oligopoly essay grade 10

Definition of oligopoly

An oligopoly is an industry dominated by a few large firms. For example, an industry with a five-firm concentration ratio of greater than 50% is considered an oligopoly.

Examples of oligopolies

Car industry – economies of scale have caused mergers so big multinationals dominate the market. The biggest car firms include Toyota, Hyundai, Ford, General Motors, VW.

• Petrol retail – see below.
• Pharmaceutical industry
• Coffee shop retail – Starbucks, Costa Coffee, Cafe Nero
• Newspapers – In the UK market share is dominated by tabloids Daily Mail, The Sun, The Mirror, The Star, Daily Express.
• Book retail – In the UK market share is dominated by Waterstones, Amazon and smaller firms like Blackwells.

The main features of oligopoly

• An industry which is dominated by a few firms.

The UK definition of an oligopoly is a five-firm concentration ratio of more than 50% (this means the five biggest firms have more than 50% of the total market share) The above industry (UK petrol) is an example of an oligopoly. See also: Concentration ratios

• Interdependence of firms – companies will be affected by how other firms set price and output.
• Barriers to entry. In an oligopoly, there must be some barriers to entry to enable firms to gain a significant market share. These barriers to entry may include brand loyalty or economies of scale. However, barriers to entry are less than monopoly.
• Differentiated products. In an oligopoly, firms often compete on non-price competition . This makes advertising and the quality of the product are often important.
• Oligopoly is the most common market structure

How firms compete in oligopoly

There are different possible ways that firms in oligopoly will compete and behave this will depend upon:

• The objectives of the firms; e.g. profit maximisation or sales maximisation?
• The degree of contestability; i.e. barriers to entry.
• Government regulation.

There are different possible outcomes for oligopoly:

• Stable prices (e.g. through kinked demand curve) – firms concentrate on non-price competition.
• Price wars (competitive oligopoly)
• Collusion- leading to higher prices.

The kinked demand curve model

This model suggests that prices will be fairly stable and there is little incentive for firms to change prices. Therefore, firms compete using non-price competition methods.

• This assumes that firms seek to maximise profits.
• If they increase the price, then they will lose a large share of the market because they become uncompetitive compared to other firms. Therefore demand is elastic for price increases.
• If firms cut price then they would gain a big increase in market share. However, it is unlikely that firms will allow this. Therefore other firms follow suit and cut-price as well. Therefore demand will only increase by a small amount. Therefore demand is inelastic for a price cut.
• Therefore this suggests that prices will be rigid in oligopoly

The diagram above suggests that a change in marginal cost still leads to the same price, because of the kinked demand curve.  Profit maximisation occurs where MR = MC at Q1.

Evaluation of kinked demand curve

• In the real world, prices do change.
• Firms may not seek to maximise profits,  but prefer to increase market share and so be willing to cut prices, even with inelastic demand.
• Some firms may have very strong brand loyalty and be able to increase the price without demand being very price elastic.
• The model doesn’t suggest how prices were arrived at in the first place.

Firms in an oligopoly may still be very competitive on price, especially if they are seeking to increase market share. In some circumstances, we can see oligopolies where firms are seeking to cut prices and increase competitiveness.

A feature of many oligopolies is selective price wars. For example, supermarkets often compete on the price of some goods (bread/special offers) but set high prices for other goods, such as luxury cake.

• Another possibility for firms in oligopoly is for them to collude on price and set profit maximising levels of output. This maximises profit for the industry.

In the above example, the industry was initially competitive (Qc and Pc). However, if firms collude, they can agree to restrict industry supply to Q2, and increase the price to P2. This enables the industry to become more profitable. At Qc, firms made normal profit. But, if they can stick to their quotas and keep the price at P2, they make supernormal profit.

• Collusion is illegal, but tacit collusion may be hard to spot.
• For collusion to be effective, there need to be barriers to entry.
• A cartel is a formal collusive agreement. For example, OPEC is a cartel seeking to control the price of oil.

See: Collusion

Collusion and game theory

Game theory is looking at the decisions of firms based on the uncertainty of how other firms will react. It illustrates the concept of interdependence. For example, if a firm agrees to collude and set low output – it relies on the other firm sticking to the collusive agreement. If the firm restricts output (sets the High price), and then the other firm betrays its agreement (setting low price). The firm will be worse off.

• This shows different options. If the market is non-collusive, firms make £4m each.
• If they collude, they make £8m.
• But, if they are colluding there is an incentive for one of the firms to exceed quota and increase output. If a firm sets low price whilst the other sets a high price, their profit rises to £10m

Collusion and game theory is more complex if we add in the possibility of firms being fined by a government regulator.

Collusion is illegal and firms can be fined. Usually, the first firm that confesses to the regulator is protected from prosecution, so there is always an incentive to be the first to confess.

• Pricing strategies
• Diagrams for oligopoly
• Game Theory

By now, you are already aware of three market forms – perfect competition , monopoly , and monopolistic competition. However, in the real world economies, most industries are oligopolistic.  In this article, we will look at the types of oligopoly and characteristics of an Oligopoly.

Oligopoly is a form of imperfect competition and is usually described as the competition among a few. Hence, Oligopoly exists when there are two to ten sellers in a market selling homogeneous or differentiated products. A good example of an Oligopoly is the cold drinks industry. In India , there are a handful of firms who manufacture cold drinks. These firms sell homogeneous as well as differentiated products in the market.

Types of Oligopoly

Pure or perfect.

One of the types of oligopoly is the perfect oligopoly. This occurs when the product is homogeneous in nature (e.g. Aluminum industry ).

Differentiated or Imperfect

Another of the types of oligopoly is an imperfect oligopoly. This occurs when product differentiation exists (e.g. Talcum powder industry).

Open and Closed

• Open – New firms can enter the market and compete with existing firms.
• Closed – Entry into the market is restricted.

Collusive and Competitive

• Collusive – This occurs when few firms come to an understanding with respect to the price and output of the products .
• Competitive – This occurs when there is a lack of understanding between the firms and they invariable compete with each other.

Partial or Full

• Partial – This occurs when one large firm dominates the industry. Also, this firm is the price leader.
• Full – This occurs when there is no price leadership in the market.

Syndicated and Organized

• Syndicated – The situation where the firms sell their products through a centralized syndicate.
• Organized – The situation where the firms create a central association to fix prices, quotas, output, etc.

