Oligopoly: strategic interaction
Few firms making big choices.
Oligopoly = market with a small number of large firms whose actions materially affect each other.
Characteristics:
- Few large firms.
- STRATEGIC INTERDEPENDENCE (each firm considers rivals' likely response).
- High barriers to entry (capital, brand, patents, scale economies).
- Differentiated or homogeneous products.
Examples: smartphones (Apple, Samsung, Google), aviation (Boeing, Airbus), oil majors, soft drinks (Coca-Cola, Pepsi), supermarkets in many countries.
Kinked demand curve (Sweezy 1939). Explains price rigidity:
- If a firm RAISES price, rivals WON'T match β firm loses share β demand ELASTIC above current P.
- If firm LOWERS price, rivals WILL match β no share gain β demand INELASTIC below current P.
Result: kink at current P. MR has a vertical gap at that quantity. Within the gap, even moderate cost changes don't change profit-max output β PRICE RIGIDITY.
Game theory and prisoner's dilemma. Two firms choosing between cooperate (high price) and defect (low price).
| B cooperates | B defects | |
|---|---|---|
| A cooperates | 80 | 100 |
| A defects | 10 | 30 |
- A's dominant strategy: defect (better off whatever B does).
- B's dominant strategy: defect.
- NASH equilibrium: both defect β both get $30.
- BOTH would be better off if both cooperated ($80 each) β but each individually prefers to defect β trapped at bad outcome.
Collusion to escape this trap:
- Cartel (explicit agreement) β like OPEC for oil.
- Tacit collusion β silent coordination (price leadership).
Most jurisdictions BAN cartels because they raise prices and harm consumers (EU Competition Law, US antitrust).
Non-price competition. Without competing on price, oligopolists compete via:
- Advertising.
- Product differentiation.
- Customer service.
- R&D.
Monopoly.
Single firm dominates market. Causes (barriers to entry):
- Legal β patents, copyrights, licences.
- Natural β production technology with declining LRAC means single firm produces most cheaply (rail, water).
- Economies of scale β incumbents have cost advantages.
- Control of essential resources β De Beers historically with diamonds.
- Network effects β value depends on number of users (search engines, social media).
Monopoly equilibrium. Profit max at MR = MC. Because D slopes down, P > MR. Therefore at profit-max output: P > MC β allocative inefficiency.
Monopoly outcomes vs PC outcomes:
- Higher price.
- Lower quantity.
- Supernormal profit (sustained in LR due to barriers).
- DEADWEIGHT LOSS (welfare not captured).
- Potential X-inefficiency (lazy management).
Natural monopoly. Where LRAC declines over the relevant output range β one firm produces most efficiently. Examples: rail networks, water utilities, electricity grids.
- Breaking up natural monopoly duplicates infrastructure β higher costs.
- Better to REGULATE (price caps, quality standards).
Price discrimination (HL extension):
- First degree (perfect): charge each consumer their maximum WTP. Captures entire CS as PS.
- Second degree: different prices for different quantities (bulk discounts).
- Third degree: different prices to different MARKETS (student discounts, peak/off-peak).
Requires market power + ability to separate markets + prevent resale.
Policy responses to market power:
- Antitrust β block anti-competitive mergers, break up monopolies (AT&T 1984, Standard Oil 1911).
- Regulation β price caps, quality standards.
- Public ownership β government provides the monopoly service.
- Promote competition β reduce barriers, allow entrants.
- Oligopoly: few firms + interdependence.
- Kinked demand β price rigidity.
- Prisoner's dilemma + collusion incentives.
- Monopoly: P > MC, DWL, sustained supernormal profits.
- Natural monopoly: regulate not break up.
- Price discrimination: 1st/2nd/3rd degree.
- Policy: antitrust, regulation, public ownership.