Short on time? This page is the recap. For explanations, diagrams and worked examples, use the full study guide.
Recap
- An oligopoly has a few large firms, high barriers to entry and interdependence: each firm’s best choice depends on its rivals’ choices. A two-firm oligopoly is a duopoly.
- Products can be identical (cement) or differentiated (cars).
- Oligopoly is inefficient: price is usually above marginal cost, so there is a deadweight loss.
- Firms have an incentive to collude and form a cartel that acts like one monopoly. But each member gains by cheating, cheating is hard to detect, and collusion is illegal in many places, so cartels tend to break down.
- Result: oligopoly prices are usually higher and quantities lower than in perfect competition, but rarely as extreme as monopoly.
Key relationships
| Term | Meaning | How to spot it in a matrix |
|---|---|---|
| Payoff matrix (normal form) | Rows = one player’s actions, columns = the other’s; each cell shows both payoffs | First number = row player, second = column player |
| Dominant strategy | One action is better whatever the other player does | The same action wins in both columns (row player) or both rows (column player) |
| Nash equilibrium | No player can raise its payoff by changing its own action alone | Both payoffs in the cell are best responses |
| Prisoner’s dilemma | Dominant strategies lead to an outcome worse for both than cooperation | Equilibrium cell is beaten by another cell for both players |
| Incentive to change a dominant strategy | A payment to one action, or a penalty on the other, that reverses every comparison | Must exceed the largest gap across the other player’s actions |
Assumptions and scope
- Two players, two actions each, one play, simultaneous choices.
- Games with more players or actions, game trees and mixed strategies are outside the course.
Mistakes to avoid
- Picking the cell with the highest total as the Nash equilibrium.
- Comparing one player’s payoff with the other player’s payoff.
- Comparing across the diagonal instead of within one column or row.
- Saying there is no equilibrium because one player lacks a dominant strategy.
- Closing only the smaller payoff gap when finding the incentive needed.
- Saying oligopolies always reach the monopoly price.
Quick self-check
Payoffs (Row, Column): (Up, Up) = (5, 5); (Up, Down) = (1, 7); (Down, Up) = (7, 1); (Down, Down) = (3, 3).
- What is Row’s dominant strategy? (Down: 7 > 5 and 3 > 1.)
- What is the Nash equilibrium? (Down, Down) with (3, 3); Column’s dominant strategy is also Down.
- Is this a prisoner’s dilemma? (Yes: both would prefer (Up, Up) with 5 each.)
- How much would a reward for choosing Up need to exceed to make Up dominant for Row? (2, the larger of the gaps 7 − 5 = 2 and 3 − 1 = 2; here they are equal.)
Next: practice questions.