4.5 Oligopoly and Game Theory

a. Define (using tables as appropriate) key terms, strategies, and concepts relating to oligopolies and simple games. b. Explain (using tables as appropriate) strategies and equilibria in simple games and the connections to theoretical behaviors in various oligopoly market and non-market settings. c. Calculate (using tables as appropriate) the incentive sufficient to alter a player’s dominant strategy.

• An oligopoly is an inefficient market structure with high barriers to entry, where there are few firms acting interdependently.
• Firms in an oligopoly have an incentive to collude and form cartels.
• A game is a situation in which a number of individuals take actions, and the payoff for each individual depends directly on both the individual’s own choice and the choices of others.
• A strategy is a complete plan of actions for playing a game; the normal form model of a game shows the payoffs that result from each collection of strategies (one for each player).
• A player has a dominant strategy when the payoff to a particular action is always higher independent of the action taken by the other player.
• A Nash equilibrium is a condition describing the set of actions in which no player can increase his or her payoff by unilaterally taking another action, given the other players’ actions. Exclusion: Dominant strategies and Nash equilibrium with more than two players or more than two actions per player, mixed-strategy equilibria, extensive form games, and normal form games with more than two players or more than two actions per player are beyond the scope of the course and the AP Exam.
• Oligopolists have difficulty achieving the monopoly outcome for reasons similar to those that prevent players from achieving a cooperative outcome in the Prisoner’s Dilemma; nevertheless, prices are generally higher and quantities lower with oligopoly (or duopoly) than with perfect competition.
• Enduring understanding PRD-3: Even with a common goal of profit-maximization, market structure constrains and influences prices, output, and efficiency.