ECO101H1 Chap.5 Monopoly, Games and Oligopoly
Monopoly, Games and Oligopoly
A Seller With a Downward-Sloping Demand Curve
Market power changes the revenue consequence of producing another unit. A seller serving the entire market cannot simply assume that every additional unit sells at an unchanged price. Under a uniform selling price, attracting more buyers normally requires a price reduction that also applies to earlier sales.
The extra unit brings revenue, while the lower price takes revenue away from other units. Marginal revenue combines those effects. This explains why using demand directly as the marginal revenue curve overstates the incentive to expand output.
An output calculation therefore has two distinct readings. First locate where marginal revenue equals marginal cost, subject to the usual profit-maximizing conditions.
Next use demand to recover the price associated with that quantity. Price can exceed marginal cost at the selected output. The efficiency comparison asks whether excluded buyers value another unit more than it costs to produce; the profit comparison instead needs total costs, including any fixed expense.
These comparisons use different information and can reach different conclusions.
What a Change in Pricing Can Accomplish
Price discrimination is a way of separating the offers made to different customers or units. Differences in demand responsiveness can make different group prices profitable, but separation must be workable.
If customers can freely resell purchases, a low-price group may supply the high-price group and undo the scheme. An answer about discriminatory pricing should therefore name both the demand difference and the restriction that preserves the groups.
There are two welfare questions: who receives surplus, and how many beneficial transactions take place.
A scheme that serves additional buyers may increase total surplus while reducing the surplus retained by existing customers. Perfect discrimination is the limiting case in which each purchased unit pays its willingness to pay. Group pricing is less fine-grained, so it should not automatically inherit every efficiency result associated with perfect discrimination.
Track actual quantities and margins before making the welfare comparison.
Incentives Inside a Payoff Matrix
Game theory adds another decision-maker whose action affects the outcome. Read each payoff pair in its stated order. To find a best response for the row player, hold a column fixed and compare that player’s payoffs across rows. Repeat for the other player while holding a row fixed.
An outcome is a Nash equilibrium when neither player gains from changing its own action while the other action remains unchanged. This is a stability condition, not a rule that maximizes the sum of payoffs.
A dominant strategy works against every listed rival action. Such a strategy makes a game easier to solve, but it need not exist.
A prisoners’ dilemma illustrates the difference between individual incentives and collective gain: each player can have a dominant action that leads to a lower joint payoff than another available cell. Choosing the cell with the largest total payoff therefore does not finish an equilibrium analysis.
Check the incentive to depart from that cell.
Cartels and Price Competition
Colluding firms attempt to maximize industry profit together and then allocate output or earnings. A member considering additional production receives its own additional sales but does not bear the entire reduction in industry revenue caused by a lower price. This creates a reason to deviate from an agreement.
A cartel calculation establishes the jointly preferred allocation; a separate incentive check is needed to predict whether it survives.
Oligopoly is not a single numerical prediction. Results depend on whether firms choose prices or quantities, whether products are identical, and what the cost conditions allow.
Under the stated identical-product Bertrand model, price competition drives the comparison toward marginal cost. Joint output restriction instead resembles monopoly. Begin a problem by naming the strategic variable and finish by stating precisely which outcome was calculated.
What this chapter covers
- 01
Monopoly Output
- 02
Marginal Revenue
- 03
Price Discrimination
- 04
Best Responses
- 05
Nash Equilibrium
- 06
Cartel Incentives
- 07
Bertrand Competition
Worked example · free
Two Customer Groups and One Cost
- 2At price 15, sell 100 units. Revenue is 1500, variable cost is 500, and profit is 1000.
- 2At price 10, sell 175 units. Revenue is 1750 and cost is 875, giving profit of 875.
- 2Charge the first group 15 and the second group 10 if resale can be prevented. Profit is 100×10+75×5=1375.
Key terms
- Marginal Revenue
- The change in total revenue from selling one additional unit; for a uniform-price seller it includes the revenue lost when earlier units also sell for less.
- Price Discrimination
- Different prices for customer groups or units that allow a seller to capture differences in willingness to pay, subject to workable separation and limits on resale.
- Best Response
- An action yielding the highest own payoff conditional on the other player’s specified action.
- Dominant Strategy
- An action that is a best choice against every action available to the rival in the stated game.
- Nash Equilibrium
- A strategy combination at which neither player can gain by changing its own action alone.
- Cartel
- An arrangement in which producers coordinate decisions to pursue joint profit, while potentially facing incentives for individual deviation.
Monopoly, Games and Oligopoly FAQ
Can I read the monopoly price from marginal revenue?
No. Marginal revenue determines the chosen quantity when compared with marginal cost. Demand then determines the price buyers will pay for that quantity; confusing these readings understates the selling price.
Does a larger markup establish a larger profit?
A markup over marginal cost describes the next unit, while profit concerns all revenue and all costs. Average total cost or an equivalent total-cost calculation is needed to determine profit.
Why can a payoff-maximizing agreement fail?
The agreement can maximize combined earnings while offering an individual member a profitable deviation. Compare that member’s payoff after changing its action while the rival continues to follow the agreement.
Must every game have a dominant strategy?
No. The best action may depend on the opponent’s choice. Check each conditional comparison before claiming dominance, and use the mutual best-response condition to identify an equilibrium when dominance is absent.
When is a two-firm market different from a monopoly?
Two firms may compete over prices or quantities instead of coordinating. The strategic choices, substitutability of their goods and cost conditions determine incentives, so seller count alone does not identify the outcome.
Exam move
Solve one monopoly problem in two colors: one for the output condition and one for the price reading. Then reconstruct a payoff matrix and mark each player’s best responses separately. For a cartel, write a final sentence identifying the profitable deviation that the joint calculation does not eliminate.
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