Greetings, in a previous video we introduced the idea of thinking about oligopolies and why oligopolies are so much harder than monopoly or competition. The reason oligopolies are so much harder is because of something we call the oligopoly problem. We call the oligopoly problem conjectural interdependence, which is a big long couple words. And conjectural interdependence, it's really means exactly what it says. It means that the firms have to have conjectures about how their rivals will behave, okay? And those conjectures are interdependent on how their rivals actually do behave, okay? Monopolies don't have to worry about that because monopolies have no rivals. Competitive firms don't have to worry about their rivals because everybody is so small that they can't have any impact on the market. But in the case of oligopoly, firms can indeed have impacts on each other. And we have to figure out how can we go ahead, I mean, you think about this, think about the Toyota problem, the Honda and Toyota. Honda and Toyota are big players in the mid-sized automobile. And Honda says, well, you know what, I think I would increase my car production by 10%. What's Toyota going to do? How will Toyota respond? Well, it's not well known, we don't know for sure what the conjecture is. Honda has to have a conjecture about what it thinks its rival Toyota's going to do, okay? It's illegal for them to call each other up. I mean that might happen, but if they ever got caught [LAUGH] if somebody was listening to that phone call, they're going to go to jail, okay? That stuff can happen. Now, but when Honda thinks about increasing its production by 10%, Honda has to think, I wonder what Toyota's going to do. I mean, we talked about this in the past, Toyota could say, well, you know what? I'm going to increase by 10% to because I want to keep my market share the same. Well, that would really cause a bout of downward pressure on price because, as we've said earlier, when we did the competitive case. If the largest corn farmer in the state of Illinois were to increase its production by 10%, what would be the impact on the market? Nothing, each player, even the largest one, is too small. That's not true for Honda. If Honda increases its output by 10% of Accords, that's going to have a depressing pressure on price in the market. But Honda has to also know, maybe Toyota will increase also by 10%, that would really push prices down. Or maybe Toyota will actually back off because they like the current price, so increasing my price of cars might not have much impact of price at all. They have to have some way to figure this stuff out, and so we need to figure out a way for us to model conjectures, okay? We have to figure out a way for us to model conjectures. It's hard, it's a hard problem. I mean, in essence you are having to do what economists call the infinite regress problem because you have to have some model that says here's what Honda thinks Toyota thinks. But then we have to know what does Toyota think Honda thinks Toyota thinks, and that begets the next question. Well, what does Honda think Toyota thinks Honda thinks Toyota thinks? And this problem is this infinite regress problem because we have to somehow build in rules for behavior in these firms. So we're going to figure out how do we model conjectures, and we're going to figure out how do we model responses? We got to think of modeling conjectures and modeling responses. [LAUGH] Some of those ways to do this can be really daunting mathematics, okay? Not just simple, multivariable calculus, but we need to much harder problem. But we're going to do is we're going to try and boil those down and think about essentially two ways. It could be very difficult, but in our analysis we're going to limit our investigation, To two paths. One is we're going to look at collusive arrangements. Collusive arrangements are sometimes called cartels. They are organizations made up by the firms in an Industry. You don't see collusive arrangements in a monopoly because there's only one firm, okay? You don't see collusive arrangements in a competitive case because even if you put together lots of them, you're still not big enough to make any impact of the market. But if you have a small number of players, like say 6 or even 56, maybe you can get together and come up with some backroom deals that you can cut. And we can figure out how they're going to set price and quantity and how they will respond to any of those little examples we keep using of bumping the cereal bowl. Some external shock to the collusive arrangement, how do they adjust to that? So that's what we'll do first and then secondly, we're going to introduce something called game theory. We're going to introduce something called game theory, and game theory was originally a branch of mathematics that has now moved into, Being used quite extensively by many social sciences, economics, political science, psychology, sociology, because it is a way to formaly model strategic interactions between people. That is if you're doing it in a sociology class or a psychology class. Or between firms if you're thinking about economics course, which is what we're doing. Or it could be between nations if you're thinking about studying political science. It's a way to model strategic behavior, think about that going forward, thanks.
