Page 716 - Krugmans Economics for AP Text Book_Neat

firm has an incentive to produce more than the agreed ship, in which one firm sets prices for the industry.
upon quantity of output—to engage in noncoopera- Another approach is nonprice competition, such
tive behavior. Informal collusion is likely to be easier as advertising.
to achieve in industries in which firms face capacity 7. Monopolistic competition is a market structure in
constraints. which there are many competing producers, each pro-
3. The situation of interdependence, in which each ducing a differentiated product, and there is free entry
firm’s profit depends noticeably on what other firms and exit in the long run.
do, is the subject of game theory. In the case of a game 8. Short-run profits will attract the entry of new firms
with two players, the payoff of each player depends on in the long run. This reduces the quantity each exist-
both its own actions and on the actions of the other; ing producer sells at any given price and shifts its
this interdependence can be shown in a payoff matrix. demand curve to the left. Short-run losses will
Depending on the structure of payoffs in the payoff induce exit by some firms in the long run. This
matrix, a player may have a dominant strategy—an ac- shifts the demand curve of each remaining firm to
tion that is always the best regardless of the other the right.
player’s actions.
9. In the long run, a monopolistically competitive
4. Some duopolists face a particular type of game industry is in zero-profit equilibrium: at its profit-
known as a prisoners’ dilemma; if each acts inde- maximizing quantity, the demand curve for each
pendently on its own interest, the resulting Nash existing firm is tangent to its average total cost
equilibrium or noncooperative equilibrium will curve. There are zero profits in the industry and
be bad for both. However, firms that expect to play no entry or exit.
a game repeatedly tend to engage in strategic behav-
10. In long-run equilibrium, firms in a monopolistically
ior, trying to influence each other’s future actions.
competitive industry sell at a price greater than mar-
A particular strategy that seems to work well in
ginal cost. They also have excess capacity because they
such situations is tit for tat, which often leads to
produce less than the minimum-cost output; as a result,
tacit collusion.
they have higher costs than firms in a perfectly competi-
5. In order to limit the ability of oligopolists to collude tive industry. Whether or not monopolistic competition
and act like monopolists, most governments pursue is inefficient is ambiguous because consumers value the
antitrust policy designed to make collusion more product diversity that it creates.
difficult. In practice, however, tacit collusion is
11. Product differentiation takes three main forms: style or
widespread.
type, location, or quality. Firms will engage in advertis-
6. A variety of factors make tacit collusion difficult: ing to increase demand for their products and enhance
a large numbers of firms, complex products and their market power. Advertising and brand names that
pricing, differences in interests, and buyers with provide useful information to consumers are valuable
bargaining power. When tacit collusion breaks to society. Advertisements can be wasteful from a socie-
down, there can be a price war. Oligopolists try to tal standpoint when their only purpose is to create mar-
avoid price wars in various ways, such as through ket power.
product differentiation and through price leader-

Key Terms

Interdependence, p. 638 Payoff matrix, p. 644 Antitrust policy, p. 653
Duopoly, p. 638 Prisoners’ dilemma, p. 645 Price war, p. 654
Duopolist, p. 638 Dominant strategy, p. 646 Product differentiation, p. 655
Collusion, p. 639 Nash equilibrium, p. 646 Price leadership, p. 656
Cartel, p. 639 Noncooperative equilibrium, p. 646 Nonprice competition, p. 656
Noncooperative behavior, p. 640 Strategic behavior, p. 647 Zero-profit equilibrium, p. 661
Game theory, p. 644 Tit for tat, p. 647 Excess capacity, p. 665
Payoff, p. 644 Tacit collusion, p. 649 Brand name, p. 672

674 section 12 Market Structures: Imperfect Competition