Chapter 17 – Oligopoly

Oligopoly : Only a few sellers , Offer similar or identical products, Interdependent

Market structure where there are a few large firms competing in a market. The key difference between this
and the 3 previous market structures we discussed (perfect competition, monopoly, and monopolistic
competition) is that here the decisions of one firm depend on the actions of other firms. In other words,
strategic interaction is important in oligopoly.
Game Theory - The study of how people behave in strategic situations: how people choose among
alternative courses of action and he must consider how others might respond to the actions he takes

17-1 Markets with Only a Few Sellers

Duopoly - Oligopoly with only two members. They decide what quantity to sell and the priceis determined
on the market by the demand.
For a perfectly competitive firm : Price = marginal cost, Quantity is efficient
For a monopoly : Price > marginal cost, Quantity is lower than the efficient quantity
In a market that is perfectly competitive each firm is a price taker. The price is equal to marginal cost and
the total quantity of output produced and consumed is efficient.
In a monopoly the monopolist is not a price taker. The price is greater than the marginal cost and the
quantity produced and consumed is less than the efficient level (there is a deadweight loss).

17-1b Competition, Monopolies, and Cartels

A duopoly can:
- Collude and form a cartel, act as a monopoly and agree on:
Total level of production
Quantity produced by each member
- Don’t collude, act in self-interest
Difficult to agree; Antitrust laws
Higher quantity; lower price; lower profit
Not competitive allocation
Nash equilibrium
Two firms collude if they reach an agreement about the quantity and price to charge. All firms acting
uniformly according to a collusive agreement form a cartel.
Collusion - an agreement among firms in a market about quantities to produce or prices to charge
Cartel - a group of firms acting in unison
For oligopolists it is difficult to obtain monopoly profits for two reasons: self-interest and antitrust laws. If
each duopolist pursues his self-interest he will produce more than the agreed quantity

17-1c The Equilibrium for an Oligopoly

A Nash equilibrium is a situation in which economic actors interacting with one another each choose their
best strategy given the strategies that the others have chosen.
Oligopolists would be better off cooperating and reaching the monopoly outcome. Yet because they each
pursue their own self-interest, they do not end up reaching the monopoly outcome and, thus, fail to
maximize their joint profit. Each oligopolist is tempted to raise production and capture a larger share of the
market. As each of them tries to do this, total production rises, and the price falls.
At the same time, self-interest does not drive the market all the way to the competitive outcome. Like
monopolists, oligopolists are aware that increasing the amount they produce reduces the price of their
product, which in turn affects profits. Therefore, they stop short of following the competitive firm’s rule of
producing up to the point where price equals marginal cost.
When firms in an oligopoly individually choose production to maximize profit:
- Produce a quantity of output
Greater than the level produced by monopoly
Less than the level produced by competition
- The price is
Less than the monopoly price
Greater than the competitive price (MC)
When firms in an oligopoly individually choose production to maximize profit, they produce a quantity of
output greater than the level produced by monopoly and less than the level produced by perfect competition.
The oligopoly price is less than the monopoly price but greater than the competitive price (which equals
marginal cost).

17-1d How the Size of an Oligopoly Affects the Market Outcome

If the oligopolists could form a cartel, they would once again try to maximize total profit by producing the
monopoly quantity and charging the monopoly price. Just as when there were only two sellers, the
members of the cartel would need to agree on production levels for each member and find some way to
enforce the agreement. As the cartel grows larger, however, this outcome is less likely. Reaching and
enforcing an agreement becomes more difficult as the size of the group increases.
If the oligopolists do not form a cartel — perhaps because the antitrust laws prohibit it — each firm has to
take into account:
• The output effect: Because price is above marginal cost, selling one more unit will raise profit.
• The price effect: Raising production will increase the total amount sold, which will lower (decrease) the
price and lower the profit
The size of an oligopoly affects the market outcome :
 As the number of sellers in an oligopoly grows larger
 Oligopolistic market looks more like a competitive market
 Price approaches marginal cost
 Quantity produced approaches socially efficient level
As the number of sellers in an oligopoly grows larger, an oligopolistic market looks more and more like a
competitive market. The price approaches marginal cost, and the quantity produced approaches the socially
efficient level.
 17-2 The Economics of Cooperation
Oligopolies would like to reach the monopoly outcome. Doing so, however, requires cooperation, which at
times is difficult to establish and maintain. To analyze the economics of cooperation, we need to learn a little
about game theory.
In particular, we focus on a “game” called the prisoners’ dilemma, which provides insight into why
cooperation is difficult. Many times in life, people fail to cooperate with one another even when cooperation
would make them all better off. An oligopoly is just one example. The story of the prisoners’ dilemma
contains a general lesson that applies to any group trying to maintain cooperation among its members.
Prisoners’ dilemma - a particular “game” between two captured prisoners that illustrates why cooperation is
difficult to maintain even when it is mutually beneficial
In the language of game theory, a strategy is called dominant strategy. Dominant strategy - a strategy that is
best for a player in a game regardless of the strategies chosen by the other players
Game oligopolists play :
In trying to reach the monopoly outcome
Similar to the game that the two prisoners play in the prisoners’ dilemma

