BUSB200F Integrated Business Foundation
Integrated Business Foundation
Hello, dear friend, you can consult us at any time if you have any questions, add WeChat: THEend8_
BUSB200F
Integrated Business Foundation
Module 6: Economic Thinking for Business
Tutorial Notes 10
Revision on Oligopoly
Financial Market (Foreign Exchange Market)
1
Revision on Oligopoly
2
Oligopoly
• Oligopoly
– Few sellers offering similar or identical products
– Interdependent firms
– Best off cooperating and acting like a monopolist
by producing a small quantity of output and
charging a price above marginal cost
• Duopoly
– An oligopoly with only two members. It is the
simplest type of oligopoly
Interaction in Oligopolies
• In Oligopolies, firms have to take in
consideration of other firms’ action.
– Example: If there are only 2 firms in Hong Kong
supply water, Firm A & Firm B. If Firm A maintains
a high pricing strategy, what should Firm B do? If
Firm B cuts the price, what should Firm A do?
• The mutual interdependence of firms’ behaviors is
known as strategic interactions between firms
• Game Theory: the study of how people behave in
strategic situations
Copyright© 2003 Southwestern/Thomson Learning
Bonnie’ s Decision
Confess
Confess
Bonnie gets 8 years
Clyde gets 8 years
Bonnie gets 20 years
Clyde goes free
Bonnie goes free
Clyde gets 20 years
gets 1 yearBonnie
Clyde gets 1 year
Remain Silent
Remain
Silent
Clyde’s
Decision
The Prisoners’ Dilemma
What would be the outcome?
• Suppose Clyde confesses, if you are Bonnie …
– Confess >>> 8 years in jail
– Silent >>> 20 years in jail !!
– Bonnie should confess
• Suppose Clyde remains silent, if you are Bonnie
…
– Confess >>> free
– Silent >>> 1 year in jail!!
– Bonnie should confess
• No matter Clyde chooses, Bonnie will confess!!
What would be the outcome?
• Dominant strategy
– The best strategy for a player to follow regardless of
the strategies chosen by the other players.
(In the Prisoners’ Dilemma, Confess is the dominant
strategy)
• Nash Equilibrium
– The equilibrium situation at which each player does
not have an incentive to deviate from the chosen
strategy, assuming other players follow the chosen
strategies.
(In the Prisoners’ Dilemma, both of them confess is the
Nash Equilibrium)
Implication
• Nash Equilibrium is not necessary efficient
• If both remain silent, they would be better off
(only suffer 1 year in jail compares to 8 years)
• Implication:
– Often people (firms) fail to cooperate with one
another even when cooperation would make
them better off
Why firms cooperate?
• Self-interest makes it difficult for the oligopoly
to maintain a cooperative outcome with low
production, high prices, and monopoly profits.
• Firms that care about future profits will
cooperate in repeated games rather than
cheating in a single game to achieve a one-
time gain.
Collusion and Cartels
• The oligopolists may agree on a monopoly
outcome.
– Collusion
• An agreement among firms in a market about
quantities to produce or prices to charge.
– Cartel
• A group of firms acting in unison.
• Caterl-monopoly
Shell and Exxon Oligopoly Game
EXXON’s payoff
EXXON sells 40
Gallons
EXXON sells 30
Gallons
SHELL’s payoff
SHELL sells 40
Gallons
(1600, 1600)
(SHELL, EXXON)
(2000, 1500)
(SHELL, EXXON)
SHELL sells 30
Gallons
(1500, 2000)
(SHELL, EXXON)
(1800, 1800)
(SHELL, EXXON)
Shell and Exxon Oligopoly Game
• Dominant strategy: sell 40 gallons
• Nash Equilibrium: both sell 40 gallons
• Total Output: 80 gallons
• Price per gallon: $40
• If they cooperate: both sell 30 gallons
• Total Output: 60 gallons
• Price per gallon: $60
Implication
• If Shell and Exxon cooperate, the two firms
would be benefited
• Cooperation is difficult to maintain, because
cooperation is not in the best interest of the
individual player.
• Cooperation among oligopolists is undesirable
from the standpoint of society as a whole
because it leads to production that is too low
and prices that are too high
Example
• The payoff table of two companies “Firm B”
and “Firm A” are as follow:
Firm B
Firm A
High price Low price
High price (2000,6000) (500,10000)
Low price (3000,4000) (1000,5000)
• Determine the dominant strategy of “Firm B” and
“Firm A” respectively. Find the Nash equilibrium.
Example
• First Step: Identify the payoffs
Firm B
Firm A
High price Low price
High price (2000,6000) (500,10000)
Low price (3000,4000) (1000,5000)
Example
• Consider opponent’s action first.
• If you want to know the strategy of Firm A:
– You should assume Firm B takes certain action.