Oligopoly and Strategic Behavior in the Market

What is Oligopoly to us in the market. Oligopoly is a market form where a market or industry is dominated by a small number of large sellers. Oligopolies can result from three main reason, Government barriers, Economies of scale, and Advertising. These things all put into place can cause an oligopoly which reduce competition and lead to higher prices for consumers.

A duopoly is a type of oligopoly where two firms have dominant or exclusive control over a market. It is the most commonly studied form of oligopoly due to how simple it is. Duopolies sell to consumers in a competitive market where the choice of an individual consumer cannot affect the firm. Examples of the Oligopolies we see the most in our everyday lives are things like, Automobiles, Cellphone Providers, Airlines and Computers, just to name a few. You can even narrow down the Cellphones themselves to Apple verse Android in a Duopoly.

The competition between Airbus and Boeing has been characterized as a duopoly for large jets as well. When you have a true duopoly, there then becomes a game tree, in which pricing by the firms takes center stage as to how much of the market share each manufacturer gets. If one person goes high and the other goes low, the person with the lower price will gain the majority of the market share and increase their total revenue. If both manufacturers price high, they will almost work as a monopoly and gain the most profit that both can.

The equilibrium of the price fixing game is not to have just a dominant strategy. If you approach the pricing that way, there is a greater chance that you will be so aggressive that you will price yourself out of potential revenue and let your competition control the market. The optimum quantity and maximum profit of a duopolist or oligopolist depend upon the actions of the firms belonging to the industry. He can control only his own output level or price, if his product is differentiated, but he has no direct control over other variables which are likely to (or do) affect his profits. In truth, the profit of each oligopolist is the result of the interaction of the decisions of all players in the market. Just like monopolistic competition there is not only price competition but non-price competition as well in oligopoly and, to some extent, in duopoly.

For example, advertising is often a life and death question in this type of market due to strategic behavior of all firms. In most oligopoly situations we find intermediate outcomes. In the example we are shown, we can see how Jill can manipulate the market by giving a lowest price guarantee for her product. This allows her to charge the highest price up front and if someone goes out and does their research, she might have to issue a small refund, if the customer never goes looking then she has made her full profit and even if she issues a refund, she will retain market share. This pricing game can also get into the tit for tat strategy. In this way, if Jack under prices Jill, Jill will have no choice in the long term to come down to his level.

Then once she is there and Jack has half the market share, he can move his prices back up to maximize profit. Jill will also do the same to maximize her profits as well. This will go back and forth. Since there are no generally accepted behavioral assumptions for oligopolists and duopolists as is found in other market forms, there are diverse patterns of behavior and many different solutions for oligopolistic and duopolistic markets. Each solution is based on different types of models and each model is based on a different behavioral assumption or a set of assumptions.

Lastly, we are looking at economic game theory. In one of the examples we learn about the prisoner’s dilemma. The prisoner's dilemma is a scenario where a decision analysis in which two individuals acting in their own self-interests do not produce the optimal outcome. The typical prisoner's dilemma is set up in such a way that both parties choose to protect themselves at the expense of the other participant.

As a result, both participants find themselves in a worse state than if they had cooperated with each other in the decision-making process. The classic prisoner’s dilemma goes like this: two members of a gang of bank robbers, Jim and Bob, have been arrested and are being interrogated in separate rooms. The authorities have no other witnesses and can only prove the case against them if they can convince at least one of the robbers to betray his accomplice and testify to the crime. Each bank robber is faced with the choice to cooperate with his accomplice and remain silent or to defect from the gang and testify for the prosecution.

If they both co-operate and remain silent, then the authorities will only be able to convict them on a lesser charge of loitering, which will mean one year in jail each, 1 year for Jim + 1 year for Bob = 2 years total jail time. If one testifies and the other does not, then the one who testifies will go free and the other will get three years, 0 years for the one who testifies + 3 for the one convicted = 3 years total.

However, if both testify against the other, each will get two years in jail for being partly responsible for the robbery, 2 years for Jim + 2 years for Bob = 4 years total jail time. So, it is in Jim and Bob’s best interest if they both stay quiet and do not testify against the other one. The same can be said from a duopoly. If both firms decide to take the higher pricing strategy together, then they will both maximize their profits and both will be happy.