18. Oligopoly

# 18. Oligopoly - Oligopoly Professor John Diamond ECON 370...

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Oligopoly Professor John Diamond ECON 370: Microeconomic Theory Lecture 18

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2 Oligopoly: Introduction Alternative Models of Imperfect Competition Monopoly and monopolistic competition Duopoly - two firms in industry Oligopoly - a few (> 2 but small) firms in industry Essential Features Nature of interaction between firms (beyond those captured in price) is essence of theories No single “grand theory”
3 Oligopoly: Analysis Simplest Model of Oligopoly: Duopoly Assume only two firms (to limit interactions) Assume homogeneous output No product differentiation Single market price No competition in quality Equilibrium: Solve for output, price of each firm

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4 Oligopoly Models: Based on Game Theory Game Theory Models of Strategic Behavior Non-cooperative simultaneous games Simultaneously choose quantities (or prices) Non-cooperative sequential games Quantity (or price) leader (dominant firm) Quantity (or price) follower Cooperative games Collusion -- jointly set quantities (or prices)
5 Quantity Competition: Introduction Assume output is strategic variable Each firm chooses output to max profits, given output level of competitor Firms “compete in outputs” Firm 1: y 1 units; Firm 2: y 2 units total quantity supplied is y 1 + y 2 market price will be p(y 1 + y 2 ) total cost functions are c 1 (y 1 ) and c 2 (y 2 )

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6 Quantity Competition: Profits Firm 1 maximizes profit, given y 2 Firm 1 profit function: 1 (y 1 ; y 2 ) = p(y 1 + y 2 )y 1 c 1 (y 1 ) Firm 1 “ Reaction Function What output y 1 maximizes firm 1 profit? given y 2 (expected or observed) Solve for reaction function y 1 = f(y 2 )
7 Quantity Competition: Example Let market inverse demand function be p(y T ) = 60 - y T y T = y 1 + y 2 Let firms’ (different) total cost functions be c 1 (y 1 ) = y 1 2 c 2 (y 2 ) = 15y 2 + y 2 2

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8 Quantity Competition: Responses 1 ( y 1 ; y 2 ) (60
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## This note was uploaded on 04/10/2010 for the course ECON 370 taught by Professor Diamond during the Spring '08 term at Rice.

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18. Oligopoly - Oligopoly Professor John Diamond ECON 370...

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