Section 1 Monopolistic Competition

10.1 A monopolistically competitive industry has the following characteristics:

10.2 Short-run profit maximization for a firm in a monopolistically competitive industry looks identical to a monopoly. In the long run, however, the demand curve is tangent to the average total cost curve, signaling zero economic profit.

Because of product differentiation, a firm’s demand curve is downward sloping. However, it is highly elastic due to the competitive nature of the industry.

Types of Product Differentiation

Location

Quality

Style, Design, and Features

Advertising

Section 2 Oligopoly

10.3 Oligopoly industries are controlled by a few large firms. Barriers to entry are significant, products are less differentiated than in monopolistically competitive industries, and pricing decisions by one firm directly impact other firms (mutual interdependence). Oligopoly firms possess market power, but not as much as a monopoly.

10.4 Cartels are agreements to restrict output to push prices higher, but are inherently unstable because cheating is profitable.

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Section 3 Game Theory

10.5 Game theory is the study of strategic decision making when multiple players each act in their own interests.

Components of a Game

Sequential-move games: Games in which players move one at a time, and are analyzed using game trees.

Simultaneous-move games: Games in which players move at the same time, and are analyzed using game tables.

Nash equilibrium is an outcome that results from all players responding optimally to all other players’ actions to maximize their expected payoffs. In a Nash equilibrium, no player wishes to deviate unilaterally from that outcome.

10.6 Solving for a Nash equilibrium requires analyzing a game table for best responses to the other player’s possible actions.

Player 1’s best response to “Left” is “Top” = 8.

Player 1’s best response to “Right” is “Down” = 7.

Player 2’s best response to “Top” is “Right” = 6.

Player 2’s best response to “Down” is “Right” = 5.

One Nash equilibrium is “Down,” “Right” = (7, 5).

Section 4 Applications of Game Theory

10.7 A Prisoner’s Dilemma occurs when optimal noncooperative play results in an outcome that is inferior to another outcome for both players.

10.8 Ways to Overcome the Prisoner’s Dilemma

Collusion: This is illegal in most cases, although international cartels exist, such as the OPEC oil cartel and various drug cartels. Also, free trade agreements are a legal form of cooperation between countries.

Repeated games: Games that are repeated by the same players, and often results in one player taking the lead on a cooperate strategy, and others follow. The possibility of retaliation in a repeated game increases the likelihood of cooperation.

Trigger Strategies Used in Repeated Games

Grim trigger: When one player defects, the other refuses to cooperate again (no forgiveness).

Trembling hand trigger: Players forgive certain instances of defection as “mistakes” before retaliation is taken.

Tit-for-tat trigger: Essentially an eye for an eye: If one player defects, the other player punishes this player until cooperation resumes.

Leadership games: Describes situations that occur when a small firm competes against a large firm, and where the market share captured by the small firm is not large enough to warrant a reaction by the large firm.

Chicken games: Describes situations that occur when opposing players have an incentive to maintain a tough stance; however, if neither player refuses to back down, the worst outcome for both players occurs.