Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 5 Firm Behavior and the Organization of Industry
Chapter 17 of 36 Oligopoly
Section 13 of
25
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Table 2 here
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Figure 4 here
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Figure 4 and Table 2 - A Common-Resources Game
In this game between two firms pumping oil from a
common pool the profit each earns depends
on both the number of wells it drills and
the number of wells drilled by the other firm.
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We can consider the problem of overuse
of common resources using game theory.
In Figure 4 and Table 2, two oil
companies, Texaco and Exxon, own adjacent oil fields.
A common pool of oil worth $12 million
extends under the two fields.
Drilling a well to recover the oil
costs $1 million.
If both Texaco and
Exxon drill one well, each will get half of the oil and earn a $5 million
profit.
If Texaco drills a second well Texaco
has two of the three wells.
Texaco gets two-thirds of the oil, and
a profit of $6 million.
Exxon gets one-third of the oil, and a
profit of $3 million.
…
If Exxon also drills a second well, the
two companies again split the oil quantity.
Each company bears the cost of a second
well and profit is only $4 million for each company.
Drilling two wells is a dominant
strategy for Texaco and Exxon.
If both companies had only drilled one
well they would have gained $5 million profit rather than $4 million after drilling
two wells.
Here again, the self-interest of the
two game players leads to an inferior outcome.
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