Question

The Key feature of Oligopoly is interdependence – we saw this in both traditional models and using game theory.

a. Explain why price can be very rigid for an oligopoly using the “Kinked Demand Model”: ​2 point

b. Explain how an oligopoly can simultaneously take one features seen for a monopoly and for perfect competition using the “Price Leader Model”: ​2 point

c. Describe how the Hirchmann Herfindahl Index (HHI) provides a more acquire measurement of market concentration than a simple Concentration Ratio like CR4: ​2 point

d. What is the actual dilemma in a “Prisoners’ Dilemma” type of game? ​2 point

e. What is the main reason why real-world Cartels have such a hard time function well? ​2 point

Answer 1

a. Under Kinked demand model the demand curve signifies that the elasticity is higher at the price Higher than the market price or in other word if a firm increases its price it will face a sharp drop in demand which will result in lower revenue whereas the elasticity is lower at price lower than current market price since it is expected that the other companies will also lower the price and there will be no impact on market share Hence, price rigidity sets in for the firm at current market price

b. Under price leadership model one of the firm is dominant and sets price which the other firm follows and the dominance can be because of size of the firm, economies of scale etc.In this model on one hand the barrier to entries are very high, dominance of the firm is there which relates to a monopoly and on the other hand we have homogeneous products,number of organization are small which are the features of Perfect competition

c. While HHI provides the level of concentration to varying degrees using square of the market share of each firm which gives much deeper insight with regards to market concentration and it takes into account the effect of dominance of the firm whereas CR4 ratio as concentration measurements gives you the total market share by the top 4 firm but that not necessarily explains the level of dominance of individual firm For example Top 4 firm each having 25% or the four firm with market share divided as 70%,10%,10%,10% have the same CR4 of 100% but higher HHI in case two which represents the dominant of firm 1 in case II which CR4 is not able to signify.

d) The actual dilemma is to identify the action which provides the best outcome for the individual when there is a zero Sum game given the individual is fully rational and knows that the other is too.

e) In real world cartel is hard to function since cartels depend upon the trust and they falls apart quickly even if only one of the member moves away from the discussed upon action as this will lead to break the whole system, also the cartel in present times will be under the scanner of antitrust regulations and government laws which will make them difficult to collude and harm consumers interest