Question

The major difficulty in analyzing oligopoly is
a. that the product of oligopolistic industries is heterogeneous.
b. taking account of how a firm believes its rivals will respond to any changes in output it makes.
c. knowing whether or not collusion for the firms is profitable.
d. accounting for different sizes of firms in an oligopolistic industry.

Answer 1

Correct option is C

Firms in an oligopoly market may agree to collude to set a price or output level for a market in order to maximize their gains. As a result of an collusive agreement, price will be higher than the market-clearing price and output is probably going to be lower than that. In this way, oligopolists try to acts as monopolists.

If oligopolists individually pursued their own self-interest without entering into a collusive agreement, then they might produce a complete quantity which is greater than the monopoly quantity and price would have been lower than the monopoly price, thus earning a smaller amount of profit. The promise of larger profits attarcts oligopolists and gives them an incentive to cooperate in a collusive agreement. However, collusive oligopoly is quite unstable and doesnot guarantee profits everytime, because the foremost efficient firms are going to be tempted to interrupt  by cutting prices so as to extend their market share.

Game theory can very well explain why oligopolies have trouble maintaining collusive arrangements to get monopoly profits and why they often ends up in cheating. While firms would be more happy collectively if they cooperate, each individual firm features a strong incentive to cheat and undercut their competitors so as to extend their market share.The prisoner’s dilemma could also be a specific sort of game in theory of games that illustrates why cooperation may be difficult to take care of for oligopolists even when it's interdependent .

Similarly to the prisoner’s dilemma scenario, cooperation is difficult to take care of in an oligopoly market because cooperation isn't within the best interest of the individual players. They tend to cheat in a collusive agreement. However, there were chances of collective outcome to get improved if firms had cooperated instead of cheating. Hence, outcome of collusive agreement gets uncertain and hard to analyse in the sense that whether it is actually profitable or no.