Oligopolies
Individual firms in oligopolistic competition make decisions in accordance with the theory of the firm; the idea that firms exist andmake decisions in order to maximize their profits. This said, each business’ pricing strategy affects other competitors in the market because all competitors must decide whether to undercut each other – to the detriment of everyone’s profits – or to cooperate by maintaining current prices and thus grossing more profit. The above diagram (p. 211) illustrates the payoffs for two firms depending on each of the firms’ chosen level of output in a simultaneous, one -time game (neither firm knows what strategy the other is going to choose). This scenario is a prisoner’s dilemma – a paradox in game theory in which two rational agents acting in self-interest do not produce the socially optimum outcome. Both firms have the potential to gross $12million each by limiting output. However, the Nash equilibrium 2 lies at the point at which both players produce high output levels. Evidently, $12 million for each firm is the best mutual outcome, yet many rational firms in oligopolies attempt to cheat their competitors by producing a higher level of output due to the temptation payoff of $14 million and the fear that their opponent will do the same thing and cheat them. In theory, the typical outcome is the Nash equilibrium. In practice, however, firms frequently collude each producing a low output in order to achieve the mutually optimum outcome. This particular model, unlike the more realistic cartel model, does not take into account the collusion and price gouging which takes place in certain industries. In the past, many firms have formed collusive agreements in which they agree to fix output at the quantity at whichmarginal cost is equal to marginal revenue, just as it would be for amonopoly, or raise prices unreasonably. While this type of explicit illegal collusion does take place, a multitude of firms continue to collude but tacitly, meaning that they have an unwritten understanding whereby firms agree to limit their competition: tacit collusion is not illegal and for that reason it is more common. In recent years, suspected collusion in the airline industry has meant ‘the average airfare has risen by more than 10% while capacity slid by nearly 20%’ (Peterson, 2015). Collusion is nothing new, and it is very difficult to prove, so it is becoming increasingly harmful to consumers who have fewer and fewer options to choose from in the rising number of oligopolistic industries. The negative effects of anti-competitive behaviour in markets are not exclusive to buyers as previously discussed. In fact, in labour markets – where consumers are the suppliers and firms are the buyers – oligopolists can still take advantage of their dominant position in themarket. Unlike in themarket form of oligopoly, where there are few sellers who control prices, oligopsony occurs where there are few buyers and many sellers. In labour markets where firms have a high degree of oligopsony power, workers have much less choice in where they work and have minimal bargaining power for wages with employers. Not only does this allow firms to depress hourly wages, but it also means that firms can coerce employees into signing non-compete forms which prevent them fromworking with competitors for a certain amount of time after they leave their incumbent job, thus pressurizing workers to remain in their current positions. According to recent empirical work, American states without non-compete enforcement have higher wages. It is, therefore, reasonable to conclude that consumer welfare in these states may be higher due to oligopolists having less control over employees causing the average worker to have more disposable income, ceteris paribus (Starr, Bishara and Prescott, 2015). Moreover, a study by MIT economist Matt Marx and Harvard economist Lee Fleming highlights that only one third of
2 A Nash equilibrium is a strategy profile in game theory where no player in a game has any incentive to deviate from their strategy after conside ring his opponent’s possible choices.
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