Chapter 15 (2)

Question 1

You might keep an eye on smaller, independent companies too

Answer 1

○ But your real preoccupation is w/ the other major players

► In other words you’re playing in a game w/ three very identifiable competitors

Contrasts w/ perfectly competitive markets:

Question 2

Ø The fact that firms in an oligopoly market compete against a few identifiable rivals w/ market power drives our analysis

Answer 2

► Perfect competition: firms only have one choice - what quantity to produce given the market price

► Oligopolists: makes strategic decisions about price & quantity that take into account the expected choices of their competitors

Question 3

OLIGOPOLIES IN COMPETITION

Answer 3

Only two big labels rather than 4: Universal & Warner

-for simplicity

Question 4

COMPETE OR COLLUDE

Answer 4

► You don’t get to be CEO of Warner or Universal if you don’t understand how an oligopoly works

► In our simplified example, the firms have two options:
○ To compete w/ each other, or to join forces and act like a monopolist

Question 5

COLLUSION

Answer 5

► the act of working together to make decisions about price & quantity

► If collusion can enable firms to higher profits —> why isn’t everyone doing it

Question 6

Ø Looking at the strategic decision (Figure 15-7), two things stand out:

Answer 6

1. As we already calculated, both firms do worse when they compete w/ each other than when they collude
   a. This is because, by competing –> they drive the quantity sold ABOVE the profit-maximizing monopoly level that would be achieved by collusion
2. Each firm has an incentive to renege on a collusion deal and compete –> regardless of what the other firm does
   a. If x firm expects x firm to produce the lower, collusion quantity: it can earn more in profits by competing then competing
   b. If x firm expects x firm to produce the higher, competitive quantity: it still earns more profits by competing than by sincerely sticking to the collusion agreement

Question 7

DOMINANT STRATEGY

Answer 7

when one strategy is always the best for a player to choose, regardless of what other players do

Question 8

NASH EQUILIBRIUM

Answer 8

► when all players in a game have a dominant strategy

► It is an outcome in which all players choose the best strategy they can –> given the choices of all other players

► A Nash equilibrium can be reached even when firms don’t have a dominant strategy

►The Nash equilibrium = significant because when it is reached –> no one has an incentive to break the equilibrium by changing strategies

Question 9

However, there is a way out of dilemma for the two CEOs

Answer 9

►The key = to remember that decisions are made not once –> but over & over again between the same set of firms

○ Once the Universal CEO realizes that the interaction is a repeated game –> his incentives change

○ If he reneges on the deal while the CEO of Warner keeps her word –> he will gain $50 million in profits for this year

Question 10

But he will be sure that Warner = will retaliate NEXT YEAR by going back to the competitive production levels

Answer 10

►He therefore knows Universal = will lose $40 million in profits EVERY YEAR

►THEREAFTER; the firm will earn $350 million in the competitive equilibrium rather than $390 million in the collusion equilibrium

Question 11

With future profits in mind: both companies may take an initial chance that the other = will hold up its end of an initial agreement to collude

Answer 11

If they stand firm –> they may keep cooperating, each producing 35 million CDS, year after year

►This sort of strategy = often the glue that holds firms together in a cartel

Question 12

CARTEL

Answer 12

a # of firms that collude to make collective production decisions about quantities or prices

Question 13

A well-known cartel = the Organization of the Petroleum Exporting Countries (OPEC)

Answer 13

► Member countries agree to limit the amount of petroleum they produce –> in order to manipulate the market price & maximize their profits

►The fact that each member country knows it is in its long-term interest to collude rather than compete = enough to keep OPEC together

► Interest in future profits dissuades any individual country from chasing short-term profits by producing more oil in any given year

► Although OPEC does not control all of the global supply of oil –> it is a powerful force in world oil prices

Question 14

Ø If cartels are so advantages for firms operating in an oligopoly –> why don’t we see more of them?

Answer 14

○ It’s because they’re usually illegal.

► No international court has the power to force OPEC to stop colluding in the global oil market

► Most countries, however, have laws against firms making agreements about prices/quantities
○ If they’re caught –> they can be fined & punished

Question 15

Oligopoly & Public Policy

Answer 15

► We saw in the monopoly chapter that Canada = has strict laws prohibiting anti-competitive business practices

► It is even illegal for an Oligopolists to OFFER to collude –> regardless of whether the collusion actually happens

► The reason why lawmakers are so concerned about collusion –> is that while it’s good for the Oligopolists –> it’s bad for the rest of us

Question 16

Remember that In a monopoly, there is dead-weight loss

Answer 16

► a welfare loss caused by the transactions that did not take place because the market equilibrium was at a higher price & lower quantity than would be efficient

► Graph (Figure 15-8) compares the producer surplus, consumer surplus, and dead-weight loss under varying amounts of competition

Question 17

**Note: that the last two graphs –collusion & monopoly–are identical

Answer 17

○ Because the market outcomes in a competitive oligopoly are between those of a monopoly & a perfectly competitive market, dead-weight loss still exists –> but it is lower than when there is collusion

► It’s no wonder governments = so keen to prevent firms from colluding–and no wonder firms are so keen to collude w/out being caught