Characteristics of Oligopoly Market

(Source: oecd.org)

1. Interdependence

The interdependence in the decision-making of the few firms that make the industry is the most important characteristic of an oligopolistic market. This is important because, when the competitors are few, if a firm makes a small change in price, output, etc., it can have a direct impact on its rivals.

In retaliation, the competitors might change their own prices, output, etc. too. Hence, it is important for firms to consider the impact of the major decisions they take on the market as well as the other firms in the industry.

2. Importance of advertising and selling costs

Due to interdependence, firms have to employ aggressive and defensive marketing techniques to gain a bigger share of the market. Hence, firms incur a lot of costs in marketing and promotional activities.

Therefore, in an oligopolistic market, advertising and selling costs have great importance.

Usually, firms from such a market avoid price cutting and try to compete on the non-price factors. If they start under-cutting one another, soon a price-war can emerge, driving some firms out of the market.

3. Group Behavior

The crux of oligopoly is group behaviour. If an oligopolist assumes profit-maximizing behaviour, then he goes against the fundamentals of an oligopolistic market.

However, there is no generally accepted theory of group behaviour. Some questions that require answers are:

• Do the members of a group agree to pull together in the promotion of common interest or do they fight to promote their individual interests?
• Does the group have a leader?
• If yes, how does he get others to follow him?

However, one thing as certain – each firm closely observes the behaviour of other firms in the industry. If then designs its moves based on the observation.

Solved Question on Types of Oligopoly

Q1. In types of oligopoly, Pure oligopoly is based on the _____________ products

• differentiated
• homogeneous
• none of the above

According to the definition, pure or perfect oligopoly occurs when the product is homogeneous in nature. Hence, the correct answer is option b.

Customize your course in 30 seconds

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Determination of Prices

• Kinked Demand Curve
• Monopolistic Competition
• Price Discrimination
• Monopolist’s Revenue Curve
• Monopoly Market
• Long Run Equilibrium of Competitive Firm and Industry
• Price Determination under Perfect Competition
• Features of Perfect Competition
• Simultaneous Changes in Demand and Supply

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10 Oligopoly

10.1 theory of the oligopoly, why do oligopolies exist.

Many purchases that individuals make at the retail level are produced in markets that are neither perfectly competitive, monopolies, nor monopolistically competitive. Rather, they are oligopolies. Oligopoly arises when a small number of large firms have all or most of the sales in an industry. Examples of oligopoly abound and include the auto industry, cable television, and commercial air travel. Oligopolistic firms are like cats in a bag. They can either scratch each other to pieces or cuddle up and get comfortable with one another. If oligopolists compete hard, they may end up acting very much like perfect competitors, driving down costs and leading to zero profits for all. If oligopolists collude with each other, they may effectively act like a monopoly and succeed in pushing up prices and earning consistently high levels of profit. We typically characterize oligopolies by mutual interdependence where various decisions such as output, price, and advertising depend on other firm(s)’ decisions. Analyzing the choices of oligopolistic firms about pricing and quantity produced involves considering the pros and cons of competition versus collusion at a given point in time.

A combination of the barriers to entry that create monopolies and the product differentiation that characterizes monopolistic competition can create the setting for an oligopoly. For example, when a government grants a patent for an invention to one firm, it may create a monopoly. When the government grants patents to, for example, three different pharmaceutical companies that each has its own drug for reducing high blood pressure, those three firms may become an oligopoly.

Similarly, a natural monopoly will arise when the quantity demanded in a market is only large enough for a single firm to operate at the minimum of the long-run average cost curve. In such a setting, the market has room for only one firm, because no smaller firm can operate at a low enough average cost to compete, and no larger firm could sell what it produced given the quantity demanded in the market.

Quantity demanded in the market may also be two or three times the quantity needed to produce at the minimum of the average cost curve—which means that the market would have room for only two or three oligopoly firms (and they need not produce differentiated products). Again, smaller firms would have higher average costs and be unable to compete, while additional large firms would produce such a high quantity that they would not be able to sell it at a profitable price. This combination of economies of scale and market demand creates the barrier to entry, which led to the Boeing-Airbus oligopoly (also called a duopoly) for large passenger aircraft.

The product differentiation at the heart of monopolistic competition can also play a role in creating oligopoly. For example, firms may need to reach a certain minimum size before they are able to spend enough on advertising and marketing to create a recognizable brand name. The problem in competing with, say, Coca-Cola or Pepsi is not that producing fizzy drinks is technologically difficult, but rather that creating a brand name and marketing effort to equal Coke or Pepsi is an enormous task.

The existence of oligopolies can lead to the combination of many firms into larger firms. This is discussed next.

Types of Firm Integration

Conglomerate.

From: Wikipedia: Conglomerate (company)

A  conglomerate  is a combination of multiple  business entities  operating in entirely different industries under one  corporate group , usually involving a  parent company  and many  subsidiaries . Often, a conglomerate is a  multi-industry company . Conglomerates are often large and  multinational .

Horizontal Integration

From: Wikipedia: Horizontal integration

Horizontal integration  is the process of a  company  increasing  production  of goods or services at the same part of the  supply chain . A company may do this via internal expansion,  acquisition or merger . [1] [2] [3]

The process can lead to  monopoly  if a company captures the vast majority of the market for that product or service. [3]

Horizontal integration contrasts with  vertical integration , where companies integrate multiple stages of production of a small number of production units.

Benefits of horizontal integration to both the firm and society may include  economies of scale  and  economies of scope . For the firm, horizontal integration may provide a strengthened presence in the reference market. It may also allow the horizontally integrated firm to engage in  monopoly pricing , which is disadvantageous to society as a whole and which may cause regulators to ban or constrain horizontal integration. [5]

An example of horizontal integration in the food industry was the  Heinz  and  Kraft Foods  merger. On March 25, 2015, Heinz and Kraft merged into one company, the deal valued at $46 Billion. [8] [9]  Both produce processed food for the consumer market.

