Oligopoly Market Analysis - Essay Example

Discuss the Role of Game Theory and the Problems Faced By the Managers in Decision Making Of a Firm Operating In an Oligopoly Market  Table of Contents Overview 3 Game Theory 4 Strategic and Interdependent Decision Making In the Oligopoly Market 6 Problems faced in Decision Making by Companies Functioning in Oligopolistic Market 8 Role of Game Theory on the Decision Making of Organizations under Oligopolistic Structure 9 References 12 Overview An oligopoly market is one that is dominated by a small number of producers, whose behaviors are mutually dependent on each other. To put it in other words, the choices made by one organization in the oligopolistic structure has a consequence on the other organizations in the market structure as well. The oligopolistic market has an elevated intensity of market concentration, which means that the market is subjugated by a few leading producers. Nevertheless, oligopoly market can be best described by the behavior of the organizations in the market instead of the structure of the market. The common characteristics of an oligopolistic market are product differentiation, barriers to entry, inter-reliant decision making amongst the organizations and non-price rivalry between the organizations1. Each organization in the oligopolistic market generally produces differentiated or branded products. The entry barriers to the oligopolistic form of market are very high which averts the weakening of the competition in the market. The few dominant organizations in the oligopoly market hence earn the maximum profits. However, these organizations are interdependent and have to consider the reaction of their competitors prior to making any decision regarding price change, production level or choice of non-price rivalry. The non-price rivalry amongst the oligopolistic organizations could be in various forms. A few of the non-price rivalry strategies are product diversification, brand development, and widespread after-sales services among others2. Owing to the interdependent nature of the organizations operating in an oligopolistic market structure, the manager of such organizations has to implement strategic decision-making so that the business decisions made by them are the most beneficial one for their organization. Strategic decision-making requires the managers of a particular organization to make presumptions about how the competing organizations would respond to any choice they make. Such kinds of business decisions are very complicated in nature and the results of these decisions are also very indecisive owing to the inter-reliance amongst the organizations. The game theory is considered to be one of the imperative tools utilized by the managers of oligopolistic organizations in the process of strategic decision-making. The concept of game theory is the analysis of models of disagreement and cooperation amongst rational as well as smart decision makers3. This study reviews the function of game theory in the decision making process of the managers of the organizations operating in an oligopolistic market structure. The study also discusses the problems faced by the managers of oligopolistic organizations while making strategic business decisions. Game Theory John von Neumann and Oskar Morgenstern had initially pioneered the hypothesis of games in the year 1944. They were the foremost to introduce the game theory in their book ‘Theory of Games and Economic Behavior’4. According to Mas-Collel & Et Al. (1995), a game can be described by four constituents, such as ‘players or participants’, ‘rules’, ‘outcomes’ and ‘preferences’5. The game theory tries to establish the most favorable choice of strategy for participants contending to maximize their end results by calculating the course of proceedings, within a specified set of strategies. Game theory exercises mathematical representations to assess circumstances concerning both disagreement as well as cooperation. The game theory analysis is complicated and difficult in comparison to the typical operational analysis. This is because, while using game theory an individual has to judge the concurrent optimization of the selection of strategy for quite a few interacting participants. Moreover, in such situations the selections of strategy of all participants have an effect on not only on the outcome of their own strategy selection but also on each of the strategy selections of every other participant6. The game theory is generally applied by participants who are occupied in varying levels of disagreement and cooperation, for instance the organizations in an oligopolistic industry. Each of the participants in such a scenario has the choice of more than one course of proceedings before them, to apply to specified situations. These choices of the course of proceedings available to each participant can be referred to as their strategies. Each participant’s selection of one particular strategy over all the others leads to a result. This particular result is only the consequences of the selection of strategies by all the participants in the game. A basic supposition of the game theory is that of the existing choices of strategies, participants would prefer one over the others. This inclination for a particular strategy illustrates the preference of the participant. The game theory tries to evaluate the rational preference of strategy selection amongst the various participants involved