ECON 101 Study Guide - Midterm Guide: Price War, Nash Equilibrium, Strategic Dominance
Economics 101 Chapter 14 Reading Notes
An oligopoly is an industry with only a small number of producers. A producer in such an
industry is known as an oligopolist. When no one firm has a monopoly, but producers
nonetheless realize that they can affect market prices, an industry is characterized by imperfect
competition. Each firm knows that its decision about how much to produce would affect the
market price since each of the firms had some market power; competition isn’t perfect
Two firms of imperfect competition: oligopoly and monopolistic competition
An oligopoly is not necessarily made up of large firms- the question is how many
competitors there are not the size of each competitor
Oligopoly is the result of the same factors that sometimes produce monopoly, but in
somewhat weaker form; the most important source is the existence of increasing returns to
scale, which gives bigger producers a cost advantage over smaller ones
When these are very strong they lead to monopoly, when they aren’t that strong, they lead to
an industry with a small number of firms
The assumption that a firm maximizes profit is enough to determine its output when it is a
perfect competitor or a monopolist
Economists often describe the behavior of oligopolistic firms as a puzzle
Duopoly: an industry in which there are only 2 producing firms, each is a duopolist
Sellers engage in collusion when they operate to raise their joint profits. A cartel is an agreement
among several producers to obey output restrictions in order to increase their joint profits.
Each firm has an incentive to break its word and produce more than the agreed upon quantity
Individual firms have an incentive to produce more than the quantity that maximizes their
joint profits because neither firm has as strong an incentive to limit its output as a true
monopolist would
A profit maximizing monopolist sets MC equal to MR
In this case^ producing an additional unit of revenue has two effects: 1) a positive quantity
effect: one more unit is sold, increasing TR by the price at which that unit is sold and 2) a
negative price effect: in order to sell one more unit, the monopolist must cut the market price
on all units sold
The negative price effect is the reason marginal revenue for a monopolist is less than the
market price; in the case of oligopoly, when considering the effect of increasing production, a
firm is concerned only with the price effect on its own units of output, not those of its fellow
oligopolists
Individual firms in an oligopolistic industry face a smaller price effect from an additional unit
of output than a monopolist does- therefore the MR from an additional unit of output is
higher; it seems like to be profitable for any 1 company in an oligopoly is to increase
production, even if that increase reduces the profits of the industry as a whole
But if everyone does this, everyone will earn a lower profit
Noncooperative behavior: when firms ignore the effects of their actions on each others’ profits,
they engage in noncooperative behavior
With only a handful of firms in an industry, its hard to determine what firms will do
Collusion is ultimately more profitable than noncooperative behavior so firms have an
incentive to collude if they can
One way is for them to formalize the agreement like a contract or establish some financial
incentives for the companies to set their prices high- but this is illegal in usa
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Document Summary
An oligopoly is an industry with only a small number of producers. A producer in such an industry is known as an oligopolist. When no one firm has a monopoly, but producers nonetheless realize that they can affect market prices, an industry is characterized by imperfect competition. Each firm knows that its decision about how much to produce would affect the market price since each of the firms had some market power; competition isn"t perfect. Two firms of imperfect competition: oligopoly and monopolistic competition. An oligopoly is not necessarily made up of large firms- the question is how many competitors there are not the size of each competitor. When these are very strong they lead to monopoly, when they aren"t that strong, they lead to an industry with a small number of firms. The assumption that a firm maximizes profit is enough to determine its output when it is a perfect competitor or a monopolist.
