What is the difference between oligopoly and cartel

When a market has multiple sellers, at least some of which provide a significant portion of sales and recognize like the monopolist that their decisions on output volume will have an effect on market price, the arrangement is called an oligopoly A market in which there are multiple sellers, at least some of which provide a significant portion of sales and recognize that their decisions on output volume have an effect on market price.

At the extreme, sellers in an oligopoly could wield as much market power as a monopolist. This occurs in an oligopoly arrangement called a cartel An arrangement in which sellers coordinate their activities so well that they behave in effect like divisions of one enterprise, rather than as competing businesses that make independent decisions on quantity and price. You may be familiar with the term cartel from the OPEC oil exporting group that is frequently described as a cartel.

In theory, a cartel would operate at the same production volume and price as it would if its productive resources were all run by a monopolist. In a cartel, every member firm would sell at the same price and each firm would set its individual production volume such that every firm operates at the same marginal cost. For the same reason that monopolies are considered harmful, cartels are usually not tolerated by governments for the regions in which those markets operate.

While firms would be better off collectively if they cooperate, each individual firm has a strong incentive to cheat and undercut their competitors in order to increase market share.

In the game, two members of a criminal gang are arrested and imprisoned. The prisoners are separated and left to contemplate their options. If both prisoners confess, each will serve a two-year prison term. If one confesses, but the other denies the crime, the one that confessed will walk free, while the one that denied the crime would get a three-year sentence.

If both deny the crime, they will both serve only a one year sentence. Betraying the partner by confessing is the dominant strategy; it is the better strategy for each player regardless of how the other plays. This is known as a Nash equilibrium. The result of the game is that both prisoners pursue individual logic and betray, when they would have collectively gotten a better outcome if they had both cooperated.

The Nash equilibrium is an important concept in game theory. It is the set of strategies such that no player can do better by unilaterally changing his or her strategy.

If a player knew the strategies of the other players and those strategies could not change , and could not benefit by changing his or her strategy, then that set of strategies represents a Nash equilibrium.

If any player would benefit by changing his or her strategy, then that set of strategies is not a Nash equilibrium. While game theory is important to understanding firm behavior in oligopolies, it is generally not needed to understand competitive or monopolized markets. In competitive markets, firms have such a small individual effect on the market, that taking other firms into account is simply not necessary.

A monopolized market has only one firm, and thus strategic interactions do not occur. Sometimes firms fail to cooperate with each other, even when cooperation would bring about a better collective outcome.

Each prisoner is in solitary confinement with no means of speaking to or exchanging messages with the other. The police offer each prisoner a bargain:. However, the resulting outcome is not Pareto-optimal. Both players would clearly have been better off if they had cooperated.

For both players, the choice to betray the partner by confessing has strategic dominance in this situation; it is the better strategy for each player regardless of what the other player does. This set of strategies is thus a Nash equilibrium in the game—no player would be better off by changing his or her strategy. As a result, all purely self-interested prisoners would betray each other, resulting in a two year prison sentence for both. This outcome is not Pareto optimal; it is clearly possible to improve the outcomes for both players through cooperation.

If both players had denied the crime, they would each be serving only one year in prison. However, the collective outcome would be improved if firms cooperated, and were thus able to maintain low production, high prices, and monopoly profits.

Coca-Cola and Pepsi compete in an oligopoly, and thus are highly competitive against one another as they have limited other competitive threats. Considering the similarity of their products in the soft drink industry i. In such a scenario, there are a number of plausible reactions and outcomes. If Coca-Cola reduces their prices, Pepsi may follow to ensure they do not lose market share. In this situation, defection results in a lose-lose. Which is to say that, due to the initial price reduction by Coca-Cola betrayal of status quo , both companies likely see reduced profit margins.

The Cournot model, in which firms compete on output, and the Bertrand model, in which firms compete on price, describe duopoly dynamics. A true duopoly is a specific type of oligopoly where only two producers exist in a market.

There are two principle duopoly models: Cournot duopoly and Bertrand duopoly. Cournot duopoly is an economic model that describes an industry structure in which firms compete on output levels.

The model makes the following assumptions:. The Cournot model focuses on the production output decision of a single firm. For example, suppose that there are two firms in the market for toasters with a given demand function. Firm A will determine the output of Firm B, hold it constant, and then determine the remainder of the market demand for toasters.

Firm A will then determine its profit-maximizing output for that residual demand as if it were the entire market, and produce accordingly. Firm B will be conducting similar calculations with respect to Firm A at the same time.

The Bertrand model describes interactions among firms that compete on price. Firms set profit-maximizing prices in response to what they expect a competitor to charge. The model rests on the following assumptions:.

Pricing just below the other firm will obtain full market demand, though this choice is not optimal if the other firm is pricing below marginal cost, as this would result in negative profits. By producing more output than it has agreed to produce, a cartel member can increase its share of the cartel's profits. Of course, if all members cheated, the cartel would cease to earn monopoly profits, and there would no longer be any incentive for firms to remain in the cartel. The cheating problem has plagued the OPEC cartel as well as other cartels and perhaps explains why so few cartels exist.

Previous Kinked Demand Theory of Oligopoly. Next Conditions for Monopoly. Removing book from your Reading List will also remove any bookmarked pages associated with this title.