ECO 182 Study Guide - Final Guide: Nash Equilibrium, Economic Equilibrium, Oligopoly
25 May 2018
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ECO182 study guide 3: Rise of the machines
Chapter 15: Oligopoly
❖ Oligopoly market structure
➢ Barriers prevent entry of new firms (natural or legal)
▪ Legal arises when demand and cost leave room for a larger number of firms
➢ Small number of firms (only a few in oligopoly)
▪ Interdependence- each firm’s profit relies on the others actions
▪ Temptation to cooperate/ form a cartel
• Cartel- a group of firms acting together to limit output,
raise price, and increase profit
❖ Duopoly- market of two firms
➢ Uses game theory
➢ Captures the essence of oligopoly (small number of firms, nearly
identical or differentiated products, and barriers that limit entry)
➢ For an individual firm, the minimum ATC is when ATC=MC
➢ For an industry, the price is set by one firm’s ATC and the quantity
from the demand curve (easy way is to find the price first, then
see the quantity demanded on the demand curve)
❖ Game theory- tool to study strategic behavior, behavior that is expected of others and the
mutual recognition of interdependence (how others behave and if it will benefit you too)
➢ Prisoner’s dilemma- (normally in a duopoly) where two people are in a situation where
they have to decide between two things, knowing the outcomes of their own decisions,
but do not know what the other person thinks
▪ Ex. If Nancy and Johnathan get arrested and separated for questioning, they each
have the decision to confess or deny. If one confesses they only get a year and the
other gets 4 years of jail time. They can each confess and get 3 years. If both deny,
they get 2 years. They do not know what the other one will choose.
• Ideally both want to deny because they will get a
year (self-interest)
• When they each work in their own self-interest, it
leads to a Nash equilibrium as the outcome and
they both get 2 years
• Some instances will have more than one Nash
equilibrium if both work in the self-interest of the
companies (see question 30 on practice exam)
• Dilemma occurs when each person contemplates
the consequences of each decision and what will
happen to the other person, it leads to equilibrium
of the game (which isn’t always the best outcome)
❖ Cheating in a duopoly
➢ Collusion- agreement between two or more firms to restrict output, raise price, and
increase profits that are illegal in the US
▪ Firms in these collusive agreements are called cartels
▪ Ex. OPEC sets oil prices and can restrict output
Nancy: confess- 3
years
Johnathan:
confess- 3 years
Nancy: confess-
4 years
Johnathan:
deny- 1 year
Nancy: deny- 1
year
Jonathan:
confess- 4 years
Nancy: deny- 2
years
Johnathan:
deny- 2 years
▪ When in one, firms act like a monopoly and
maximize economic profit
• Marginal revenue acts like a monopoly MR
curve and produce less than what the market
demands and set price higher
▪ Profit- MC=MR (MR is demand)
▪ Cost curve- horizontal sum of the MC curves of
the two firms
▪ Maximized profit- MC1=MR
➢ Firms in a cartel can either cheat or comply
▪ Like the prisoner’s dilemma, there are four options
▪ When one firm cheats:
• They (the firm that cheated) produce more items, price falls, and have more
economic profit (win)
• Other firm ATC exceeds price and incur economic loss (lose)
▪ When both cheat:
• Becomes like perfect competition and both firms earn 0 economic profit
• Is the Nash equilibrium
➢ R&D game
▪ Part of the oligopoly games and also prisoner’s dilemma
▪ Game of chicken- normally arises with new technology that cannot be patented
• Both firms can benefit from the R&D of either firm (one spends the money and
the other mooches off)
• It’s like a game of chicken because the first person has to put the money in R&D
while the other just gets the benefits
• Equilibrium is when one firm does the R&D
Ex. If Samsung invests for the development of a new type of glass for their
phones, a year later Apple uses that same technology in their phones even if
they did not invest in developing that glass
➢ Repeated Duopoly Game
▪ If played repeatedly, it is possible for duopolies to successfully collude and make a
monopoly profit
▪ Cooperative equilibrium-firms make and share
monopoly profit that has additional punishment
strategies that enable them to achieve it
▪ Tit-for-tat- one player cooperates if the other player
cooperated in the previous but cheats now since
the other player cheated previously (punishment
lite)
• Ex. If you play monopoly fairly this game after
stealing from the bank last time, but your friend
“loses track” of how many rolls they’ve been in jail for this game while playing a
fair game last time
▪ Trigger- one cooperates if the other cooperates until one decides to cheat to punish
the other one (punishment harsh)
• Ex. When playing monopoly with a friend, you two plays fairly every time but this
time they take more houses than they paid for
▪ Limit pricing- set price high enough to keep competitors out
➢ Antitrust law- regulate oligopolies and prevents them from becoming or behaving like
monopolies (these laws want completion in markets and not for one firm to set prices)
▪ Sherman Act, 1890- outlaw any “combination, trust, or
conspiracy that restricts interstate trade” and prohibited
the “attempt to monopolize” (don’t want them to work
together to create a monopoly) (think sharing-Sherman)
▪ Clayton act, 1914- make illegal business practices like
price discrimination, interlocking directorships, and
acquisition of a competitor’s shares if they lessen
competition or create monopolies (eliminate unfair
business practices that lessen competition) (think
Clayton-competition)
▪ Price fixing is illegal (violates antitrust law)
▪ Resale price maintenance- manufacture agrees with the distributer on the price a
product can be resold
• Inefficient: promotes monopoly pricing
• Efficient: incentive to provide in efficient level of retail service in selling a
product
▪ Tying arrangement- sell one product if they buy another different product as well
• Make larger profit
• Price discriminate and take a larger consumer surplus
• Ex. printers and printer ink, razors and blades
▪ Predatory pricing- set a low price to drive competition out of business
• Not always found/skeptism if it occurs
• Ex. Walmart, probably
▪ HHI- FTC guideline that is challenged or blocked if its HHI is above 100 or 200
Chapter 16: Public Choices, Public Goods, and Healthcare
❖ Public good- serve the greater community
❖ Excludable- those who pay enjoy its benefits (exclude those who don’t pay)
➢ Ex. Netflix, concerts, restaurants, those coffee shops that make you pay to use their Wi-
Fi or bathroom
❖ Nonexcludable- anyone can use them
➢ Ex. NPR, public parks, services of the NYPD, watching Office reruns on cable
❖ Rival- each use decreases the quantity available for someone else (think physical goods)
➢ Ex. 1,000 bobble head bulls at a bulls game, buying and eating a brownie
❖ Nonrival- does not decrease in quantity when someone uses it (think services)
➢ Ex. UBPD, downloading a textbook online