On November 16, 2015,  Marriott International  announced that it would purchase  Starwood Hotels  for $13.6 billion, creating the world’s largest hotel chain once the deal closed. [11]  The merger was finalized on September 23, 2016. [12]

AB-Inbev acquisition of SAB Miller for $107 Billion which completed in 2016, is one of the biggest deals of all time. [13]

Vertical Integration

From: Wikipedia: Vertical integration

In  microeconomics  and  management ,  vertical integration  is an arrangement in which the  supply chain  of a company is owned by that company. Usually each member of the supply chain produces a different  product  or (market-specific) service, and the products combine to satisfy a common need. It is contrasted with  horizontal integration , wherein a company produces several items which are related to one another. Vertical integration has also described  management styles  that bring large portions of the supply chain not only under a common ownership, but also into one  corporation  (as in the 1920s when the  Ford River Rouge Complex  began making much of its own steel rather than buying it from suppliers).

Vertical integration and expansion is desired because it secures the supplies needed by the firm to produce its product and the market needed to sell the product. Vertical integration and expansion can become undesirable when its actions become anti-competitive and impede free competition in an open marketplace. Vertical integration is one method of avoiding the  hold-up problem . A monopoly produced through vertical integration is called a  vertical monopoly .

Vertical integration is often closely associated to vertical expansion which, in  economics , is the growth of a business enterprise through the  acquisition  of companies that produce the intermediate goods needed by the business or help market and distribute its product. Such expansion is desired because it secures the supplies needed by the  firm  to produce its product and the market needed to sell the product. Such expansion can become undesirable when its actions become  anti-competitive  and impede free competition in an open marketplace.

The result is a more efficient business with lower costs and more profits. On the undesirable side, when vertical expansion leads toward  monopolistic  control of a product or service then regulative action may be required to rectify anti-competitive behavior. Related to vertical expansion is  lateral expansion , which is the growth of a business enterprise through the acquisition of similar firms, in the hope of achieving  economies of scale .

Vertical expansion is also known as a vertical acquisition. Vertical expansion or acquisitions can also be used to increase scales and to gain market power. The acquisition of  DirecTV  by  News Corporation  is an example of forward vertical expansion or acquisition. DirecTV is a  satellite TV  company through which News Corporation can distribute more of its media content: news, movies and television shows. The acquisition of  NBC  by  Comcast  is an example of backward vertical integration. For example, in the United States, protecting the public from communications monopolies that can be built in this way is one of the missions of the  Federal Communications Commission .

One of the earliest, largest and most famous examples of vertical integration was the  Carnegie Steel  company. The company controlled not only the mills where the  steel  was made, but also the mines where the  iron ore  was extracted, the coal mines that supplied the  coal , the ships that transported the iron ore and the railroads that transported the coal to the factory, the  coke  ovens where the coal was cooked, etc. The company focused heavily on developing talent internally from the bottom up, rather than importing it from other companies. Later, Carnegie established  an institute  of higher learning to teach the steel processes to the next generation.

Oil companies , both multinational (such as  ExxonMobil ,  Royal Dutch Shell ,  ConocoPhillips  or  BP ) and national (e.g.,  Petronas ) often adopt a vertically integrated structure, meaning that they are active along the entire supply chain from  locating deposits , drilling and extracting  crude oil , transporting it around the world,  refining  it into petroleum products such as  petrol/gasoline , to distributing the fuel to company-owned retail stations, for sale to consumers.

Lateral Integration

Lateral expansion , in  economics , is the growth of a business enterprise through the acquisition of similar companies, in the hope of achieving  economies of scale  or  economies of scope . Unchecked lateral expansion can lead to powerful  conglomerates  or  monopolies .

Lateral integration differs from horizontal integration as the integration is not exact. For example, one of the examples of horizontal integration was one hotel chain buying another. This did not enhance the company’s product offerings other than having more hotel options.

On the other hand, Parker Hannifin acquired Lord Corporation. While the two companies make similar types of products, their product offerings were distinct. There was not much overlap with the types of products offered. Instead, Parker Hannifin was not able to provide a far greater product offering in the given sectors.

The Strength of an Oligopoly

From: Wikipedia: Concentration ratio

The most common concentration ratios are the CR 4  and the CR 8 , which means the market share of the four and the eight largest firms. Concentration ratios are usually used to show the extent of market control of the largest firms in the industry and to illustrate the degree to which an industry is  oligopolistic . [1]

N-firm concentration ratio is a common measure of market structure and shows the combined market share of the N largest firms in the market. For example, the 5-firm concentration ratio in the UK pesticide industry is 0.75, which indicates that the combined market share of the five largest pesticide sellers in the UK is about 75%. N-firm concentration ratio does not reflect changes in the size of the largest firms.

Concentration ratios range from 0 to 100 percent. The levels reach from  no, low  or  medium  to  high  to “total” concentration

Perfect competition

If there are  N  firms in an industry and we are looking at the top  n  of them, equal market share for all of them means that CR n  =  n/N . All other possible values will be greater than this.

No concentration

If CR n  is close to 0%, (which is only possible for quite a large number of firms in the industry  N ) this means  perfect competition  or at the very least  monopolistic competition . If for example CR 4 =0 %, the four largest firm in the industry would not have any significant market share.

Low concentration

0% to 40%. [5]  This category ranges from perfect competition to an oligopoly.

Medium concentration

40% to 70%. [5]  An industry in this range is likely an oligopoly.

High concentration

70% to 100%. [5]  This category ranges from an oligopoly to monopoly.

Total concentration

100% means an extremely concentrated  oligopoly . If for example CR 1 = 100%, there is a  monopoly .

10.2 Game theory

Game theory basics, dominant versus non-dominant strategies.

From: Wikipedia: Cooperative game theory

In game theory , a cooperative game (or coalitional game ) is a game with competition between groups of players (“coalitions”) due to the possibility of external enforcement of cooperative behavior (e.g. through contract law ). Those are opposed to non-cooperative games in which there is either no possibility to forge alliances or all agreements need to be self-enforcing (e.g. through credible threats ). [1]

Cooperative games are often analysed through the framework of cooperative game theory, which focuses on predicting which coalitions will form, the joint actions that groups take and the resulting collective payoffs. It is opposed to the traditional non-cooperative game theory which focuses on predicting individual players’ actions and payoffs and analyzing Nash equilibria . [2] [3]

Cooperative game theory provides a high-level approach as it only describes the structure, strategies and payoffs of coalitions, whereas non-cooperative game theory also looks at how bargaining procedures will affect the distribution of payoffs within each coalition. As non-cooperative game theory is more general, cooperative games can be analyzed through the approach of non-cooperative game theory (the converse does not hold) provided that sufficient assumptions are made to encompass all the possible strategies available to players due to the possibility of external enforcement of cooperation. While it would thus be possible to have all games expressed under a non-cooperative framework, in many instances insufficient information is available to accurately model the formal procedures available to the players during the strategic bargaining process, or the resulting model would be of too high complexity to offer a practical tool in the real world. In such cases, cooperative game theory provides a simplified approach that allows the analysis of the game at large without having to make any assumption about bargaining powers.