in a conflict situation. The game theory thus assists an individual participant in the process of selection of a strategy that would result in that particular participant’s utmost level of benefit, keeping in consideration the strategy selections of other participants in the game7. Accordingly, game theory is beneficial in the process of planned decision making, where unlike the individual decision making process, the eventual outcome of a circumstance relies on the selection of strategies made by all the other players concerned. The various players involved in a game generally have divergent aspirations and objectives, which may result in a disagreement between them and they might not essentially cooperate with each other while selecting their strategies8. For instance, there is usually a stress between cooperation as well as self-interest amongst the organizations operating in the oligopoly markets. Thus, the game theory offers general methods for the assessment of scenarios in which the small number of organizations in the oligopoly market make strategic decisions that have an influence on the welfare of the other organizations in the market as well. Game theory is utilised by the managers of organizations operating in the oligopoly framework for the assessment of conflict amongst the organizations as well as for the interactive decision making course9. Strategic and Interdependent Decision Making In the Oligopoly Market The organizations in the oligopoly market have to make strategic business decisions considering the response of their competing organizations. This is because owing to their interdependent nature, their individual decision would impact all the other organizations’ behavior as well as profits. For instance, in view of the airline industry which is an oligopolistic industry, any price cut in the fares by a particular overseas airline in order to raise its profits could be followed by the other overseas airlines as well. Such a scenario would result in loss for every overseas airline company in the industry, illustrating that the behavior of one particular organization in the oligopoly market can affect the behavior as well as profit of the other organizations operating in the same market. Another instance of interdependency of the oligopolistic organizations is when the decision of one company to enhance its advertising and hence generate more profits as well as market shares depends on the response of its competitor to such advertisement. Thus, in order to make profit enhancing decisions, the managers of organizations operating in oligopolistic markets have to take the response of their competitor in consideration while making their strategic decisions10. In general, there are three kinds of situations of strategic decision making, such as the simultaneous decisions, the sequential decisions and the repeated decisions. The simultaneous decisions are when the manager of an organization makes an individual choice without possessing any idea of the decision of their competitor. In such cases, the managers of each organization choose their course of action and all the organizations exercise their strategies concurrently or simultaneously. The sequential decisions are those when the manager of one organization makes a choice before the manager of another organization. While the repeated decisions situations are those when the same group of organizations makes strategic choices frequently over a period of time11. Problems faced in Decision Making by Companies Functioning in Oligopolistic Market The main difficulty encountered by the managers of companies functioning in the oligopoly market is the prediction of the reaction or response of their competitor companies. It is very complicated for the managers of the companies functioning in oligopoly market to make their business decisions as the response of their competitors would always remains uncertain, which would impact their profits. Additionally the competitors would always make decisions that would result in maximum profit for them, considering their anticipation of the decisions to be made by their competitors12. The goal of every organization is to optimize its profits and hence the basic objective of managers of the organizations during business decision making is to equate the marginal revenue of the organization to its marginal cost. When the marginal revenue of an organization is higher than its marginal cost, the managers increase the production level and reduce the price. On the other hand, when the marginal cost of an organization is greater than its marginal revenue, then the managers reduce the level of production of the organization and elevate the price of their products13. However, unlike other forms of market, the organizations in oligopoly have to employ intricate strategic thinking to maximize their profit. This is because in the other forms of market, such as the monopoly, the perfect competition and the monopolistic competition, the organizations have a definite demand curve for their products and hence can comfortably decide the quantity of product to be produced by them, where their marginal revenue would be equal to their marginal cost14. The organizations operating in these forms of market do not have to be concerned about the response of other organizations, since either the organization is negligibly small or else a monopoly. However, in an oligopoly market structure, there are few organizations and