Rivalry among the Few

For our third example of imperfect competition. we turn back to markets in which only a few firms compete. This time. instead of focusing on collusion. we consider the fascinating case where firms have, a strategic interaction with each other. Strategic interaction is.found in any market which has relatively few competitors. Like a tennis player trying to outguess her opponent. each, ‘business must ask how ,its rivals will react to changes in key business decisions. If GE introduces a new model of. refrigerator, what will Whirlpool, its principal rival, do? If American Airlines lowers its transcontinental fares, bow will United react?,

Consider as an example the market for air shuttle services between New York and Washington. currently served by Delta and US Airways. This market is called a duopoly because is served by two firms. Suppose that Delta has determined that if it cuts fares 10 percent, its profits will rise as long as US Airways does not match its cut but its profits will fall if US Airways does match its price cut. If they cannot collude, Delta must.make an educated guess as to how US Airways will respond to its price moves. Its best approach would be to estimate how US Airways would react to each of its actions and then to maximize profits with this analysis is the province of game theory. to’ which we turn shortly. ‘ Similar strategic interactions are found in many large industries: in television. in automobiles. even in economics textbooks.

Unlike the’ simple approaches of monopoly and perfect competition, it turns there is no simple theory to explain how oligopolists behave. Different cost and demand structures. different industries. even different tern peraments on the part of the firms’ managers will lead to different strategic interactions and to different pricing strategies. Sometimes. the best behavior, is to introduce some randomness into the response simply to keep the opposition off baIance. Competition among the few introduces a completely new feature into economic life: It forces firms to take into account competitors’ reactionsto price and output deviations and brings strategic considerations into their markets.

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