Overview
This lecture covers oligopoly market structures, focusing on strategic behavior, game theory, key models, and the effects of advertising and collusion among firms.
Oligopoly Basics
- Oligopoly is a market with a few large firms dominating the industry.
- Firms in an oligopoly are interdependent and must consider rivals' actions when making decisions.
- Examples include industries like automobiles, steel, and airlines.
Oligopolistic Industries & Concentration
- High concentration industries have most sales controlled by a small number of firms.
- Concentration ratios and the Herfindahl-Hirschman Index (HHI) measure industry dominance.
Oligopoly Behavior & Game Theory
- Strategic behavior involves anticipating and reacting to competitors' moves.
- Game theory analyzes interactions and predicts outcomes based on strategies of each firm.
- Nash equilibrium occurs when no player can benefit by changing their strategy alone.
- Repeated games can encourage cooperation via reciprocity, unlike one-time games.
Major Oligopoly Models
- Kinked-demand model: firms expect rivals to match price cuts but not price increases, leading to price rigidity.
- Cartel/collusion model: firms collude to set output or prices, maximizing joint profit.
- Price leadership model: a dominant firm sets price, and others follow to avoid price wars.
Collusion, Cartels, and Obstacles
- Collusion involves firms agreeing to fix prices or output, either overtly (openly) or covertly (in secret).
- OPEC is an example of overt collusion among oil-producing nations.
- Barriers to collusion include differing costs, demand uncertainties, and the temptation to cheat for extra profit.
Oligopoly and Advertising
- Advertising is used heavily to differentiate products and maintain or increase market share.
- Positive effects: provides information, promotes competition, and can lower prices.
- Negative effects: may mislead consumers and create brand loyalty that reduces competition.
Efficiency and Welfare Effects
- Oligopoly may lead to higher prices and less output compared to pure competition.
- Productive and allocative inefficiency can result, but advertising can sometimes increase efficiency.
Key Terms & Definitions
- Oligopoly — a market structure with few dominant firms.
- Game Theory — study of strategic decision making among interdependent firms.
- Nash Equilibrium — a stable outcome where no firm benefits from changing its strategy alone.
- Kinked-Demand Curve — demand curve model predicting price stability in oligopolies.
- Cartel — a group of firms colluding to act as a monopoly.
- Price Leadership — a model where one firm sets prices and others follow.
- Concentration Ratio — percentage of market share held by top firms.
- Herfindahl-Hirschman Index (HHI) — measure of market concentration using squared market shares.
Action Items / Next Steps
- Review assigned textbook chapters on oligopoly and game theory.
- Complete practice problems on oligopoly models and game theory scenarios.
- Prepare for in-class discussion on real-world examples of oligopolies.