cournot1-1 - Oligopoly Models Static vs. dynamic models...

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ECO 171 Industrial Organization Oligopoly Models Static vs. dynamic models Characteristics of the markets Homogeneous products Differentiated products Strategic considerations: Decision variable role of prices vs. capacity choice Cournot (capacity choice/quantities) Bertrand (prices) Timing of decisions: Simultaneous moves Sequential moves (Stackleberg)
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ECO 171 Industrial Organization Overview Determination of price and market shares Two identical firms Many identical firms Two firms with different costs Key questions: How much total output and price? What determines the shares of firms Key concepts: Residual demand Reaction functions Cournot equilibrium
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ECO 171 Industrial Organization The Cournot Model Start with a duopoly Two firms making an identical product (Cournot supposed this was spring water) Demand for this product is p=D(Q)=D(q 1 +q 2 ), where q 1 is output of firm 1 and q 2 is output of firm 2 Linear case: P = A - BQ = A - B(q 1 + q 2 ) Marginal cost for each firm is constant at c per unit Simultaneous choice of output.
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ECO 171 Industrial Organization Cournot model: solution Revenue of firm 2 = D ( q 1 +q 2 ) q 2 Note that demand depends not only on q 2 but also on q 1. It is called the residual demand form firm 2. Each firm chooses its output given a conjecture of what the other firm will do. In equilibrium conjectures are correct. Marginal revenue for firm 2 = D ( q 1 +q 2 ) +(dp/dq)q 2 Maximize profits by setting MR = MC=c This gives a “best choice” q 2 given conjecture q 1 . This is called a best response or reaction function q 2 =R 2 ( q 1 ). Likewise q 1 =R 1 ( q 2 ). Cournot equilibrium: ( q 1 ,q 2 ) that are best responses to each other.
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ECO 171 Industrial Organization The Cournot model (cont.) P = (A - Bq 1 ) - Bq 2 $ Quantity ( q 2 ) A - Bq 1 If the output of firm 1 is increased
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cournot1-1 - Oligopoly Models Static vs. dynamic models...

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