Firms are self-interested and do not cooperate even though cooperation (cartel) would increase profits. Each
firm has incentive to cheat

Controversies over Antitrust Policy

Public Policy Toward Oligopolies
Policymakers try to induce firms in an oligopoly to compete rather than cooperate in order to move the
allocation of resources closer to the social equilibrium
Antitrust Laws
- The Sherman Antitrust Act, 1890
Elevated agreements among oligopolists from an unenforceable contract to a criminal conspiracy
- The Clayton Act, 1914
Further strengthened the antitrust lays
- These laws are used to prevent mergers and to prevent oligopolists from colluding
Price-fixing agreements among competing firms should be illegal.
Antitrust laws have been used to condemn some business practices whose effects are not obvious.
(Antiinhisar qanunları təsiri aşkar olmayan bəzi biznes təcrübələrini pisləmək üçün istifadə edilmişdir.)
Here we consider three examples: Resale price maintenance , Predatory pricing , Tying
1. Resale Price Maintenance - According to this practice, retailers are required to charge customers a given
price. This practice might seem anti-competitive because it prevents the retailers from competing on price.
Defenders of this practice claim that it is not aimed at reducing competition and that it has the legitimate
goal to ensure that retailers offer good service to the buyers of the good.
2. Predatory Pricing - Some claim that charging prices that are too low may be intended to drive other firms
out of the market. However skeptics argue that predatory pricing is not a profitable strategy because in order
to drive out a rival, prices have to reach a level below cost.
3. Tying - According to this practice a producer offers two goods together “tied” in a bundle. Some claim
that in some cases this is aimed at obtaining market power. However, rather than a tool to expand market
power, tying might simply be a form of price discrimination

1. The key feature of an oligopolistic market is that

a. each firm produces a different product from other firms.
b. a single firm chooses a point on the market demand curve.
c. each firm takes the market price as given.
d.)) a small number of firms are acting strategically.

2. If an oligopolistic industry organizes itself as a cooperative cartel, it will produce a quantity of

output that is ________ the competitive level and ________ the monopoly level.
a. less than, more than
b. more than, less than
c.)) less than, equal to
d. equal to, more than

3. If an oligopoly does not cooperate and each firm chooses its own quantity, the industry will produce
a quantity of output that is ________ the competitive level and ________ the monopoly level.
a.)) less than, more than
b. more than, less than
c. less than, equal to
d. equal to, more than

4. As the number of firms in an oligopoly grows large, the industry approaches a level of output that is
________ the competitive level and ________ the monopoly level.
a. less than, more than
b. more than, less than
c. less than, equal to
d.)) equal to, more than

5. The prisoners’ dilemma is a two-person game illustrating that

a. the cooperative outcome could be worse for both people than the Nash equilibrium.
b. even if the cooperative outcome is better than the Nash equilibrium for one person, it might be worse for
the other.
c.)) even if cooperation is better than the Nash equilibrium, each person might have an incentive not to
cooperate.
d. rational, self-interested individuals will naturally avoid the Nash equilibrium because it is worse for both
of them.

6. The antitrust laws aim to

a. facilitate cooperation among firms in oligopolistic industries.
b. encourage mergers to take advantage of economies of scale.
c. discourage firms from moving production facilities overseas.
d.)) prevent firms from acting in ways that reduce competition.