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Basic Oligopoly Models
Basic Oligopoly Models
MANAGERIAL ECONOMICS
Lecturer:
Mr. Yoopi Abimanyu, Ph.D.
Composed by:
ANDY
000009361
MAGISTER MANAGEMENT
UNIVERSITAS PELITA HARAPAN
The Plaza Semanggi
Granadha Business District, 3rd, 16th, and 17th Floor
Jl. Jend. Sudirman Kav.50
Jakarta 12930
TABLE OF CONTENTS
Cover Page....1
Table of Contents.....2
Basic Oligopoly Models3
Sweezy Oligopoly..3
Cournot Oligopoly4
Stackelberg Oligopoly..5
Bertrand Oligopoly..6
Oligopoly Models Comparison7
Contestable Markets....7
Bibliography.....8
Cournot Oligopoly
Cournot model is an industry in which there are few firms serving many consumers;
the firms produce differentiated or homogeneous products; each firm believes rivals
will hold their output constant if its output is changed; and barriers to entry do exist.
The relationship amongst Cournot oligopolists is called best-response function or
reaction function, which defines a firms profit-maximizing output for given output
level of other firm. The reaction functions for Cournot duopolists are as follows:
And
Cournot equilibrium occurs at the intersection of
the reaction curves (C), in which neither firm has
incentive to change its output given the other
firms output.
Market demand in homogeneous-product Cournot
duopoly is defined as P = a b (Q1 + Q2) and thus
marginal revenues for such Cournot duopolists are denoted as follows:
MR1(Q1,Q2) = a bQ2 2bQ1
and
The greater the output of a firm; the lower the demand, marginal revenue, and profitmaximizing output of the rival.
In Cournot oligopoly, industry output is below socially efficient level since P > MC
and thus, there is deadweight loss. The amount by which P > MC depends on number
of firms in the industry and the degree of product differentiation. In homogeneousproduct Cournot oligopoly with large number of firms, equilibrium price is close to
MC and industry output approximates perfect competitions with no deadweight loss.
Basic tool to summarize Cournot oligopolists profit is isoprofit curve, which defines
the output combination of all firms that yield a given firm the same profit level. Every
point on isoprofit curve yields the same profit level. The closer the isoprofit curve to a
firms monopoly output, the higher the profit. Isoprofit curve reaches its peak when it
intersects the firms reaction function. However, isoprofit curves do not intersect each
other.
differentiated-product market are upward sloping and thus, the equilibrium occurs at a
point where P > MC.
Oligopoly Models Comparison
A firms optimal decision and profit in oligopolistic market vary depending on
interaction type existing in the market. Using the same market demand and cost
conditions, the outcomes in different oligopolies reveals the followings:
The highest market outputs are produced in Bertrand oligopoly, followed by
Stackelberg, Cournot, and then, collusion.
The highest profit is generated by Stackelberg leader and colluding firms, followed
by Cournot, Stackelberg follower, and then Bertrand.
Contestable Markets
Contestable market is an industry in which all firms have access to the same
technology; consumers respond quickly to price changes; incumbent firms cannot
respond quickly to an entry by lowering their prices; and there are no sunk costs. In
such a market, potential incumbent firms have no market power over customers and
strategic interaction between incumbents and potential entrants is similar to Bertrand
oligopoly. Hence, the equilibrium price corresponds to marginal cost (P = MC) and
firms earn zero economic profits.
In perfectly contestable market, incumbents are disciplined by new firms threat of
entry. A new firm can enter the market with the same technology and charge slightly
lower price. As the incumbents cannot quickly lower their prices, all their customers
will shift to be the entrants and thus, the incumbents have no alternative but to lower
their prices equal to the production cost in order to keep out the entrant.
The absence of sunk costs is important for contestable market since if sunk costs exist
and potential entrant believes that incumbents will lower their prices to respond to its
entry, the entrant may be left with no customers and such new entry will be
unprofitable. In this case, incumbents may not be disciplined by potential entry and
higher prices may prevail.
BIBLIOGRAPHY
Michael R. Baye. 2010 Managerial Economic and Business Strategy, 7th ed.
McGraw-Hill.
Yoopi Abimanyu, Ph.D. 2012. Ekonomi Manajerial (Second Edition), Cet.1.
Bogor: Penerbit Ghalia Indonesia