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Lec3-Oligopoly-Examples - ECMC41 Imperfect...

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ECMC41: Imperfect Competition (Oligopoly) - Some Examples Oligopoly refers competition amongst the few. So we are investigating a situation where a small number of firms are competing in a market. Not only is the number of these firms limited it but we often also assume the firms are supplying an identical product (i.e. their output is viewed as perfect substitutes by consumers). In such an environment we have competition , that is, the firms’ look out for their own best interest which means they do not cooperate. But at the same time given there are not very many firms thus each firm possesses market power . So we have imperfect competition . Each firm is aware of its market power and that each of the other firms possesses. So when undertaking their profit maximizing decision making each firm is concerned with the decisions (strategies) that are likely to be employed by their rivals. As such models of oligopolistic behavior focus a great deal of attention on strategic interaction , that is, how one firm’s optimal behavior in equilibrium depends upon the optimal behavior employed by rival firms. Usual Environment: Simultaneous moves One shot game (i.e. not repeated over and over again) Rationality (i.e. each player wants to maximizes their payoff/profits) Identical output/products, i.e. in the eyes of consumers they are perfect substitutes Other common, but not necessary assumptions include: There are only two (n=2) firms. This is called Duopoly . Further simplifying assumptions are often made about the cost structure of each firm such as how simple/nice it is and whether the cost structure (technology) employed by each firm differs at all from firm to firm. Of course we must have an assumption of what market demand looks like. Let us now look into this environment via several situations (or cases): Case #1: Cournot Model – Symmetric Costs This is a quantity picking game. In a Cournot game the firms pick their optimal level of output given a guess/forecast of the level of output their rivals will make. Thus each firm’s optimal level of production depends on (is a function of) the level of production (strategy employed by) the other firms (i.e. strategic interaction). Cournot Conjecture : When deciding on their optimal level of output firms assume that the other firms will not choose to vary their level of production once all of the firms (optimal) production decisions are announced. If we all announce proper/rational (equilibrium) strategies (production plans or output levels) based on fair expectations of what other firms will produce then in equilibrium no 1 | P a g e
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firm will want to deviate from these announced plans (i.e. no firm can earn higher profits by switching plans after all these production plans have been announced). Such a set of strategies where each player is playing their best response given the play being played by their rivals in the game is called a
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Lec3-Oligopoly-Examples - ECMC41 Imperfect...

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