Interdependence in Oligopolistic Markets
- Created by: s.waterhouse
- Created on: 28-05-17 19:06
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- Interdependence in Oligopolistic Markets
- Game theory
- Two players are working out how to further their interests
- Fate of the players depends on their own decisions and the decisions of the others
- Players are interdependent
- Two players are working out how to further their interests
- Prisoners' dilemma
- Used to understand how interdependent firms act in an oligopolistic market
- The choices of the different firms is summarised using a payoff matrix
- Example: 2 firms --> Choice of high level of output or low level of output
- Both firms choose low output: Firm A makes a profit of 200, Firm B makes a profit of 200
- If both firms cooperate and restrict output to low levels, the outcome will be better for both than if they both output at high levels
- However, only works well if both firms can be trusted
- If both firms cooperate and restrict output to low levels, the outcome will be better for both than if they both output at high levels
- Firm A low output, Firm B high output: Firm A makes a profit of 100, Firm B makes a profit of 300
- It is in the interests of each firm to stop cooperating and raise output
- However, this will only work if they do this before the other firm
- If one firm raises output, it is in the interests of the other firm to keep output low and take the reduced profit
- First mover advantage
- Cartels are unstable as any firm can have an advantage if they break the agreement before the others
- It is in the interests of each firm to stop cooperating and raise output
- Both firms choose high output: Firm A makes a loss of 100, Firm B makes a loss of 100
- If both firms cooperate and restrict output to low levels, the outcome will be better for both than if they both output at high levels
- However, only works well if both firms can be trusted
- If both firms cooperate and restrict output to low levels, the outcome will be better for both than if they both output at high levels
- Both firms choose low output: Firm A makes a profit of 200, Firm B makes a profit of 200
- Kinked demand curve
- Assumptions
- If one firm raises prices, the others will not raise theirs
- Price = increased, demand = price elastic
- Customers are likely to switch to buying goods from other firms
- Any firm that raises price will lose out
- The fall in demand will more than cancel out the gains from charging a higher price
- A firm which raises prices will see quite a large drop in demand
- If one firm lowers price, the others will also lower theirs
- Price = decreased, demand = price inelastic
- A firm which lowers prices will not gain any market share
- Any firm that reduces price will lose out
- The average price for their products will fall but they will not gain market share
- If one firm raises prices, the others will not raise theirs
- However, only shows one type of interdependence
- Does not explain behaviour in every oligopoly
- If assumptions are not appropriate, the model will not predict behaviour correctly
- Other models may be needed
- The outcome
- Firms have no incentive to change prices
- Firms will lose out as a result of changing prices
- Prolonged periods of price stability
- Firms have no incentive to change prices
- Assumptions
- First mover disadvantage
- If the first mover overestimates demand for product, they make losses
- Competitors can use technology developed by the first firm, reducing their costs
- They can charge a lower price than the first mover
- Potential profits or losses depend on the numbers in the payoff matrix
- Different decisions are needed for different situations
- Game theory
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