Firm Decision-making Processes and Oligopoly Theory

Abstract

The typical industrial organization economist interested in examining the behavior of firms in market environments characterized by small numbers does not approach his task with any unified set of analytical tools which one could call the theory of oligopoly. Instead, he comes armed with a whole smorgasbord of formal models, ad hoc models, case-study information, and vague notions concerning the impact of business psychology and sociology. The various theories, whether they be formal or informal, are based on a bewildering collection of a priori behavioral assumptions, formal mathematics, hard case-study information, casual empiricism, hand waving, and as much as possible of the traditional theory of the atomistic competitive firm. For those of us interested in public policy analysis this state of affairs is troublesome. On the onie hand, many of the interesting policy issues arise in markets dominated by a small number of large firms and therefore some viable alternative to the competitive model is desirable. On the other hand, existing formal models often do not provide a useful framework for policy analysis. This essay proceeds by briefly reviewing the formal models which appear to make up the corpus of formal oligopoly theory. These models are then evaluated in terms of their ability to generate testable hypotheses that can differentiate oine model from the next and oligopoly behavior from competitive market behavior, as well as the usefulness of these models in the analysis of particular markets and particular public policies. I conclude that there is little qualitative difference in the implications associated with most of the models, but, more importantly, that the formal models are not really utilized by serious students of actual markets and public policies. Rather, the important characteristic of much of this applied work is the use of informal models, stories, the consideration of particular decision-making processes, situation-specific consideratioins of uncertainty, information costs, other transactions costs, and various institutional constraints. Since it appears that the important characteristics of oligopoly behavior are not captured by conventional models, some suggestions for further research which deals more explicitly with the behavior associated with the oral tradition of industrial organization are given; specifically, more careful analysis of actual firm decision-making processes and the phenomena which determine them is called for.

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