Lecture Notes: Oligopolies

Introduction

• Presenter: Jacob Reed from ReviewEcon.com
• Focus: Understanding oligopolies for microeconomics or macroeconomics exams
• Resource: Total review booklet available on ReviewEcon.com

Basics of Oligopolies

• Market Structure: Few sellers, typically fewer than 10
• Barriers to Entry: High; includes high startup costs, customer loyalty, government regulations
• Interdependence: Firms mutually impact each other's outcomes
• Price Control: Firms have some influence on price, less than a monopoly
• Examples: Cell phone service providers, airlines

Oligopoly Graph

• Kinked Demand Curve: Present in oligopoly graphs
• Relevance: Not required for AP Microeconomics exam

Efficiency of Oligopolies

• Allocative Efficiency: Not allocatively efficient; price above marginal cost
  • Higher prices and lower quantities compared to perfect competition
  • Results in deadweight loss
• Productive Efficiency: Not productively efficient; not producing at minimum average total cost
  • Operate on the downward sloping portion of average total cost curve

Analyzing Oligopolies: Game Theory

• Game Theory: Used to understand interdependent strategic behavior
  • Relevant across disciplines, e.g., psychology (Prisoner's Dilemma)
• Prisoner's Dilemma: Shows challenges in cooperative behavior
  • Example not fully covered, more info on ReviewEcon.com

Game Theory in Oligopolies

• Payoff Matrix: Used to analyze oligopoly behavior
  • Example: Simmer's Sandwiches and Ryan's Rubens (Duopoly)
  • Strategies: Firms can choose to lower or raise prices
  • Economic Profits: Payoffs shown in matrix quadrants

Analyzing Payoff Matrix

• Collusion Outcome: Best for both firms, akin to monopoly outcome
  • Example: Upper left quadrant, combined profit of $1,500
• Antitrust Policies: Prevent collusive outcomes

Step-by-Step Payoff Analysis

1. Ryan's Rubens Decisions:
   • Lower price for higher profit ($800 vs. $600 and $400 vs. $200)
   • Dominant Strategy: Lower price regardless of Simmer's Sandwiches actions
2. Simmer's Sandwiches Decisions:
   • Optimal choices depend on Ryan's Rubens actions
   • No dominant strategy; decisions vary

Nash Equilibrium

• Definition: Most likely outcome where neither firm benefits from changing strategy
• Example: Upper right quadrant with selected choices
  • Ryan's Rubens lowers price, Simmer's Sandwiches raises price
  • Profits: Simmer's Sandwiches $800, Ryan's Rubens $400

AP Microeconomics Exam Tips

• Be aware of multiple Nash equilibria (e.g., 2019 exam)
• Reading Payoff Matrices:
  • First number is profit for the firm on the left
  • Second number is profit for the firm on top
  • Strategies and payoffs should be clearly linked to respective firms

Conclusion

• Practice payoff matrices and oligopoly behaviors using ReviewEcon resources
• Visit ReviewEcon.com for more study materials and games

End of Notes