Introduction to market economies and game theory
Four market types control a society’s economy. These are identified by the number of producers, their control over prices, and barriers to entry- how hard it is for new businesses to jump into a market.
The first market type that we will focus on is perfect competition. Agricultural products are typically sold in this market. Take the example of a bundle of farmers all growing identical strawberries to get in the market. There is strong competition between the strawberry farmers, given one farmer cannot convince you to pay $10 for the berries if another farmer is offering them for $4.
On the opposite end of the spectrum lands the second market type; a monopoly. This market is when one large company produces a product with few substitutes, due to high barriers preventing competition. A monopoly producer can effectively raise prices as high as they wish. There are two types of markets in between these extremes. Monopolistic competition is a market with a multitude of producers and relatively low barriers; their products are similar, but not identical. For example, the infamous American fast-food chain, McDonalds. They share similarities in product with Burger King, but their products are not precisely identical. One of the two fast-food corporations might be able to charge a slightly higher price if, for whatever reason, consumers prefer that type of burger, but if either tries to vastly increase their prices, consumers would be attracted to their competitor.
The next market type is an Oligopoly. An oligopoly is a market with high barriers to entry and is dominated by a few companies. A strong example would be the technology market. To read this article, an electronic device must be in use, whether it be a phone, tablet, or laptop. Only a few companies dominate the technological field, such as Microsoft, Apple, or HP. Each company sells similar products functionally, but neither company sells identical devices. If two companies, such as Apple and Microsoft are selling a laptop at similar prices, they compete through non-price competition. Non-price competition indicates that the competition between both companies does not revolve around any monetary principles. Companies will focus on their style, quality, location, and service. They have a goal to distinguish themselves from their competitors. The most notable form of non-price competition is advertising. Each year companies spend billions of dollars towards introducing new products and services.
Oligopolies seem to operate like monopolistic competition, but the key component that differentiates oligopolies is that they are made up of a few large companies, while a monopolistic market contains several firms. This means each company makes decisions with the actions of its competitors in mind. This is known as game theory.
Game theory is the study of strategic decision-making. A classic component of game theory is something called ‘prisoner’s dilemma’- a paradox in decision analysis in which two individuals acting in their self-interest do not produce an optimal outcome. Even if people or companies rationally follow their self-interest, the best outcome is hard to reach when they cannot or do not cooperate. Game theory serves as an explanation for questions, such as we get cafes and pharmacies parallel to each other, or why supermarkets rapidly cut prices in a dogfight for market share.