Oligopoly Basic Models
7.1 Explain the assumptions and main features of the four basic oligopoly models.
Conditions for Oligopoly: Relatively few firms, usually less than 10.
Duopoly - two firms
Triopoly - three firms
The products firms offer can be either differentiated or homogeneous.
Role of Strategic Interdependence
What you do affects the profits of your rivals? What your rival does affects your profits?
An Example: You and another firm sell differentiated products
How does the quantity demanded for your product change when you change your price?
Key Insights:
The effect of a price reduction on the quantity demanded of your product depends upon
whether your rivals respond by cutting their prices too!
The effect of a price increase on the quantity demanded of your product depends upon
whether your rivals respond by raising their prices too!
Strategic interdependence: You arent in complete control of your own destiny!
Kinked-Demand Model
-Developed by Paul Sweezy (Harvard) in 1939, Robert Hall and Charles Hitch (Oxford).
-Few firms in the market
-Each producing differentiated products.
-Barriers to entry
-Each firm believes rivals will match (or follow) price reductions, but wont match (or follow)
price increases.
-Key feature of kinked-demand Model
Price-Rigidity
Cournot
Model
-French Mathematician Antoine Augustin Cournot 1838
-A few firms produce goods that are either perfect substitutes (homogeneous) or -imperfect
substitutes (differentiated)
-Firms set output, as opposed to price
-Each firm believes their rivals will hold constant output if it changes its own output (
The output of rivals is viewed as given orfixed)
-Barriers to entry exist
Reaction Functions
Suppose two firms produce homogeneous products.
Firm As reaction (or best-response) function is a schedule summarizing the amount of QA
firm A should produce in order to maximize its profits for each quantity of QB produced by
firm B.
Consider a duopolistic market with two firms, A and B, facing a market demand curve of
P=120-qA qB for the same product.
Assume that the cost of production is CA =10qA for firm A and CB = 20qB for firm B.
Situation where each firm produces the output that maximizes its profits, given the the output
of rival firms No firm can gain by unilaterally changing its own output.
Summary of Cournot Equilibrium
The output 40 maximizes firm As profits, given that firm B produces 30
The output 30 maximizes firm Bs profits, given that firm A produces 40
Neither firm has an incentive to change its output, given the output of the rival
Beliefs are consistent:
In equilibrium, each firmthinksrivals will stick to their current output -- and they do!
7.2 Calculate the best reply and the equilibrium of the Cournot oligopoly, Stackelberg
oligopoly, and Bertrand Model (homogenous product).
7.3 Represent the best reply curves and equilibrium of the Cournot oligopoly and Statckelberg
oligopoly in graphs.
7.4 Compare Oligopoly outcomes in different models, and with monopoly, perfect
competition: differences in consumer surplus, producer surplus, deadweight loss, profit,
production rate, etc