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Oligopoly
Oligopoly
Oligopoly
Chapter 9
Oligopoly
An oligopoly implies there are only a few
firms in the market
The firms may sell identical or differentiated
products
Barriers to entry prevent new firms from
entering (the difference between Oligopoly
and Monopolistic Competition)
When making decisions, the Oligopolist must
consider the reaction of its rivals. Firms will
act strategically.
ECON 2106: Managerial Economics © Prof. Colin Mang, 2010
Lecture 9: Oligopoly and Strategic Decision Making
Sweezy Oligopoly
1. There are few firms and many
customers
2. The firms produce differentiated
products
3. Each firm believes that rivals will
match price cuts, but not price
increases
4. Barriers to entry exist
Sweezy Oligopoly
Demand is “Kinked”
Sweezy Oligopoly
Marginal Revenue
– The Marginal Revenue Curve is not
straight. We need to compare the MR
curves associated with the two portions of
the demand curve
Sweezy Oligopoly
Profit Maximization
– Sweezy firms set MR = MC
Cournot Competition
1. There are few firms and many
customers
2. The firms could produce either
homogenous or differentiated products
3. Firms believe that they can vary their
output without drawing a response
from their rivals
4. Barriers to entry exist
Cournot Competition
Basically each firm believes that its own
demand curve (called the residual curve
dr) is exactly the same shape as the
market demand curve
The difference between the two curves
is the Residual Quantity (Qr) produced
by the firm’s rivals
Cournot Competition
Each firm sets MR = MC ; however, MR
will depend on the size of Qr.
Cournot Competition
Taking all the possible values of Qr, we
can find all the values of output the firm
would choose. This is called the
Reaction Function
Q1 = r1(Q2)
We can do the same for Firm 2
This will yield an equilibrium where the
two functions intersect
Cournot Competition
Finding the Reaction Function
– Suppose Inverse Demand is given by
P = a – b(Q1 + Q2)
How much residual demand does firm 1
face?
Cournot Competition
If P = (a – bQ2) – bQ1 then
MR = (a – bQ2) – 2bQ1
Using MR = MC we can find the
reaction function
Cournot Competition
Ex. Suppose Inverse Market Demand is
given by P = 324 – (Q1 +Q2) and each
firm has a cost function
1 2
C = 10,000 + Qi where MC = Qi
2
What is the equilibrium quantity that
each firm supplies and what is the
market price?
Cournot Competition
Ex. Suppose Inverse Market Demand is
given by P = 120 – (1/5)(Q1 +Q2) and
each firm has a cost function
3 2 3
C = 1000 + Qi where MC = Qi
10 5
What is the equilibrium quantity that
each firm supplies and what is the
market price?
Graphical Equilibrium
Each Firm is as best off as it can be
when producing at the equilibrium point
Changing Equilibrium
Suppose Firm 2 develops a new
technology that lowers its Marginal
Cost. A reduction in MC2 will shift Firm
2’s Reaction Function outwards
(because it is now willing to supply more
output at any price)
Firm 2 will produce more and also have
a greater market share
ECON 2106: Managerial Economics © Prof. Colin Mang, 2010
Lecture 9: Oligopoly and Strategic Decision Making
Changing Equilibrium
Notice that Firm 2 also moves to a
higher Iso-Profit Curve. This incentive to
get increased profits is a main driver of
research and development spending
Stackelberg Oligopoly
Graphically
– Given that Firm 2 will always choose along r2 its
Reaction Function, Firm 1 should choose the point
on r2 that yields itself the most profit (where its Iso-
profit curve is tangent to r2)
Stackelberg Oligopoly
Mathematically
Step 1 : Find the Follower’s Reaction
Function
Step 2 : Find the Profit Maximizing
point for the Leader
Step 3 : Find the Follower’s Quantity
Bertrand Competition
1. There are few firms and many
customers
2. The firms sell similar products
3. Firms compete on price and always
react to price changes by competitors
4. Consumers can easily observe the
prices of different firms
5. Barriers to entry exist
Bertrand Competition
Each time a firm sets a price, its rivals
will try to beat it
HOW LOW WILL THEY GO?
Bertrand Competition
Firms value production in two ways:
P = AC Firm can’t lose money
Bertrand Competition
Bertrand Competition is good for
consumers but not always good for
firms as reduced prices lead to lower
profits