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Chapter 11

ECON 1B03 Chapter Notes - Chapter 11: Nash Equilibrium, Competitive Equilibrium, Oligopoly

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Hannah Holmes

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Chapter 11: Oligopoly
Characterized by a few only a few, usually big firms selling homogenous products
These firms are independent
o The actions of one firms affects the profits of others
Examples include sugar industry, soft drinks, big oil companies and tobacco companies
There are barriers to entry in oligopolistic markets
o Set-up costs could be prohibitively high and deter entry
o Firms might behave in a way that new firms would not be able to compare
Existing firms can produce more than their profit-maximizing output level
in order to flood the market and sell cheap
If firms could enter the market freely to capitalize on positive economic profit, the
market would look like a perfectly competitive market
o Many firms would produce identical products
o Entry would reduce the price down to approach marginal cost (MC) and the
quantity would approach the competitive equilibrium quantity
o Firms would see their profits go to zero economic profits in the long run (LR)
Oligopolistic firms want to limit entry into their industry so they can preserve their
market shares and maintain positive economic profits
Some firms will act cooperatively and collude to fix prices or market output levels
o If firms manage to cooperate, its tacit collusion so any dealings won’t be traced
Colluding firms form a cartel
o Best known is OPEC
Collusive agreements among firms are hard to maintain
Collusion requires firms to think in terms of joint action and joint profits
o Using common sense, we know that firms will most likely act in their own self-
There will always be temptation for any firm to cheat on the agreement and increase its
profit at the expense of other firms
Is a market with two firms
Nash Equilibrium
No one can independently make themselves better off by changing their strategy
You cant gain by changing what you are currently doing if no one else changes too
Everyone’s strategy is their best strategy depending on everyone else’s strategy
Prisoners Dilemma
When the inability of two firms to cooperative is illustrated as a game
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