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- 1 Understanding what oligopoly is and what its characteristics are.
- 2 We have heard of game theory, but how is game theory applicable in the oligopoly market?
What is an oligopoly market?
An oligopoly market is characterized by a limited number of dominant suppliers who wield significant influence over the market dynamics. This market structure is defined by a handful of sellers who hold substantial market share and thus possess the ability to impact prices, production, and overall industry trends. Oligopoly markets are prevalent across various countries and sectors, presenting distinct characteristics and implications. There are two types of oligopoly markets; competitive oligopoly markets and less competitive markets.
Characteristics of oligopoly markets
Interdependent Firms
Firms that are affected by another firm’s action are said to be interdependent in an oligopolistic market. Therefore, such firms consider what their rivals create and do in order for them to regulate its price and outputs. So, how exactly do interdependent firms affect price output? The moment competitors are fewer in the market or market output and price is changed by the firm, it directly affects its rivals.
Significant Barriers to Entry
Barriers to entry refer to factors that obstruct or discourage new entrants from joining a market, ultimately restricting competition. In oligopolistic markets, significant barriers often exist, potentially leading to unlawful cooperation between firms. For example, economies of scale can lead to a few dominant firms in the market. If new players enter, it could alter the long-term industry dynamics. When firms collaborate to create strategic barriers, newcomers struggle to compete effectively within the industry.
Strategic Behavior
Strategic behavior in business occurs when a firm chooses to engage in competition with its rivals, but does so by carefully considering how their actions will influence their competitors’ reactions and overall market dynamics. In this context, firms and industries often differentiate their products to gain a competitive edge, leading to increased profits. Oligopoly markets frequently experience price wars, prompting companies to seek alternative strategies to avoid such conflicts. These non-price strategies encompass areas like after-sales service, warranties, advertising, and marketing. By adopting these approaches, businesses can shape consumer demand and stimulate an increase in supply, allowing them to thrive in the competitive landscape.
How Game Theory Is Applied In An Oligopoly Market
In an oligopoly market, industries are not solely influenced by their own decisions, but also by the decisions made by other firms within the same market segment. Game theory, a mathematical branch, addresses decision-making scenarios where an individual’s choices are influenced by the decisions of others.
A pivotal concept in game theory is the Nash equilibrium, particularly relevant in oligopoly scenarios. It requires two parties to collaborate and make the same choice for mutual benefit. In oligopoly markets, firms often base their production decisions not only on their own choices but also on those of their rivals. Game theory aids these firms in assessing how competitors may act when interdependent decisions are at play.
For instance, game theory helps shed light on why oligopolies tend to exhibit non-competitive behavior and how they might pursue monopoly-like profits. Consider a scenario where firms contemplate cooperating for shared substantial profits or deceiving one another to reap individual gains. This mirrors the prisoner’s dilemma, where two prisoners isolated from communication must decide whether to betray each other or remain silent, impacting their prison sentences. Similarly, in the oligopoly market, firms can either choose to cooperate for massive profits or betray each other for potential individual gains. The strategy of betraying rivals often prevails, irrespective of the competitor’s decision.
Overall, game theory offers insights into the intricate decision-making dynamics within oligopoly markets, unveiling the delicate balance between cooperation and competition among firms.
How game theory explains behavior of firms
Business
As discussed earlier, game theory is a branch of mathematics that determines how another person’s decision affects the other person. How does Game theory affect business? While venturing into business, the person might decide to compete with someone else who is selling the same product and this will lead him to make investments in innovation or in hiring more capable employees so as to make better products. In this way, game theory helps businesses grasp the significance of each strategic move.
Consumer pricing product strategy
Consider the case of Alibaba’s “BLACK FRIDAY” strategy, a prime example of how game theory influences business decisions. During festive seasons, products are offered at significantly reduced prices to lure in consumers. This practice taps into the principles of game theory by creating a scenario where consumers are more likely to buy when prices are lowered. Similarly, game theory finds application when businesses introduce new products to the market. By offering enticing deals and prices, companies aim to attract customers and gain an edge over their competitors.
In essence, game theory sheds light on the intricacies of how the decisions made by one firm influence the decisions of others. It also delves into the rationale behind firms prioritizing their individual gains over collective profit-sharing. This strategic behavior stems from the understanding that in a competitive landscape, each firm strives to secure its own position and maximize its outcomes within the constraints of market dynamics.
With a background in journalism, Ritika Sharma has worked with many reputed media firms focusing on general news such as politics and crime. She joined The Coin Republic as a reporter for crypto, and found a great passion for cryptocurrency, Web3, NFTs and other digital assets. She spends a lot of time researching and delving deeper into these concepts around the clock, and is a strong advocate for women in STEM.
