Imperfect Competition

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Imperfect Competition

• Oligopoly

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Outline

• Types of imperfect competition
• Oligopoly and its characteristics
• Collusion and cartels
• Equilibrium for an oligopoly
• Game theory and the economics of cooperation
• Prisoners Dilemma
• Public policy toward oligopolies

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Imperfect Competition

• Based on the number of sellers and product type

Imperfect Competition
Perfect Competition
Monopoly
Oligopoly
Monopolistic Competition
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Oligopoly

• Oligopoly is a market structure in which only a
  few sellers offer similar or identical products
• A key feature of oligopoly is the tension between
  cooperation and self-interest
• Duopoly is a limited case of oligopoly with two
  sellers
• Cooperation among oligopolists results in
  collusion
• Collusion is an agreement among firms in a market
  about quantities to produce or prices to charge

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Oligopoly

• Collusion results in a cartel
• A cartel is a group of firms acting in unison and
  the market functions like a monopoly
• However, cartels are not easy to form and sustain
  in the absence of a binding agreement
• Self-interest in the form of profit motive
  translates into cornering the larger share of the
  market
• Where is the equilibrium for an oligopoly?

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Oligopoly

• Nash equilibrium is a situation in which economic
  actors interacting with one another each choose
  their best strategy given the strategies the
  others have chosen
• Due to the presence of the Nash equilibrium
  oligopolists stop short of producing output where
  PMC
• 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

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Oligopoly

• At this equilibrium, the oligopoly price is less
  than the monopoly price but greater than the
  competitive price
• Impact of the number of sellers on the oligopoly
  market
• The output effect
• The price effect
• The larger the number of sellers the smaller the
  price effect and in such an event oligopoly may
  approach a competitive market equilibrium

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Game theory

• Game theory is a study of how people behave in
  strategic situations
• Prisoners dilemma is a particular game between
  two captured prisoners that illustrates why
  cooperation is difficult to maintain even when it
  is mutually beneficial
• The sentence that each prisoner receives depends
  on his/her decision (whether to confess or to not
  confess) and on the decision made by the other
  prisoner

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Game theory
P.1s Decision
P.2s Decision
Dominant strategy is to confess and it is the
Nash equilibrium.
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Application of Prisoner's Dilemma to Oligopoly
Jacks (J) Decision
Marys (M) Decision
Dominant strategy is to produce 40 L each. This
equilibrium quantity is called the Nash
equilibrium.
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The Prisoners Dilemma and Welfare

• Depending on the circumstances, a non-cooperative
  equilibrium could lead to loss of welfare
• Overuse of common property resources
• However, lack of cooperation is desirable from
  welfare point of view if the oligopolists would
  reach a monopoly outcome with cooperation
  (reduction in total surplus)
• Oligopolists can solve prisoners dilemma if the
  game is repeated more than once.

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Public Policy Toward Oligopolies

• Policy aims to induce firms to compete rather
  than cooperate
• Canadas Competition Act subjects the following
  activities to criminal prosecution
• Bid-rigging
• Price discrimination
• Resale price maintenance
• Predatory pricing

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Controversies over Competition Policy

• Resale price maintenance
• Does not reduce competition
• One of the mechanisms to solve free-rider problem
• Predatory pricing
• Is not a profitable business strategy
• Tying
• Is it a form of price discrimination?
• Efficiency effects of tying are ambiguous
• The Microsoft Case

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Priosoners Dilemma

• http//www.miskatonic.org/pd.html
• http//www.miskatonic.org/cgi-bin/pd.cgi