Question

Question 1 (microeconomic Concept):

(a) Oligopolies are industries with few competitors and high barriers to entry. Firms in oligopoly

share a very peculiar relationship. Using game theory and the kinked demand curve, explain

this relationship and why you believe firms behave this way.

(b) The COVID-19 pandemic brought with it not only health issues but many economic dilemmas.

One major problem that was experienced all around Australia was the shortage of certain

products from supermarket shelves. With you understanding of economic concepts and with

the aid of diagrams, explain why this had occurred. Do you think it was rational for consumers

to behave this way?

Answer 1

a)

Oligopolies are industries with few competitors and high barriers to entry. Firms in Oligopoly share a very peculiar relationship. An oligopolist, has to figure out the environment before computing the best output. “Figuring out the environment”, when there are rival firms in the market, means guessing (or inferring) what the rivals are doing and then choosing a “best response” .This means that firms in oligopoly markets are playing a ‘game’ against each other. To understand how they might act, we need to understand how players play games. This is the role of Game Theory.

Game theory is the study of how people behave in strategic situations. By ‘strategic’ we mean a situation in which each person, when deciding what actions to take, must consider how others might respond to that action.

The concepts which are used in game theory in Oligopoly are:

1. Strategies: Strategies are the choices that a player is allowed to make. In Oligopoly since there are few firms they need to make different types of strategies because firms here plays game in order to stay in the market and compete with each other. Examples: – In game trees (sequential games), the players choose paths or branches from roots or nodes. – In matrix games players choose rows or columns – In market games, players choose prices, or quantities, or R and D levels. – In Blackjack, players choose whether to stay or draw.

2. Sequential Games: A sequential game is a game that is played in strict order. One person makes a move, then another sees the move and then she moves. Examples: – Chess and checkers. In Oligopoly market also firms wait for the move of its rival firm. For example: Telecom industries.

A Sequential Game looks in this way:

3. Simultaneous Games: Simultaneous games occur when players have to make their strategy choices without seeing what their rivals have done. Note: These do not literally have to be simultaneous. In oligopoly market also firms sometimes make strategies without seeing what their rival firm has done.

A Matrix Game:

Players/one/two	left	Right
Up
Down

4. Payoffs: Payoffs describe what a player gets when she plays the game. In some cases, we do not have to be very precise. For example, some games are “zero-sum”, when one person wins, another loses. Then it doesn’t really matter what number we assign. A winner could get 1 and a loser, -1. Or a winner could get, say, 15 and the loser -15. More often, though, payoffs can vary a lot. To fully describe a game, we need to explain the consequences of every move by every player. Examples: – Profits for firms – Prizes (first, second third) in competitions – Inventions in R and D games.

5. A Sequential Game with Payoffs: In the above game, the first number refers to the (dollar) payoff for the first mover, the second is the payoff for the second mover.

6. Consider a Pricing Game Between Two Firms: Firms price simultaneously. They may price High or Low or Both Pricing High yields the highest profits. But each wants to cheat each other.

	B , Low (P=1)	High ( P=2)
A Low (P=1)	4,4,	6,3
High (P=2)	3,6	5,5

7. Simultaneous Game Payoffs: In the above game, the first number refers to the Row player’s payoffs (the number of years in prison) .The second number refers to the Column player’s payoffs (the number of years in prison).

8. Equilibrium : Once they have described strategies and payoffs, they can go ahead and try to predict how a player will play a game. But where do they start? “Equilibrium” is the term game theorists use to describe how the game will (likely?) be played. The Oligopolist will focus on two types of equilibrium: Elimination of Dominated Strategies and Nash Equilibrium.

In an oligopolistic market, the kinked demand curve hypothesis states that the firm faces a demand curve with a kink at the prevailing price level. The curve is more elastic above the kink and less elastic below it. This means that the response to a price increase is less than the response to a price decrease. The oligopolist faces a kinked‐demand curve because of competition from other oligopolists in the market. If the oligopolist increases its price above the equilibrium price P, it is assumed that the other oligopolists in the market will not follow with price increases of their own.

Here DD is the demand curve under oligopoly market, P is the price and M is the output.

b) The Covid-19 pandemic brought with it not only health issues but many economic dilemmas. One major problem that was expericenced all around Australia was the shortage of certain products from supermarket shelves. This happened because as the whole world was suffreing from pandemic world was shut down , many countries had lockdown even it happend in Austratia , therefore many products are imported from other countries which was not happening at that moment of time but there was demand as we know for certain products like the daily necessary products the demand does not fall but here supply was less so there was a hike in the price of the products which were availabe but it was less for the consumers.

This is the demand and supply graph which can help in understanding it better.

From this diagram we can see that the supply of the goods from SS has become S1S1 for this reason price rose and quantity has already fallen down.Yes, it was rational for consumers to behave in such way because everyone wants to survive, so even the price went up demand for the goods in the supermarket did not fall as it was necessary for the consumers to buy it therefore what ever they got with high price which was availabe in the super market was bought by the consumers.