Oligopoly: A market structure in which:
o Natural or legal barriers prevent the entry of new firms.
Natural oligopoly: A natural barrier stops firms due to mismatch in demand and price.
Legal monopoly: A legal barrier to entry protects the small number of firms in the market.
Duopoly: An oligopoly market with only two firms.
If there is 1 firm in the market, it makes an economic profit until a second firm enters.
If there are 3 firms in the market, all firms make an economic loss until a firm leaves.
o A small number of firms compete.
Each firm’s actions influence the profits of all the other firms.
There is temptation to create a cartel (group of firms acting together to limit output, raise
prices, and increase profit).
o May produce identical products and compete on prices, or differentiate products and compete on price,
product quality, and marketing.
Game theory: A set of tools for studying strategic behaviour that the expected behaviour of others and the
recognition of mutual interdependence.
Game: All games share four common features:
o Strategies (the possible actions of each player)
o (A) and (B) have been caught for petty stealing and is to receive 2 years in prison, but the attorney
believes that they may be responsible for a larger theft. He cannot charge them without confessions.
Each prisoner is placed in separate rooms and is not allowed to communicate.
Each is told that he is suspected of a larger crime
If both of them confess to the larger crime, each will receive 3 years in prison.
If he alone confesses and his accomplice does not, he will receive 1 year in prison, while his
accomplice will receive 10 years in prison.
o Strategy: Since there are two prisoners, the possible outcomes are:
Both deny. (A) confesses and (B) denies.
(B) confesses and (a) denies.
Payoff matrix: A table that shows the payoffs for
every possible action by each prison for every
possible action by each other player.
o Outcome: The combination of both prisoners’ choices
Nash equilibrium / Dominant-strategy equilibrium:
(A) takes the best possible action given the action of (B)
(B) takes the best possible action given the action of (A)
From (A)’s point of view,
If (B) confesses, (A)’s best action is to confess.
If (B) does not confess, (A)’s best action is to confess. (vice versa)
The best strategy of each prisoner is to confess regardless of the strategy of the other player.
For the prisoners, the equilibrium of the game is not the best outcome.
Oligopoly Price-Fixing Game:
o Two firms (T) and (G) produce gears. They produce identical gear (perfect substitutes), and they have
identical costs and market prices in a natural duopoly.
o Suppose that (T) and (G) enter a collusive agreement (an agreement between firms to form a cartel to