Defining Oligopoly and Game Theory

The main ideas of the game theory are:

·         They exist in oligopoly type of market

·         There is a mutual interdependence between firms

·         Each firm is analyzing the behavior of rivals

·         The firm can act in collusion and non-collusion

“Game theory was developed by economists John Neumann and Oskar Morgenstern in the 1940s to analyze strategic behavior” (Principles of Microeconomics, John E. Sayre, Alan J. Morris). The theory, I assume, was the result of observation on a human nature.

There are numerous evidences of game theory in the current economy. One of the examples was presented in a textbook – OPEC. As a cartel organization, OPEC raised the oil prices acting collusively.

The payoff matrix shows possible scenarios of market/profit share for collusive agreements. The main idea of the matrix is to show the options based on firms’ sticking/non-sticking to the agreement.

The main principle of collusive/cartel idea is to come to an agreement on prices, market share or production quotas. In this way, all participants will gain the maximum profit share. The main condition for gaining this maximum profit share is no cheating among the participants. This main condition can be maintained only during relatively short period of time. History shows that all firms tend to cheat trying to gain extra profit or market share.