562_ Lecture5_oligopoly

# 562_ Lecture5_oligopoly - SI 562 Lecture 5...

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1 Page 1 SI 562 Lecture 5 1 Oligopoly (Chapter 7.1 and 7.2) Yan Chen Fall 2009 Agenda Oligopoly » Cournot Nash equilibrium » Stackelberg equilibrium 2 Stackelberg equilibrium » Bertrand competition » Tacit Collusion Next week: » Optimal mechanism design Oligopoly • Oligopolistic Market Structures Few Firms » Consequently, each firm must consider the reaction of rivals to price, production, or product decisions 3 » These reactions are interdependent Heterogeneous or Homogeneous Products Example -- athletic shoe market Nike has 47% of market Reebok has 16% and Adidas has 7%

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2 Page 2 Nokia’s Challenge in Cell Phones 1998: the market leader in cell phones was Motorola with 25% market share and Nokia second with 20% 2002: Nokia held 37% of the market and Motorola 17% wireless web, photos, and other high-speed G3 th li 4 technologies Entry of other firms and new products, such as Dell, Palm, NEC, Samsung and Panasonic pose threats to Nokia’s profit margins 2005: Nokia 31.9%, Motorola 17.9%, Samsung 12.8% Being a leader in a oligopoly does not mean that you remain the leader for long. Oligopoly: Fundamentals ± Types of Oligopoly Behavior Non-cooperative (or competitive) Cooperative (or collusive) Non-cooperative models 5 Cournot Bertrand Stackelberg Example: Retail Gas Prices Two identical gas stations, A and B, are located directly across from one another on a long isolated ( (but not divided) highway. Currently, P = \$3/gal. at both gas stations. 6 A is thinking about raising the price to \$3.25/gal., knowing that if they both raise their price to \$3.25 they will both make more money than they are making now. What should A do?
3 Page 3 How should an oligopolist behave to maximize profits? Correct answer depends on how its competitors behave (mutual interdependence) 7 Quantity Competition 8 The Cournot Model What are reasonable beliefs about how a competitor will behave? Take competitors’ output as given: the Cournot Model A finite, typically small, number 9 of firms Homogeneous product market Consumers: passive, described by an aggregate demand function

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4 Page 4 Cournot Competition Firms select independently the quantities of production to bring to the market Output levels jointly determine the market price according to the inverse 10 market price according to the inverse demand function Strategy spaces: quantities of production A Cournot equilibrium is just a Nash equilibrium of the quantity competition game The Model: Duopoly As in the case of a monopoly, the firm wants to maximize: profit = P(q) * q - TC(q) But now remember that P is a function of 11 total output, not just the output of the individual firm Firm 1 Profit = P(q 1 + q 2 ) * q 1 -TC(q 1 ) Taking the derivative with respect to q 1 gives you Firm 1’s reaction function , showing how much output 1 will produce for every level of q 2.
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## This note was uploaded on 12/16/2009 for the course SI 562 taught by Professor Chen during the Fall '08 term at University of Michigan.

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562_ Lecture5_oligopoly - SI 562 Lecture 5...

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