Understanding Oligopolies for AP Microeconomics

Nov 5, 2024

Lecture Notes on Oligopolies

Introduction

  • Speaker: Jacob Reed from ReviewEcon.com
  • Focus: Understanding oligopolies for AP Microeconomics exam
  • Additional resources: Total review booklet at ReviewEcon.com

Basics of Oligopoly

  • Definition: Market structure with very few sellers (typically fewer than 10)
  • Characteristics:
    • High barriers to entry (e.g., high startup costs, customer loyalty, government regulations)
    • Firms are mutually interdependent; actions of one affect others
    • Less price control than a monopoly
  • Examples: US cell phone service providers, airlines

Oligopoly Graph

  • Features a kinked demand curve, similar to a monopoly
  • Not required for AP Microeconomics exam analysis

Efficiency in Oligopolies

  • Allocative Efficiency: Not allocatively efficient
    • Prices above marginal cost
    • Higher prices and lower quantities than perfectly competitive markets
    • Presence of deadweight loss
  • Productive Efficiency: Not productively efficient
    • Do not produce at minimum average total cost
    • Operate on downward sloping portion of average total cost curve

Analyzing Oligopoly Behavior

  • Game Theory: Method to understand interdependent strategic behavior
    • Used in economic analysis of oligopolies
    • Example: Prisoner's Dilemma demonstrates difficulty in cooperative strategies
  • Application in Economics:
    • Game theory helps explain firm behavior in oligopolies

Game Theory Payoff Matrix Example

  • Scenario: Duopoly between Simmer's Sandwiches and Ryan's Rubens
  • Strategies: Firms can choose to lower or raise prices
  • Payoffs: Displayed within a matrix; economic profits depend on outcomes
  • Collusion Outcome: Best combined profit for both firms (illegal due to antitrust laws)
    • Example: Upper left quadrant with $1,500 combined profit

Determining Outcomes in Game Theory

  • Ryan's Rubens Analysis:
    • Decision based on expected action of Simmer's Sandwiches
    • Lower price is dominant strategy for Ryan's Rubens
  • Simmer's Sandwiches Analysis:
    • Decision based on expected action of Ryan's Rubens
    • No dominant strategy
  • Nash Equilibrium:
    • Most likely outcome where both firms have no incentive to deviate
    • In example, Simmer's raises price, Ryan's lowers price

Additional Considerations for AP Exams

  • Multiple Nash Equilibria: Possible to have more than one
  • Exam Examples: Practice with real exam questions (e.g., 2019 question)
  • Reading Payoff Matrices:
    • Firm on the left: Strategies and payoffs listed first
    • Firm on the top: Strategies and payoffs listed second

Conclusion

  • Oligopoly understanding crucial for AP Microeconomics
  • Further practice and resources available at ReviewEcon.com
  • Encouragement to practice solving payoff matrices and use review materials

These notes aim to cover all important points from the lecture on oligopolies, focusing on preparation for AP Microeconomics exams. For more detailed practice, consider using additional resources suggested by the speaker.