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Homework answers / question archive / How can you determine if companies in an oligopoly are playing tit for tat pricing? Looking for illustration of Cournot Equilibrium and Reactive Curve

How can you determine if companies in an oligopoly are playing tit for tat pricing? Looking for illustration of Cournot Equilibrium and Reactive Curve

Economics

How can you determine if companies in an oligopoly are playing tit for tat pricing?

Looking for illustration of Cournot Equilibrium and Reactive Curve.

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An oligopoly is an industry with only a small number of producers. Oligopolies have been around as long as commerce has. The members of an oligopoly change the nature of a free market. While they can't dictate price and availability like a monopoly can, they often turn into friendly competitors, since it is in all the members' interest to maintain a stable market and profitable prices.

The new oligopoly is made up of multinational corporations that have chosen specific product or service categories to dominate. In each category, over time, only two to four major players prosper. Starting a new company in that market segment is difficult, and the few that do succeed are often gobbled up or run out of business by the oligopolies.

Few multinationals aspire to be monopolies. Monopolies attract government regulation and consumer anger (just ask Microsoft). Small oligopolies (such as Coke, Pepsi, and Cadbury-Schweppes) make plenty of money and avoid the constant attention of the regulators.

source: http://www.oligopolywatch.com/stories/2003/04/17/definingTheNewOligopoly.html

Now, let us see how tit for tat pricing strategy is evolved in oligopoly. First, let us see the conditions necessary for Tit for Tat to be successful:

1) Stable set of players
2) Players must have a significant stake in what happens in the future
3) No known or fixed number of future transactions.

A tit for tat strategy involves playing cooperatively at first, and then doing whatever the other player did in the previous period. Firms can make greater short-term profits by cheating, but long-term profits will be higher if they cooperate implicitly.

source: http://www.econ.wisc.edu/~jhertel/L22.ppt.
http://www.wits.ac.za/sebs/downloads/2006/chapter_13_part_2.ppt.

Now, let us understand how tit for tat works from the perspective of Game Theory.

In game theory, the prisoner's dilemma is a type of non-zero-sum game in which two players can "cooperate" with or "betray" the other player. In this game, as in all game theory, the only concern of each individual player ("prisoner") is maximizing their own payoff, without any concern for the other player's payoff per se. In the classic form of this game, Cooperating is strictly dominated by defecting (i.e., betraying one's partner), so that the only possible equilibrium for the game is for all players to defect. In simpler terms, no matter what the other player does, one player will always gain a greater payoff by playing defect. Since in any situation playing defect is more beneficial than cooperating, all rational players will play defect.

The way tit-for-tat works in the classic Prisoner's Dilemma scenario is that even though in one game of prisoner, it would make sense to defect; in an unknown number of games, it's better to cooperate with other people by trusting them at first and then ceasing to trust them if they betray the trust until they start cooperating again.

The Tit for Tat strategy is "initially cooperate, then do whatever the other player did last time." That means Tit for Tat is "forgiving." If a player defects, but then returns to cooperating, Tit for Tat will return to cooperating also.

source: http://swik.net/User:alex/Alex+Bosworth+-
+The+Races/The+Prisoner's+Dilemma+in+Digg+Story+Promotion/

Now let us take a real life example of Dell and HP. Both the companies are operating in the market with no price change. Then, Dell cuts price and increases its market share/profitability and HP loses its market share/profitability. Then, HP also cuts prices and gain market share/profitability while Dell loses its market share and profitability. Thus, we see that first Dell and HP cooperated with each other and when Dell cut the prices, HP also followed it and cut the prices. Thus, we see here that companies are playing a Tit for Tat pricing. A reaction curve for firm 2 is the same with the 1s and 2s interchanged.

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