Exercise 8-1: Defining Oligopoly and Game Theory

I will start off today's entry with an interesting picture I found on the Internet as I initially struggled with the different types of markets. I thought this might help other students as well to better understand the different types of markets:

source: http://fintowin.com/wp-content/uploads/2011/07/types_of_market_structure.jpg

Part of this exercise is to explain the differences between oligopoly, perfect competition, and monopolistic competition. While perfect competition only exists in a market where there are many different firms offering identical products (as mentioned above, for example farmers producing and selling milk), monopolistic competition has also many small firms but differentiated products. The examples really helped me make this clear. There are many authors out there writing novels and every novel is different. While there are also many farmers out there, but every cow produces the same type of milk initially. (Minor differences might exist thought).

On the other hand, oligopoly exist where there are only a few firms offering the same product. A good example would be the tobacco industry.

Personally, I would prefer the Monopolistic competition. The reason being that I do believe that if there are many different companies in one market, they have to compete harder, be more innovative and can't just charge any price, but have to be competitive and earn their business. At the same time, since the products they offer are differentiated, a consumer has the choice of different features depending on which manufacturer or service provider he or she decides to do business. Having said that, it does depend on the type of product. I would not expect to get milk from such a market.

I am a consumer that thinks twice about major, and even minor purchases. Having worked as a Buyer and still buying some product for my current employer, I have to make choices on a daily basis a consumer. Depending on the situation I put my focus on different aspects. As an example, when we have to hire a third party company do some on site work for our business, safety is number one. We would find out what the potential suppliers safety record is before we even get a quote. However, when it comes to batteries for a flashlight for example, price and availability are more the focus than the brand name for example.

As a consumer I do feel in control most of the time, with some exceptions such as finding a mobile phone provider - which I guess would be a Oligopoly, since there aren't all that many companies offering these services, especially not when one has to travel outside the city limits.

Game Theory:

The idea behind game theory is that every company acts according to its self interest. What that means is that if two competitors could work together and have a collusion in which they decide at what price and quantity to sell their products in order to make sure both get an equal amount of profit, sooner or later one of the two companies is very likely to "cheat" and try to sell more and/or at a different price in order to outperform the competitor. This eventually leads to the other party not having a choice but to also cheat. Once both sides are cheating they both make the same amount of profit, but the profit for each is lower than when they were working together.


This phenomena can be better understood by looking at what is called a "pay-off matrix". There are 4 possibilities on how these two companies operate:


1. They cooperate and set prices so they can both get the highest return
2. One  company sticks to the agreement while the other cheats. This results in higher profit for the cheating company and lower profit for the honest one
3. Both companies do not cooperate, or cheat. This will result in lower profits than if both companies would be cooperating


The two competitors will make the most combined profit if they cooperate. If one of them cheats, it will make a higher profit until the other competitor figures it out and also breaks the agreement, at which point both companies make less profit than if they would still stick to the initial agreement.


A recent example of a company that was suspected to be part of a collusion is Apple with it's e-book store, see the news story here.

Exercise 7-1: Defining Monopolistic Competition

Size:	Small Company	Medium Company	Large Company
Features:
Differentiated products	Brewster's - With a few locations in Alberta and Saskatchewan and specialized on brewing own beer	Boston Pizza - Franchises all over Canada and some in the US, specialized in Pizza, but offering a variety of dishes.	McDonald's - Franchises all over the world and market leader when it comes to Hamburgers.
Control over price	Edelweiss store - Grocery and gifts store with imported goods from Germany	Pawn Shops - Can be various stores with the same owner and have control over the price	Rolex - High end watches
Mass advertising	Kokanee - Western Canadian Beer brand with TV and newspaper ads	President's Choice - Medium company with advertisement in newspaper, TV, flyer's	Scotiabank - every possible way of advertisement: in-store, TV, Radio, Newspaper, Internet, Billboards, Hockey arenas...
Brand name goods	No Name - Superstore house brand with little advertisement other than Superstore trucks, flyer's and in-store	Easton - Recognized hockey brand	Coca Cola - world wide leader when it comes to Pop

The main characteristics of a Monopolistic Competition are that there are many companies that are relatively small to the size of the market and therefore have small market shares. No special entry or exit requirements exist for new companies and while they all offer similar products, they try to differentiate from each other and advertise to inform the buyers on why product A is better than product B.