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Chapter 17

Chapter 17 Economics.docx

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Harvard University
Economics 10a
Gregory Mankiw

Chapter 17 Economics: Oligopoly • Oligopoly: a market structure in which only a few sellers offer similar or identical products o Firms are interdependent; the actions of one seller will deeply impact another seller • Game theory: the study of how people behave in strategic situations o Strategica firm considers others’responses to his course of action o Each firm in an oligopoly knows that its profits depend not only on how much it produces, but also how much others produce • Oligopolies have tension between cooperation and self-interestoligopolists are best off when they work together and act like a monopolist, producing a small quantity of output and charging a price above marginal cost • Duopoloy: an oligopoly with only two members o Downward sloping demand curve • Collusion: an agreement among firms in a market about quantities to produce or prices to chargeusually agree on a monopoly outcome because that outcome maximized the total profit that producers can get from the market • Cartel: a group of firms acting in unison; the market is transformed into a monopoly o Each member will want a larger market share because that means a larger profit o Sellers reach an agreement to maximize total profits by producing the monopoly quantity o Reaching and enforcing an agreement becomes more difficult as size increases • Antitrust laws prohibit explicit agreements among oligopolists • Nash equilibrium: a situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen o There is no incentive to make a different decision o Oligopolists would be better off if they reach the monopoly outcome by cooperating o Because firms pursue their own self-interest, they do not end up reaching the monopoly outcome and maximizing their joint profit o Each oligopolist is tempted to raise production and capture a larger market sharetotal production rises, but price falls o Oligopolists are aware that increasing the amount that they produce reduces the price of the productwhich decreases profitsthey don’t produce up to where P=MC o When firms in an oligopoly individually choose production to maximize profit, they produce a quantity of output greater than the level produced by monopoly and less than the level produced by competition • In making the production decision, firm owners have to consider: o The output effect: Because price is above marginal cost, selling one more unit at the going price will raise profits o The price effect: Raising production will increase the total amount sold, which will lower the price of the good and lower the profit on all the other units sold o Output effect > Price effect: production will increase o Output effect < Price effect: production will not be raised and should be reduced o Each oligopolist continues to increase production until these two marginal effects exactly balance • The larger the number of sellers, the less each seller is concerned about its own impact on the market pricethe magnitude of the price effect fallsa firm increases production as long as price is above marginal cost o It looks more and more like a group of competitive firms, which only consider the output effect • As the number of sellers in an oligopoly grows larger, an oligopolist market looks more and more like a competitive market.
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