Types of Strategies

General strategy.

This is simply any rule that a player uses. These strategies can be “good” or “bad.” For example, if you have to choose heads or tails for a coinflip, you may use the strategy “tails never fails” and always pick tails even though there is no advantage to this strategy. Additionally, when playing the game of Blackjack, you may have a rule that you always hit when you have a score of 20. If you do not know how to play Blackjack, I will simply state that this is generally a very, very bad idea! Even though it is a poor strategy, it is still a strategy nonetheless.

Dominant Strategy

From: Wikipedia: Strategic dominance

In game theory , strategic dominance (commonly called simply dominance ) occurs when one strategy is better than another strategy for one player, no matter how that player’s opponents may play. Many simple games can be solved using dominance.

Nash Equilibrium

From: Wikipedia: Nash equilibrium

In terms of game theory, if each player has chosen a strategy, and no player can benefit by changing strategies while the other players keep theirs unchanged, then the current set of strategy choices and their corresponding payoffs constitutes a Nash equilibrium.

Stated simply, Alice and Bob are in Nash equilibrium if Alice is making the best decision she can, taking into account Bob’s decision while his decision remains unchanged, and Bob is making the best decision he can, taking into account Alice’s decision while her decision remains unchanged. Likewise, a group of players are in Nash equilibrium if each one is making the best decision possible, taking into account the decisions of the others in the game as long as the other parties’ decisions remain unchanged.

Informally, a strategy profile is a Nash equilibrium if no player can do better by unilaterally changing his or her strategy. To see what this means, imagine that each player is told the strategies of the others. Suppose then that each player asks themselves: “Knowing the strategies of the other players, and treating the strategies of the other players as set in stone, can I benefit by changing my strategy?”

If any player could answer “Yes”, then that set of strategies is not a Nash equilibrium. But if every player prefers not to switch (or is indifferent between switching and not) then the strategy profile is a Nash equilibrium. Thus, each strategy in a Nash equilibrium is a best response to all other strategies in that equilibrium. [13]

The Nash equilibrium may sometimes appear non-rational in a third-person perspective. This is because a Nash equilibrium is not necessarily Pareto optimal . [Note: We do not talk about Pareto optimality in this class, but you can think of it as a best-case for everyone situation.]

The Prisoner’s Dilemma

From: Wikipedia: Prisoner’s dilemma

The prisoner’s dilemma is a standard example of a game analyzed in game theory that shows why two completely rational individuals might not cooperate, even if it appears that it is in their best interests to do so. It was originally framed by Merrill Flood and Melvin Dresher while working at RAND in 1950. Albert W. Tucker formalized the game with prison sentence rewards and named it “prisoner’s dilemma”, [1] presenting it as follows:

Two members of a criminal gang are arrested and imprisoned. Each prisoner is in solitary confinement with no means of communicating with the other. The prosecutors lack sufficient evidence to convict the pair on the principal charge, but they have enough to convict both on a lesser charge. Simultaneously, the prosecutors offer each prisoner a bargain. Each prisoner is given the opportunity either to betray the other by testifying that the other committed the crime, or to cooperate with the other by remaining silent. The offer is: If A and B each betray the other, each of them serves two years in prison If A betrays B but B remains silent, A will be set free and B will serve three years in prison (and vice versa) If A and B both remain silent, both of them will serve only one year in prison (on the lesser charge).

It is implied that the prisoners will have no opportunity to reward or punish their partner other than the prison sentences they get and that their decision will not affect their reputation in the future. Because betraying a partner offers a greater reward than cooperating with them, all purely rational self-interested prisoners will betray the other, meaning the only possible outcome for two purely rational prisoners is for them to betray each other. [2] The interesting part of this result is that pursuing individual reward logically leads both of the prisoners to betray when they would get a better individual reward if they both kept silent. In reality, humans display a systemic bias towards cooperative behavior in this and similar games despite what is predicted by simple models of “rational” self-interested action. [3] [4] [5] [6] This bias towards cooperation has been known since the test was first conducted at RAND; the secretaries involved trusted each other and worked together for the best common outcome. [7]

The prisoner’s dilemma game can be used as a model for many real world situations involving cooperative behavior. In casual usage, the label “prisoner’s dilemma” may be applied to situations not strictly matching the formal criteria of the classic or iterative games: for instance, those in which two entities could gain important benefits from cooperating or suffer from the failure to do so, but find it difficult or expensive—not necessarily impossible—to coordinate their activities.

Game Tables

In the game above, we need some way to display all of the information in a condensed format. To accomplish this, we use a game table. For the sake of displaying the game tables in an accessible manner, I will use the following format:

You will see that the information is exactly the same as the information presented. For example, if A stays silent, but B betrays, we would be in the top, right payout cell (which is -3,0).

The next question is what the “best” outcome is. We will examine that but going back to the two strategies discussed earlier.

Solving Prisoner’s Dilemma with Dominant Strategy

The iterated elimination (or deletion) of dominated strategies (also denominated as IESDS or IDSDS) is one common technique for solving games that involves iteratively removing dominated strategies. In the first step, at most one dominated strategy is removed from the strategy space of each of the players since no rational player would ever play these strategies. This results in a new, smaller game. Some strategies—that were not dominated before—may be dominated in the smaller game. The first step is repeated, creating a new even smaller game, and so on. The process stops when no dominated strategy is found for any player. This process is valid since it is assumed that rationality among players is common knowledge , that is, each player knows that the rest of the players are rational, and each player knows that the rest of the players know that he knows that the rest of the players are rational, and so on ad infinitum (see Aumann, 1976).

There are two versions of this process. One version involves only eliminating strictly dominated strategies. If, after completing this process, there is only one strategy for each player remaining, that strategy set is the unique Nash equilibrium [2] . This will be discussed next.