they are huge enough to have an effect on the market. The organizations operating in an oligopolistic structure have to constantly respond to the decisions and choices of their competitors, and their competitor companies have to similarly always respond to the decisions of their rivals. Consequently, the major problems faced by the managers of the companies functioning in oligopolistic market structure are estimation of the demand of their products and their marginal revenue in addition to forecasting the behavior of their competitors15. In an oligopoly market structure, there are few organizations that supply to the market and the decisions of each such organization pertaining to their production level and the price of their products influence the demand curve as well as the marginal revenue of all other organizations in the market. As a result, the organizations operating in the oligopoly are interdependent on each other. Role of Game Theory on the Decision Making of Organizations under Oligopolistic Structure In the oligopolistic market structure, every organization’s demand curve, marginal revenue and profit relies on the strategic business decisions relating to pricing, production level and expansion of every competing organization. Under these circumstances, the managers of such organizations employ game theory for making strategic decisions for the benefit of their organization. The two most common types of situations faced in the game theory are the ‘simultaneous decision games’ and the ‘sequential decision making games’. The first decision making form is applicable when the managers of the organizations take their decisions without the knowledge of their competitor’s decision. The second situation is when the managers are aware of their competitor’s decision, prior to making their own decisions16. According to game theory, when two players are involved in a game, the strategy that would lead to an optimized outcome for a player irrespective of whatever strategy the other player chooses is known as the dominant strategy for the particular player. Similarly, if in an oligopolistic environment a dominant strategy exits for the involved organizations, then the managers of each firm would opt for their dominant strategy and would also presume that the managers of the rival organizations would also pursue their dominant strategies. If there is cooperation amongst the involved organizations, their managers would choose a strategy that would be beneficial for all. However, if there is disagreement between the organizations and if each of the organization would have a dominant strategy then each of them would follow their dominant strategy17. Nevertheless, if one of the involved organizations possesses a dominant strategy in a particular case and the others do not, then the manager of the organization having a dominant strategy would follow the dominant strategy. The other organizations in the market, realizing that the particular organization would pursue its dominant strategy, would take their optimal decisions accordingly. In circumstances when there is a lack of dominant strategy balance, the managers of the organizations choose their strategy based on the consecutive removal of dominated strategies till there are no dominated strategies present. In this context, dominated strategies are those which are not selected by the managers because there are other strategies available to the organization which would provide them a comparatively superior payoff18. When there is lack of simultaneous clear decision amongst the organizations in an oligopoly, the managers of the organizations are likely to select strategies that are mutually best as well as strategically stable. The resultant equilibrium is known as the Nash Equilibrium, where no organization has an inducement to change and no individual organization can make a different choice and increase its payoff. Therefore, the state of Nash equilibrium is considered to be strategically stable19. Thus, it can be concluded that the organizations in the oligopoly market, owing to their definite characteristics of interdependence and intense market concentration have to employ game theory because their decision-making process is strategic in nature. The managers of such firms make their business decisions to obtain optimized results, keeping in consideration the response of all the other organizations in the market. References Anderton, Alain. Economics. India: Pearson Education, 2000. Arnold, Roger. A. Microeconomics. USA: Cengage Learning, 2010. Carbaugh, Robert. J. Contemporary Economics: An Applications Approach. USA: M.E. Sharpe, 2010. Friedman, James. W. Oligopoly Theory. UK: CUP Archive, 1983 Gibbons, Robert. Game Theory For Applied Economists. USA: Princeton University Press, 1992. Ginevicius, Romualdas. & Krivka, Algirdas. 2008. “Application of Game Theory for Duopoly Market Analysis”. Journal of Business Economics and Management, Vol. 9(3), 207-217. Hay, Frederick. George & Et. Al. Intermediate Microeconomics: A Perspective On Price Theory. UK: Manchester University Press ND, 1996. Mas-Collel, Andreu. & Et. Al. Microeconomic Theory. UK: OxfordUniversity Press, 1995. McEachern, William. A. Economics: A Contemporary Introduction. USA: Cengage Learning, 2011. Thomas, Christopher & Et. Al. Managerial Economics. India: Tata McGraw Hill Education, 2010. Vives, Xavier. Oligopoly Pricing: Old Ideas and New Tools. UK: MIT Press, 2001. Read More