Clearly, games are not played once. Firms must decide on advertising budgets, investment strategies, and pricing policies continuously. While explicit collusion violates the antitrust statutes, strategic reaction does not. Yet, strategic reaction in a repeated game may have the same effect as tacit collusion.
Consider the game in Figure 9. Suppose that British Airways and Lufthansa were competing for business on the New York to London route during the off season. To lure travelers they were offering discount fares. The question is, how much to discount? Both airlines were considering a deep discount of $400 round trip or a moderate discount of $600. Since the average per trip cost to the airline is $200, each $600 ticket produces profit of $400, and each $400 ticket produces profit of $200.
Clearly, demand is sensitive to price. Assume that studies of demand elasticity have determined that if both airlines offer tickets for $600, they will attract 6000 passengers per week (3000 for each airline), and each airline will make a profit of $1.2 million per week ($400 profit * 3000 passengers).
However, if both Airlines offer the deep discount fares of $400 they will attract 2,000 additional customers per week for a total of 8000 (4000 for each airline). While they will have more passengers, each ticket brings in less profit and total profit falls to $800,000 per week ($200 profhet times 4000 passengers).
What if the two airlines offer different prices? To keep things simple we will ignore brand loyalty and assume that whichever airline offers the deep discount gets all of the eight thousand passengers. If British Airways offers the $400 fare it will sell 8000 tickets per week and make $200 profit each, for a total of $1.6 million. Since Lufthansa holds out for $600, they sell no tickets and make no profit. Similarly, if Lufthansa were to offer tickets for $400, it would make $1.6 million per week while British Airways would make zero.
It was precisely this logic that led American Airlines president Robert Crandall to suggest to Howard Putnam of Braniff Airways in 1983, "I think this is dumb as hell . . . To sit here and pound the @#%* out of each other and neither one of us making a @#%* dime." ... "I have a suggestion for you, raise your @#%* fares 20 percent. I'll raise mine the next morning."
Since competing firms are prohibited from even talking about prices, Crandall got into a lot of trouble with Justice Department when Putnam turned over a tape of the call in which these comments were made.
If Lufthansa figures out that British Airways will simply play the same strategy that Lufthansa is playing, both will end up charging $600 per ticket and earning $1.2 million, instead of charging $400 and earning only $800,000 per week even though there has been no explicit price-fixing.
Game theory has been used to help understand many other phenomena from the provision of local public goods and services to nuclear war. It is clear, for example, that if government finance were done on a voluntary basis, households would have a strong incentive not to contribute. This example of a prisoners' dilemma will be discussed in some detail in upcoming posts. In addition, state and defense department analysts use game theory extensively to play out alternative strategies during times of conflict. Many believe that the arms race between the United States and the Soviet Union prior to 1989 was a simple prisoners' dilemma.
Contestable Markets Before we discuss the performance of oligopolies, we should note one relatively new theory of behavior that has limited applications but some important implications for understanding imperfectly competitive market behavior.
A market is perfectly contestable if entry to it and exit from it are costless. That is, a market is perfectly contestable if a firm can move into it in search of profits but lose nothing if it fails. To be part of a perfectly contestable market, a firm must have capital that is both mobile and easily transferable from one market to another.
 Take, for example, a small airline that can move its capital stock from one market to another with little cost. Provincetown Boston Airlines (PBA) flies between Boston, Martha's Vineyard, Nantucket, and Cape Cod during the summer months. During the winter, the same planes are used in Florida, where they fly up and down that State's West Coast between Naples, Fort Myers, Tampa, and other cities. A similar situation may occur when a new industrial complex is built at a fairly remote site and a number of trucking companies offer their services. Because the trucking companies capital stock is mobile, they can move their trucks somewhere else at no great cost if business is not profitable.
Because entry is cheap, participants in a contestable market are continuously faced with competition or the threat of it. Even if there are only a few firms competing, the openness of the market forces all of them to produce efficiently or be driven out of business. This threat of competition remains high because new firms face little risk in going after a new market. If things do not work out in a crowded market, they do not lose their investment. They can simply transfer their capital to a different place or different use.
In contestable markets, even large oligopolistic firms end up behaving like perfectly competitive firms. Prices are pushed to long-run average cost by competition, and positive profits do not persist.
Review Oligopoly is a market structure that is consistent with a variety of behaviors. The only necessary condition of oligopoly is that firms are large enough to have some control over price. Oligopolies are concentrated industries. At one extreme is the cartel, in which a few firms get together and jointly maximize profits---in essence, acting as a monopolist. At the other extreme, the firms within the oligopoly vigorously compete for small contestable markets by moving capital quickly in response to observed profits. In between are a number of alternative models, all of which stress the interdependence of oligopolistic firms.
*CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 296-298*
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