You can use the following set of steps:

• Pick one person (it doesn’t matter).
• If their opponent picks choice A, what will your person pick?
• If their opponent picks choice B, what will your person pick?
• If you choose the same thing for both of your opponent’s choices, then that is the dominant strategy. We say that choice strictly dominates the other choice and you can cross off the strictly dominated strategy.
• Repeat for the opponent (this should be easier).
• If the choices are different, there is no dominant strategy

Let us return to the prisoner’s dilemma game table. Let us act as player A and decide what player A would do in a variety of situations.

If player B stays silent, what should we do as player A? If we stay silent, then we would lose 1 (meaning one year in prison.) If we betray, we earn 0. In this case we should betray as no prison is better than one year in prison.

If player B betrays, what should we do as player A? If we stay silent, then we get three years in prison. If we betray, we get two years in prison. In this case, we should betray as two years in prison is better than 3 years in prison.

Therefore, the dominant strategy for player A is to betray. This is because regardless of what player B chooses to do, player A’s best choice is to betray. We can therefore eliminate “A-stay silent” since player A will not stay silent.

We can now move to player B to see if there is a dominant strategy for player B. It should be noted that, in theory, there does not need to be, but with our games there will be (if player A has one.) So, now let us play our modified game as player B.

If player A chooses to stay silent – STOP! – what did we just discuss? Player A will not choose to stay silent, so we do not need to worry about this. So, if player A chooses to betray, what should we do as player B? If we stay silent, we get three years in prison whereas we only get two years in prison if we betray. Therefore, player B should betray.

Thus, the dominant strategy for this game is (A,B)=(Betray,Betray).

There are additional exercises in the companion. Each player can have either 0 or 1 dominant strategies.

Solving Prisoner’s Dilemma with Nash Equilibrium

As mentioned earlier, we are looking for a stable solution. That is, a situation where neither player has an incentive to change their choice based on the other player’s choice. To find the Nash Equilibrium, you can follow these steps:

• Choose a player (again, it doesn’t matter which).
• Pick a choice (it doesn’t matter which).
• Based on your choice, what will the opponent pick?
• Based on what your opponent picks, what would you pick?
• If it is the same as your original choice, it is a Nash Equilibrium. If not, it is not a Nash Equilibrium.
• Repeat for the other choice(s).

So, let us return to our game. Without loss of generality, let us play as player A. It should be noted that playing as player B will yield the same exact results.

As player A, let us begin by staying silent. What will player B do? Player B can either stay silent (one year in prison) or betray (0 years in prison.) Player B will betray. Now, since we know that player B will betray, what should player A do? If player A stays silent, we get 3 years in prison but if we betray we only get two years in prison. Thus, we, as player A, should betray. But this is different from where we started, thus we do not have a Nash Equilibrium. The chain for this event is:

A: Silent >> B: Betray >> A: Betray — A has changed their choice, not a Nash Equilibrium.

Now, as player A, let us start by betraying. If we betray, player B can either stay silent (3 years in prison) or betray (2 years in prison.) Thus, player B will betray. When player B betrays, what should we do? We can either stay silent (3 years in prison) or betray (2 years in prison.) Thus, we betray. This is exactly where we started, thus, we have a Nash Equilibrium. In fact, we could continue to do this forever and the chain would stay exactly the same. The chain for this scenario is:

A: Betray >> B: Betray >> A: Betray — A has kept their choice the same, so A:Betray, B:Betray is a Nash Equilibrium.

10.3 Cartels and Collusion

Game theory and oligopolies.

So what was the foray into game theory for? It allows us to explore how individual firms in oligopolies want to act. Let us consider two firms that each produce widgets. They can each choose to either produce at a high price level or low price level. Remember, for a firm to produce more (and sell it) they have to charge less. And if a firm restricts its output, they can charge more. Recall, a monopolist is able to make an additional profit because it restricts output and charges more whereas a firm in a perfectly competitive market may sell more, but at a lower price, and therefore earns a lower profit.

Let us use the following game table showing each firms’ profits:

First, let us step back and just look at the game table. What should each firm do? It seems like each firm should just set their price high. But, is that what will happen?

Let us look for the dominant strategy. As player A, if player B chooses to set a high price, we should should charge a low price (70>65). If player B chooses to set a low price, we should choose low price (40>20). Therefore, as player A, we should always choose to set our price low. The same applies for player B as setting their price low is always better than setting their price high regardless of what player A does (100>90 and 60>40).

So, even though it “makes sense” for both firms to set their prices high, both firms will set their prices low. The same would apply to the Nash Equilibrium.

What does this mean in the real world? If the two firms could cooperate and fully trust each other, they would each set their prices high. This is what we call collusion and will be discussed shortly. But, whether it is due to laws or just human nature, firms are never able to collude too long. Eventually, firms will move to the dominant strategy. While firms would like to keep their prices high, there are typically forces that prevent this.

From: Wikipedia: OPEC

The Organization of the Petroleum Exporting Countries ( OPEC , / ˈ oʊ p ɛ k / OH-pek ) is an intergovernmental organization of 14 nations, founded in 1960 in Baghdad by the first five members ( Iran , Iraq , Kuwait , Saudi Arabia , and Venezuela ), and headquartered since 1965 in Vienna, Austria . As of September 2018, the then 14 member countries accounted for an estimated 44 percent of global oil production and 81.5 percent of the world’s “proven” oil reserves , giving OPEC a major influence on global oil prices that were previously determined by the so called “ Seven Sisters ” grouping of multinational oil companies.

The stated mission of the organization is to “coordinate and unify the petroleum policies of its member countries and ensure the stabilization of oil markets, in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers, and a fair return on capital for those investing in the petroleum industry.” [4] The organization is also a significant provider of information about the international oil market. The current OPEC members are the following: Algeria , Angola , Ecuador , Equatorial Guinea , Gabon , Iran , Iraq , Kuwait , Libya , Nigeria , the Republic of the Congo , Saudi Arabia (the de facto leader), United Arab Emirates , and Venezuela . Indonesia and Qatar are former members.

The formation of OPEC marked a turning point toward national sovereignty over natural resources , and OPEC decisions have come to play a prominent role in the global oil market and international relations . The effect can be particularly strong when wars or civil disorders lead to extended interruptions in supply. In the 1970s, restrictions in oil production led to a dramatic rise in oil prices and in the revenue and wealth of OPEC, with long-lasting and far-reaching consequences for the global economy . In the 1980s, OPEC began setting production targets for its member nations; generally, when the targets are reduced, oil prices increase. This has occurred most recently from the organization’s 2008 and 2016 decisions to trim oversupply.

