Key Concepts and Summary

Key Concepts and Summary

An oligopoly is a situation where a few firms sell most or all of the goods in a market. Oligopolists earn their highest profits if they can band together as a cartel and act like a monopolist by reducing output and raising price. Since each member of the oligopoly can benefit individually from expanding output, such collusion often breaks down—especially since explicit collusion is illegal.

The prisoner’s dilemma is an example of game theory. It shows how, in certain situations, all sides can benefit from cooperative behavior rather than self-interested behavior. However, the challenge for the parties is to find ways to encourage cooperative behavior.

Glossary

cartel

a group of firms that collude to produce the monopoly output and sell at the monopoly price

collusion

when firms act together to reduce output and keep prices high

duopoly

an oligopoly with only two firms

game theory

a branch of mathematics often used by economists that analyzes situations in which players must make decisions and then receive payoffs based on what decisions the other players make

kinked demand curve

a perceived demand curve that arises when competing oligopoly firms commit to match price cuts, but not price increases

prisoner’s dilemma

a game in which the gains from cooperation are larger than the rewards from pursuing self-interest