Week 6 - Oligopoly & Game Theory Flashcards
(33 cards)
Define Oligopoly
an industry dominated by a small number of firms
What is an oligopoly? What are their main aims?
an oligopoly that tries to act as if they were a monopoly for 3 main reasons:
- reduce supply
- raise prices
- increase profits
What is collusion?
when firms make agreements (illegal in many places) to keep prices high
Even when an oligopoly does not collude, why are prices higher than in a competitive market?
Because firms in an oligopoly are interdependent and tend to avoid price wars, leading to prices that are typically higher than in competitive market
If one lowers prices, others might too, starting a price war, which hurts everyone’s profits.
So, to avoid aggressive competition, firms often keep prices higher and more stable—not by agreement, but by recognizing it’s in their best interest.
What is strategic decision making?
decision making in situations that are interactive, where the outcome depends on the actions of other participants - your best choice depends on what others do
What is a monopoly?
a market with only one seller, so it can:
- control the entire supply of a good or service.
- set high prices without worrying about competition
- maximize its profits because consumers have few or no alternatives.
An example of strategic decision making
Example: Imagine two pizza shops across the street. If one offers “Buy 1 Get 1 Free,” the other must decide: match the deal or lose customers. Each shop’s move affects the other’s succes
How does a cartel try to move a market?
from ‘Competitive’ towards ‘as if controlled by a monopolist
What are the 3 main reasons a cartel tends to collapse and lose their power?
- Cheating by members (trying to secretly undercut prices or supplying more to gain more profit)
- New entrants (who sell at lower price) or a demand response (where if cartel prices too high, consumers switch to substitutes)
- Government action through prosecution or regulation (against illegal collusion)
Why is there an incentive for cartel members to cheat?
Because when a cartel raises prices by limiting supply, each member earns high profits. This creates temptation to secretly produce more and sell extra at the high price.
The cheater gains extra revenue.
The losses from lower prices are shared across all members.
Result: Cheating benefits the individual, even though it weakens the cartel.
Why is a member of a cartel more likely to cheat than a monopolist?
A monopolist who increases output lowers the price and bears all the loss, so it has less reason to cheat itself.
In a cartel, if one firm cheats and increases output:
It gains more revenue.
But the price drop affects all members, so the loss is shared.
👉 This makes cheating more rewarding for a single cartel member.
What formula is used to calculate profit in economics?
Π=(P−C)×Q
Π = Profit
P = Price per unit
C = Cost per unit
Q = Quantity sold
How is cartel cheating an example of the Prisoner’s Dilemma?
Cartel cheating is like the Prisoner’s Dilemma:
Each member benefits most by cheating while others cooperate.
Two people (or firms) can either cooperate or betray (cheat).
If both cooperate, they do well.
If one cheats while the other cooperates, the cheater does even better, and the cooperator loses.
If both cheat, both lose or do worse than if they had cooperated. This shows that cooperation is hard to sustain, even when it’s in the group’s best interest.
Define Pirsoner’s dilemma
The Prisoner’s Dilemma is a situation where pursuing individual self-interest leads to the worst outcome for the group, where no one benefits
What is dominant strategy?
A dominant strategy is one that gives a higher payoff than any other, no matter what the other player does
What is a weakly dominant strategy?
A weakly dominant strategy is a choice that is never worse than the other options, and sometimes better—depending on what the other player does.
👉 It’s a safe bet: it might help, and it won’t hurt
How can communities overcome the Prisoner’s Dilemma?
Political scientist Elinor Ostrom showed that communities with repeated interactions often develop rules or norms that limit selfish behavior.
Game theory also shows that when games are repeated or sequential, players are more likely to cooperate to avoid punishment and build trust.
What is tacit collusion?
Tacit collusion is when firms reach collusive outcomes without a formal agreement.
They act in ways that keep prices high or limit competition, just by observing and matching each other’s behavior.
What is a Focal point?
When two people need to coordinate without communicating (like meeting in London with no agreed time/place), Schelling found that people tend to naturally gravitate toward a common, obvious choice — a focal point.
In London, for example:
Most people might independently write:
🕛 12:00 PM
📍 Big Ben or Trafalgar Square
Even though nothing was agreed upon, they match because it’s the most natural, shared guess.
This shows how social norms, culture, or obvious landmarks help people coordinate without talking`
How do prices behave in an oligopoly? How does number of firms in the oliogpoly affect prices?
In an oligopoly, prices tend to be:
Below monopoly levels
Above competitive levels
👉 The more firms in the market:
The closer prices get to competitive levels
The harder it is to maintain collusion
Define Barriers to entry
Factors that increase the cost to new firms of entering an industry
e.g.
High startup costs (e.g. factories, equipment)
Legal barriers (e.g. patents, licenses)
Strong brand loyalty
Access to key technology or distribution channels
Economies of scale that favor large existing firms
How do barriers to entry affect the success of cartels and oligopolies?
they are more successful w barriers to entry - reduce entrants
Name 3 important barriers to entry
- Control over a key resource or input
- Economies of scale
- Government barriers
What role does the U.S. government play in regulating or supporting cartels?
- Most cartels are illegal under the Sherman Antitrust Act of 1890.
- Antitrust laws are used to: Prosecute cartels, block mergers, Break up large firms
- However, sometimes the government supports cartels by creating barriers or price supports.
👉 Example: The U.S. raises milk prices through subsidies and quotas.