Economists often cite OPEC as a textbook example of a cartel that cooperates to reduce market competition , but one whose consultations are protected by the doctrine of state immunity under international law . In December 2014, “OPEC and the oil men” ranked as #3 on Lloyd’s list of “the top 100 most influential people in the shipping industry”. [5] However, the influence of OPEC on international trade is periodically challenged by the expansion of non-OPEC energy sources, and by the recurring temptation for individual OPEC countries to exceed production targets and pursue conflicting self-interests.

At various times, OPEC members have displayed apparent anti-competitive cartel behavior through the organization’s agreements about oil production and price levels. [26] In fact, economists often cite OPEC as a textbook example of a cartel that cooperates to reduce market competition, as in this definition from OECD ‘s Glossary of Industrial Organisation Economics and Competition Law : [1]

International commodity agreements covering products such as coffee, sugar, tin and more recently oil (OPEC: Organization of Petroleum Exporting Countries) are examples of international cartels which have publicly entailed agreements between different national governments.

OPEC members strongly prefer to describe their organization as a modest force for market stabilization, rather than a powerful anti-competitive cartel. In its defense, the organization was founded as a counterweight against the previous “ Seven Sisters ” cartel of multinational oil companies, and non-OPEC energy suppliers have maintained enough market share for a substantial degree of worldwide competition. [27] Moreover, because of an economic “ prisoner’s dilemma ” that encourages each member nation individually to discount its price and exceed its production quota, [28] widespread cheating within OPEC often erodes its ability to influence global oil prices through collective action . [29] [30]

OPEC has not been involved in any disputes related to the competition rules of the World Trade Organization , even though the objectives, actions, and principles of the two organizations diverge considerably. [31] A key US District Court decision held that OPEC consultations are protected as “governmental” acts of state by the Foreign Sovereign Immunities Act , and are therefore beyond the legal reach of US competition law governing “commercial” acts. [32] [33] Despite popular sentiment against OPEC, legislative proposals to limit the organization’s sovereign immunity, such as the NOPEC Act, have so far been unsuccessful. [34]

Cartel Theory

From: Wikipedia: Cartel

A cartel is a group of apparently independent producers whose goal is to increase their collective profits by means of price fixing , limiting supply, or other restrictive practices . Cartels typically control selling prices, but some are organized to force down the prices of purchased inputs. Antitrust laws attempt to deter or forbid cartels. A single entity that holds a monopoly by this definition cannot be a cartel, though it may be guilty of abusing said monopoly in other ways. Cartels usually arise in oligopolies —industries with a small number of sellers—and usually involve homogeneous products .

A survey of hundreds of published economic studies and legal decisions of antitrust authorities found that the median price increase achieved by cartels in the last 200 years is about 23 percent. [4] Private international cartels (those with participants from two or more nations) had an average price increase of 28 percent, whereas domestic cartels averaged 18 percent. Less than 10 percent of all cartels in the sample failed to raise market prices.

In general, cartel agreements are economically unstable in that there is an incentive for members to cheat by selling at below the agreed price or selling more than the production quotas set by the cartel (see also game theory ). This has caused many cartels that attempt to set product prices to be unsuccessful in the long term . Empirical studies of 20th-century cartels have determined that the mean duration of discovered cartels is from 5 to 8 years [5] . However, once a cartel is broken, the incentives to form the cartel return and the cartel may be re-formed. Publicly known cartels that do not follow this cycle include, by some accounts, the Organization of the Petroleum Exporting Countries (OPEC).

Price fixing is often practiced internationally. When the agreement to control price is sanctioned by a multilateral treaty or protected by national sovereignty, no antitrust actions may be initiated [6] . Examples of such price fixing include oil, whose price is partly controlled by the supply by OPEC countries, and international airline tickets, which have prices fixed by agreement with the IATA , a practice for which there is a specific exception in antitrust law.

Prior to World War II (except in the United States), members of cartels could sign contracts that were enforceable in courts of law. There were even instances where cartels are encouraged by states. For example, during the period before 1945, cartels were tolerated in Europe and were promoted as a business practice in German-speaking countries. [7] This was the norm due to the accepted benefits, which even the U.S. Supreme court has noted. In the case, the U.S. v. National Lead Co. et al. , it cited the testimony of individuals, who cited that a cartel, in its protean form, is “a combination of producers for the purpose of regulating production and, frequently, prices, and an association by agreement of companies or sections of companies having common interests so as to prevent extreme or unfair competition.” [8]

Today, however, price fixing by private entities is illegal under the antitrust laws of more than 140 countries. Examples of prosecuted international cartels are lysine , citric acid , graphite electrodes , and bulk vitamins . [9] This is highlighted in countries with market economies wherein price-fixing and the concept of cartels are considered inimical to free and fair competition, which is considered the backbone of political democracy. [10] The current condition makes it increasingly difficult for cartels to maintain sustainable operations. Even if international cartels might be out of reach for the regulatory authorities, they will still have to contend with the fact that their activities in domestic markets will be affected. [11]

For a cartel to be successful, some or all of the following conditions are necessary:

• A small number of firms.
• Products are relatively undifferentiated from one firm to the next.
• Prices are easily observable.
• Prices show little variation over time.

Introduction to Microeconomics Copyright © 2019 by J. Zachary Klingensmith is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License , except where otherwise noted.

