OLIGOPOLY

VAIBHAV BHAMORIYA
SESSION 15, MANAGERIAL ECONOMICS
IIM KASHIPUR, PGP 2018-19
UNDERSTANDING OLIGOPOLY

• Strategic interactions between firms are relevant

• Few large firms
• Product can be differentiated or homogenous
• No single model relevant for all oligopolies

• Beliefs and strategic interaction

• If a firm lowers price, competitors can either lower or maintain existing price
• Profit maximization principle same as monopoly
SWEEZY OLIGOPOLY

• Few firms and many consumers

• Differentiated products
• Competition matches price reduction but not increase in prices
• Entry barriers exist

• Profit maximization : MR = MC
• P > MC0 : economic profit (monopoly power) – deadweight loss
• A range exists where changes in MC do not affect profit maximising output
• The firm has an incentive not to change its price despite decrease in MC over this range
COURNOT OLIGOPOLY

• Few firms and many consumers

• Differentiated or homogenous products
• Rivals will hold output constant in face of change of output by firm
• Entry barriers exist

• Reaction function is Q-Q curve of both firms

• Q2 increases – price decrease – P1 decreases and MR decreases = a greater output by firm 2 leads
to lower profit maximising output for firm 1.
COURNOT OLIGOPOLY (CONTD.)

• P=a-b(Q1+Q2)

• MR1(Q1,Q2) = a-bQ2- 2bQ1

• MR2 (Q1,Q2) = a- bQ1-2bQ2

• Revenue R1= PQ1= {a+-(Q1+Q2)} Q1

• MR1(Q1,Q2) = a-bQ2- 2bQ1 and a similar analysis for marginal revenue of firm 2 results.

• Q1= r1(Q2) = {(a-c1)/2b} – ½ Q2 from MR = MC criterion

ISOPROFIT CURVES

• All combinations of outputs produced by all firms that yields a given frim the
same level of profits
• Isoprofit curves that lie closer to monopoly output lead to higher profits
• Isoprofit curves reach their peak when they intersect firm 1’s reaction
function
• Isoprofit curves do not intersect each other

• To maximise profit it chooses an isoprofit curve that is just tangential to

given output of firm 2
 CHANGES IN MARGINAL COSTS &
COLLUSION
• An accurate grasp of how other firms in the market will respond to
managers decision is critical.
• Restricting output or increasing prices = Collusion
• Shaded area represents combinations for two firms that yield higher
profits than cournot equilibrium
• AB represents a line if each firm ‘agreed’ to produce output that in total
equalled the monopoly output
• Maximising industry profit = EF
INCENTIVE TO RENEGE ON COLLUSIVE AGREEMENTS

• Get everyone to collude and then cheat

 STACKELBERG OLIGOPOLY

• Few firms many consumers

• Differentiated to homogenous products
• Single firm (leader) chooses an output level before all other firms choose their output
• Leader output as given and choose outputs that maximise profit given the leaders output
• Entry barriers exist

• The leader must choose an output that will maximise profit given that the follower reacts to whatever the leader
does
• Q1= (a+c2 -2c1) / 2b
BERTRAND OLIGOPOLY

• Few firms many consumers

• Identical products at marginal cost
• Price competition and firms react optimally to prices charged by competitors
• Consumers have perfect info and there are no transaction costs
• Entry barriers exist

• All consumers will purchase from the firm charging the lowest price.
• Firms would undercut each other and no firm would go below MC.
• Either raise switching costs or remove perception that products are identical.
CONTESTABLE MARKET

• All producers have access to technology

• Consumers respond quickly to price changes
• Existing firms cannot respond quickly to entry by lowering price
• No sunk costs