every possible action by each
player for every possible action by the other player
A player behaving rationally (in pursuit of their own best interest), chooses the best
possible action given all possible actions taken by the other player
If both players are rational and choose their actions in this way, the outcome is an
equilibrium called a Nash Equilibrium first proposed by John Nash
Nash Equilibrium
- Player A takes the best possible action given the action of player B
- Player B takes the best possible action given the action of player A
This game is called “Prisoners’ Dilemma” (see text)
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