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3.4.4 Oligopoly (Edexcel)

Last updated 20 Sept 2023

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This Edexcel study note covers Oligopoly

a) Characteristics of Oligopoly:

• High Barriers to Entry and Exit: Oligopolistic markets often have significant barriers that prevent new firms from entering the industry or existing firms from easily exiting. These barriers can include high capital requirements, economies of scale, patents, and government regulations.
• High Concentration Ratio: Oligopolies are characterized by a small number of large firms dominating the market. The concentration ratio measures the market share held by the largest firms in the industry, and in oligopolistic markets, this ratio is typically high.
• Interdependence of Firms: Oligopolistic firms are highly aware of the actions and decisions of their competitors. They must consider how their own choices, such as pricing and marketing strategies, will affect the behavior and reactions of rival firms.
• Product Differentiation: Oligopolistic firms often engage in product differentiation to distinguish their offerings from competitors. This can include branding, quality variations, and advertising to create brand loyalty.

b) Calculation of n-Firm Concentration Ratios and Their Significance:

The n-firm concentration ratio measures the combined market share of the largest n firms in an industry. It is calculated by summing the market shares of these firms. Significance:

• Higher concentration ratios indicate a more concentrated industry with fewer dominant firms.
• Lower concentration ratios suggest a more competitive industry with a greater number of smaller firms.
• It can provide insights into the degree of market power held by the largest firms and potential antitrust concerns.

c) Reasons for Collusive and Non-Collusive Behavior: Collusive Behavior:

• Maintaining High Prices: Firms in an oligopoly may collude to set high prices and limit competition, increasing their profits collectively.
• Stability: Collusion can provide market stability, reducing uncertainty for firms and consumers.
• Avoiding Price Wars: Collusion helps firms avoid destructive price wars.

Non-Collusive Behavior:

• Competition: Firms may choose to compete aggressively to gain market share and increase profits individually.
• Legal Constraints: Antitrust laws and regulations prohibit collusion, encouraging firms to compete independently.
• Differences in Objectives: Firms may have differing goals and incentives that make collusion difficult.

d) Overt and Tacit Collusion; Cartels and Price Leadership:

• Overt Collusion: Occurs when firms openly agree to cooperate and set prices or output levels. This can lead to the formation of cartels, which are explicit agreements among firms to coordinate their actions.
• Tacit Collusion: Involves firms behaving in a manner that resembles collusion without any explicit agreement. Firms may follow observed pricing patterns set by competitors or engage in price leadership, where one dominant firm sets the price and others follow suit.

e) Prisoner's Dilemma in a Two-Firm Model:

The prisoner's dilemma is a classic game theory scenario where two rational players, in this case, two firms, make decisions that result in suboptimal outcomes. In an oligopolistic context, if both firms choose to compete aggressively, they may trigger a price war and both suffer lower profits. However, if both firms collude and set high prices, they both earn higher profits. The dilemma arises because each firm has an incentive to betray the collusion agreement to gain a larger share of the profits, but if both firms do this, they both end up worse off.

f) Types of Price Competition:

• Price Wars: Fierce competition where firms continuously lower prices to gain market share, often resulting in reduced profits for all.
• Predatory Pricing: Occurs when a firm sets very low prices with the intent of driving competitors out of the market, after which it can raise prices.
• Limit Pricing: A strategy where a dominant firm sets prices low enough to discourage new entrants from the market.

g) Types of Non-Price Competition:

• Product Differentiation: Firms emphasize the unique qualities and features of their products through branding, quality, design, or advertising.
• Advertising and Marketing: Firms engage in extensive advertising and marketing campaigns to create brand loyalty and awareness.
• Innovation: Competing through the development of new products, technologies, or processes.
• Customer Service: Offering exceptional customer service and support as a competitive advantage.
• Distribution Channels: Establishing efficient distribution networks to reach customers faster and more conveniently.

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Introduction to Monopolistic Competition and Oligopoly

Chapter objectives.

In this chapter, you will learn about:

• Monopolistic Competition

Bring It Home

The temptation to defy the law.

Laundry detergent and bags of ice—products of industries that seem pretty mundane, maybe even boring. Hardly! Both have been the center of clandestine meetings and secret deals worthy of a spy novel. In France, between 1997 and 2004, the top four laundry detergent producers (Proctor & Gamble, Henkel, Unilever, and Colgate-Palmolive) controlled about 90 percent of the French soap market. Officials from the soap firms were meeting secretly, in out-of-the-way, small cafés around Paris. Their goals: Stamp out competition and set prices.

Around the same time, the top five Midwest ice makers (Home City Ice, Lang Ice, Tinley Ice, Sisler’s Dairy, and Products of Ohio) had similar goals in mind when they secretly agreed to divide up the bagged ice market.

If both groups could meet their goals, it would enable each to act as though they were a single firm—in essence, a monopoly—and enjoy monopoly-size profits. The problem? In many parts of the world, including the European Union and the United States, it is illegal for firms to divide markets and set prices collaboratively.

These two cases provide examples of markets that are characterized neither as perfect competition nor monopoly. Instead, these firms are competing in market structures that lie between the extremes of monopoly and perfect competition. How do they behave? Why do they exist? We will revisit this case later, to find out what happened.

Perfect competition and monopoly are at opposite ends of the competition spectrum. A perfectly competitive market has many firms selling identical products, who all act as price takers in the face of the competition. If you recall, price takers are firms that have no market power. They simply have to take the market price as given.

Monopoly arises when a single firm sells a product for which there are no close substitutes. We consider Microsoft, for instance, as a monopoly because it dominates the operating systems market.

What about the vast majority of real world firms and organizations that fall between these extremes, firms that we could describe as imperfectly competitive ? What determines their behavior? They have more influence over the price they charge than perfectly competitive firms, but not as much as a monopoly. What will they do?

One type of imperfectly competitive market is monopolistic competition . Monopolistically competitive markets feature a large number of competing firms, but the products that they sell are not identical. Consider, as an example, the Mall of America in Minnesota, the largest shopping mall in the United States. In 2010, the Mall of America had 24 stores that sold women’s “ready-to-wear” clothing (like Ann Taylor and Urban Outfitters), another 50 stores that sold clothing for both men and women (like Banana Republic, J. Crew, and Nordstrom’s), plus 14 more stores that sold women’s specialty clothing (like Motherhood Maternity and Victoria’s Secret). Most of the markets that consumers encounter at the retail level are monopolistically competitive.

The other type of imperfectly competitive market is oligopoly . Oligopolistic markets are those which a small number of firms dominate. Commercial aircraft provides a good example: Boeing and Airbus each produce slightly less than 50% of the large commercial aircraft in the world. Another example is the U.S. soft drink industry, which Coca-Cola and Pepsi dominate. We characterize oligopolies by high barriers to entry with firms choosing output, pricing, and other decisions strategically based on the decisions of the other firms in the market. In this chapter, we first explore how monopolistically competitive firms will choose their profit-maximizing level of output. We will then discuss oligopolistic firms, which face two conflicting temptations: to collaborate as if they were a single monopoly, or to individually compete to gain profits by expanding output levels and cutting prices. Oligopolistic markets and firms can also take on elements of monopoly and of perfect competition.

