FOUNDATION COURSE

IN MANAGERIAL

EL
ECONOMICS
Dr Barnali Nag
IIT Kharagpur PT
N
Lecture 36: Oligopoly – Choice of P and Q using an example
Example
• Two firms: Vodafone and Airtel are service providers in a
small town

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• Assuming fixed cost = 0 and Marginal Cost = `10

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• The market demand schedule is given

• They form a Cartel, i.e. firms colluding to decide on the

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price to charge and quantity to produce

• If they act like a monopoly in unison, for each firm: Q =

30, P = `40, profits = `900
Conflict between collusion and self interest
• Both firms earning higher profit (`900) if they stick to the cartel
agreement

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• But, individually they have incentive to break the agreement
• And together end up producing more than monopoly output at

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a lesser price and lesser profit (`800)
• Self interest and lack of trust on rivals may make it difficult for
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cartels to sustain
• Especially since there is no legal binding possible on the cartel
members
FOUNDATION COURSE
IN MANAGERIAL

EL
ECONOMICS
Dr Barnali Nag
IIT Kharagpur PT
N
Lecture 37: Oligopoly – Equilibrium and other market
outcomes
Oligopoly Equilibrium
The market outcome in case of oligopoly is called a Nash
Equilibrium where economic participants interacting with

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one another each choose their best strategy given the

PT
strategies that all the others have chosen
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Market Outcomes
• QCompetition > QOligopoy > Qmonopoly
• PCompetition < POligopoy < Pmonopoly

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• Looking back at the two effects of increasing output:
• Output effect – If P > MC, raising output raises profit
• Price effect – Raising output reduces prices and hence profits

PT
• If Output effect > Price effect, output will be increased and vice versa

• As the number of firms in a market increases price effect becomes

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smaller
• P approaches MC
• Oligopoly looks more like a competitive market
• Output increases towards competitive level
FOUNDATION COURSE
IN MANAGERIAL

EL
ECONOMICS
Dr Barnali Nag
IIT Kharagpur PT
N
Lecture 38: Oligopoly – Game Theory
Game Theory
• Game theory helps us understand oligopoly and other
situations where “players” interact and behave

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strategically
• Players can be anyone – firms, individuals, countries etc

PT
• Game is a situation where the players interact and
respond to each other’s moves with an objective in mind
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• Strategy is an action plan to win the game, taking into
consideration the behaviour and likely responses from the
opponent player(s)
Example of the Prisoners’ Dilemma
• Dominant strategy: a strategy that is best for a

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player in a game regardless of the strategies
chosen by the other players

PT
• Prisoners’ dilemma: a “game” between two
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captured criminals that illustrates why
cooperation is difficult even when it is mutually
beneficial
The Game
• The police have caught two suspected bank robbers A and B
but only have enough evidence to imprison each for 1 year.

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• The police question each in separate rooms and lay down
the following offer:
PT
• If you confess and provide evidence against your partner,
you go free.
N
• If you do not confess but your partner implicates you, you get
20 years in prison.
• If you both confess, each gets 8 years in prison.
Outcome
• Dominant strategy for each is to confess

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• Nash Equilibrium : Both confess

• Both would have been better off if they remained silent

PT
• Self interest leads each into choosing an outcome where
both are actually worse off
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FOUNDATION COURSE
IN MANAGERIAL

EL
ECONOMICS
Dr Barnali Nag
IIT Kharagpur PT
N
Lecture 39: Oligopoly – Game Theory (Contd.)
Vodafone and Airtel example relook as a
Game
• Each firm’s objective is to maximize profit

• They collude and decide to produce the monopolistic output

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together and charge the monopoly price

• So each produces 30 units and get a profit of `900

PT
• If one breaks the agreement and produces 40, he gets `1000
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and the other gets `750

• If both break the agreement, each gets `800

• What is each firm’s dominant strategy

• What is the Nash Equilibrium?

Example 2: Coke and Pepsi’s decision to
advertise or not
• A duopoly market with only two major producers of aerated soft drinks

• Advertising can shift individual demand curve of each of the firms to

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the right

• But, advertising is costly

PT
• Firms may collude and decide not to advertise, in which case each
earns a profit of say, `80 crores each
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• If both decide to advertise, they earn a profit of `30 crores each

• If one breaks the deal and advertises, and the other does not, it earns
a profit of ` 130 crores while the other suffers a loss of `20 crores

• What is the dominant strategy for each firm?

Is cooperation possible?
• Repeated games can enforce a cooperative equilibrium

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• What is the difference if it is a finite game?

PT
• “Tit for tat” strategy – whatever one player does in one

round, the other player does in the following round

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FOUNDATION COURSE
IN MANAGERIAL

EL
ECONOMICS
Dr Barnali Nag
IIT Kharagpur PT
N
Lecture 40: Oligopolistic pricing
Implications of the Prisoner’s dilemma on
pricing
• Kinked demand curve – Demand is kinked at the currently
prevailing price and is elastic above this price and inelastic

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below

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• Price rigidity – Producers are reluctant to change prices even if
costs or demand changes
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• Price signalling – Implicit collusion where a firm initiates a price
rise with the hope that the other will follow suit

• Price leadership – One of the firms acts as the price leader and
announces price changes and the other firms follow
Price Leadership
• Dominant Price Leadership

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• Barometric Price Leadership

• Aggressive Price Leadership

PT
N
FOUNDATION COURSE
IN MANAGERIAL

EL
ECONOMICS
Dr Barnali Nag
IIT Kharagpur PT
N
Lecture 41: Public Policy towards Oligopolies
Government intervention
• In oligopolies, it is possible for output and price to be
close to monopoly situation

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• Hence government intervention required to

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• Promote competition

• Prevent cooperation
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Laws around the globe
• Sherman Antitrust Act (1890): Forbids collusion between
competitors

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• Clayton Antitrust Act (1914): Strengthened rights of

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individuals damaged by anticompetitive arrangements
between firms
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• In India, Competition Law (2002)

• NDRC in China
Why implementing the law could be
difficult?
• While price fixing agreements are anti competitive, it is difficult
to determine if there is a genuine reason to raise prices for

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everyone
• Business practices could be having economic rationale behind

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legitimate objectives and competition law could end up stifling
them
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• Three cases could be considered
• Resale price maintenance
• Predatory pricing
• Tying