Question

Answer the following questions about oligopoly.

1. If a group of sellers could form a cartel, what quantity and price would they try to set?
2. What is the prisoner's dilemma, and what does it have to do with oligopoly

Answer 1

An oligopoly is a market structure where in a few large firms dominate the entire market and act like profit maximizing firms.

Generally, in oligopoly markets, firms form a cartel or a mutual agreement to chose a strategy which would maximize their profits. Once firms form a cartel, they act like one profit maximizing firm and chose output and price at the point MR = MC, which maximizes their profits.

Generally, oligopoly firms are faced with a prisoner's dilemma problem, where in due to interdependent nature of firms, action of one player affects payoffs to other players. If firms form a cartel, and set very high prices, there are chances of one firm defecting from this agreement to charge high price, and instead charge a low price and divert all sales to itself. This leaves other firms with zero sales. As a result of this, other firms respond by getting into price wars and also charging low price. This continues till the point firms are charging lowest price possible and making zero profits.

This shows how firms in oligopoly are faced with the issue of prisoners dilemma, due to interdependent nature of firms.