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Oligopoly Notes & Questions (A-Level, IB)

Relevant Exam Boards: A-Level (Edexcel, OCR, AQA, Eduqas, WJEC), IB, IAL, CIE Edexcel Economics Notes Directory | AQA Economics Notes Directory | IB Economics Notes Directory

Oligopoly Definition: An Oligopoly is a market structure where only a few sellers dominate the market.

Oligopoly Examples & Explanation: Because there are only a few firms (players) in an Oligopoly, they tend to be highly interdependent of one another – meaning they will take in account each others’ actions when trying to compete in the market. Another characteristic is these markets also exhibit high barriers to entry, such that new firms cannot easily enter into the market. This characteristic is shared with Monopolies (one firm dominating) and Duopolies (two-firms dominating), explaining how they can dominate the market with large amounts of market share. If we consider the oil & gas industry, they tend to be an Oligopoly in most countries (think Shell, BP, Exxon) due to the huge capital investment required for oil exploration/mining, making it difficult for new producers to enter into the market. When a large oil/gas producer sells their oil at a lower price to increase their sales volume, other producers are likely to lower their prices as well to protect their share of the market. As a result, Oligopolies tend to keep market prices stable and focus on non-price competition, so that firms can avoid a price war. However, the negative oil prices from the coronavirus pandemic is also caused by other factors, including a lack of storage capacity for oil producers forcing them to sell, and a global lack of demand for oil during the crisis. In general, oil producers in OPEC agree on an amount of output to maintain a relatively high price for oil, meaning higher profits for the industry.

Oligopoly Economics Notes with Diagrams

Oligopoly video explanation – econplusdal.

The left video explains oligopoly and the kinked-demand curve, the right looks at competition and cartels in the oligopoly market structure.

Oligopoly Multiple Choice Questions (A-Level)

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12: Module 10- Monopolistic Competition and Oligopoly

• Last updated
• Save as PDF
• Page ID 48264
• 12.1: Introduction to Oligopolies
• 12.2: Why do Oligopolies Exist?
• 12.3: Collusion or Competition?
• 12.4: Prisoner’s Dilemma
• 12.5: Learn By Doing- Prisoner’s Dilemma
• 12.6: Putting It Together- Monopolistic Competition and Oligopoly
• 12.7: Discussion- Oligopoly
• 12.8: Assignment- Grocery Competition
• 12.9: Assignment- Problem Set—Monopolistic Competition and Oligopoly
• 12.10: Why It Matters- Monopolistic Competition and Oligopoly
• 12.11: Introduction to Monopolistically Competitive Industries
• 12.12: Monopolistic Competition
• 12.13: Introduction to Analyzing and Graphing Monopolistic Competition
• 12.14: Profit Maximization under Monopolistic Competition
• 12.15: Learn By Doing- Profit Maximization Under Monopolistic Competition
• 12.16: Entry, Exit and Profits in the Long Run
• 12.17: Monopolistic Competition and Efficiency
• 12.18: Product Differentiation and Advertising

Monopoly: Compilation of Essays on Monopoly | Markets | Economics

Here is a compilation of essays on ‘Monopoly’ for class 9, 10, 11 and 12. Find paragraphs, long and short essays on ‘Monopoly’ especially written for school and college students.

Essay on Monopoly

Essay Contents:

• Essay on the Disadvantages of Monopolies

Essay # 1. Introduction to Monopoly :

ADVERTISEMENTS:

The market, form of monopoly is the opposite extreme from that perfect competition. It exists whenever an industry is in the hands of single of producer. In the case of perfect competition there are so many individual producers that no one of them has any power over the market and an; one firm can increase or diminish its production without affecting the market price. A monopoly, on the other hand, has power to influence the market price. By reducing its output, it can force the price up, and by increasing its output it can force the price down.

The word monopoly is made of two words; MONO +POLY. Here ‘Mono’ means one and ‘Poly’ implies the seller, thereby the literal meaning of the word Monopoly is one seller or one producer. Thus, pure monopoly refers to that form of market organisation wherein there is single firm (or producer) producing a commodity for which there are no good or close substitutes.

According to Watson, “A monopolist is the only producer of a product that has no close substitutes.” Changes in prices and outputs of other goods sold in the economy must leave the monopolist unaffected. Conversely, changes in the monopolist’s price and output must leave the other producers of the economy unaffected.

Essay # 2. Features of Monopoly :

(i) Single Producer:

There is a single firm producing the commodity in the market.

(ii) No Close Substitutes:

For the monopoly to exist single producer is the necessary condition but not a sufficient one. It is also essential that there should be no close substitute of the commodity in the market. This second condition would be even more difficult to fulfil than the first, since there are few things for which there is no substitute.

For instance, Usha are produced by a single firm alone but there are close substitutes of Usha fans that are available in the market in the form of Relifans, Khaitan Ashoka, Crompton, etc. Hence, though the firm producing Usha fans is single yet it cannot be termed a monopoly firm.

It is, therefore, essential for a monopoly to exist that there should be no close substitutes available in the market. This condition can be stated in other words as that the cross elasticity of demand for the output of the firm with respect to the price of every firm’s product is zero.

(iii) Barriers to the Entry:

The entry into the industry is completely barred or made impossible. If new firms are admitted into the industry, monopoly itself breaks down. This ban on entry may be legal, natural or institutional but it must essentially be there.

(iv) Firm and Industry:

Since in monopoly there is single firm producing the commodity, hence the difference between firm and industry vanishes automatically.

(v) Downward Sloping AR and MR Curves:

The monopoly firm is like an industry, and faces a downward sloping demand curve for its product; thus, it has to lower its price in order to sell more. For, it is this nature of demand curve that determines the nature of average and marginal revenue curves. Under perfect competition, we know, average revenue and marginal revenue curves coincide in a horizontal line. But that is not so under monopoly.

With a monopoly, however, the average revenue curve, which is the same as the market demand curve, is downward sloping. Furthermore, the marginal revenue curve does not coincide with the average revenue curve rather, it remains below it. Thus, for a monopolist firm both AR and MR curve are downward sloping and MR remains below AR as shown in the diagram.

The Oil Market as an Oligopoly

• Categories: Marketing and Advertising Oil Oligopoly

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Table of contents

Introduction, oil supply outside the oligopoly, literature review, conclusion/recommendation.

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