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Unformatted text preview: C H A P T E R 25 Oligopoly Prior to Chapter 23, we always dealt with competitive markets, and in Chapter 23, we introduced an extreme version of market power in the form of a monopolist who produces a good without close substitutes and is protected by high barriers to en- try. We now merge these two ideas the ideas of competition and market power in our analysis of oligopolies. An oligopoly, like a monopoly, is protected by barriers to entry and by the fact that there are no close substitutes to the output that is be- ing produced. The (small number of) firms within an oligopoly, however, compete with one another. The question we confront in this chapter is how this competition between firms in an oligopoly affects the market power of the oligopoly, and we will see that the answer depends on what form the competition takes. Regardless, however, there is always an incentive for firms in an oligopoly to collude with one another and behave as if the oligopoly was a monopoly but Prisoners Dilemma incentives for the individual firms often make such collusion difficult to sustain. Chapter Highlights The main points of the chapter are: 1. When firms in an oligopoly compete on price, we call this Bertrand compe- tition ; when they instead compete on quantity (and allow the price to form), we call it Cournot competition . 2. The strategic variable used in oligopoly competition turns out to matter a great deal, with Bertrand competition eliminating all market power while Cournot competition allows firms to benefit from the market power of the oligopoly. (In part B of the chapter, we show mathematically that Cournot competition converges to perfect competition as the number of firms in an oligopoly gets large. Bertrand competition, on the other hand, converges to perfect competition as soon as the number of firms jumps from 1 to 2.) 3. Another way to differentiate between different forms of oligopoly competi- tion involves asking whether some firms announce their strategic variable 617 25A. Solutions to Within-Chapter-Exercises for Part A before others have to. If one firm moves before the other, the first is called the Stackelberg leader and the second is called the Stackelberg follower , with this type of competition referred to as Stackelberg competition . 4. In environments of simultaneous competition (like Bertrand or Cournot com- petition), we use the concept of Nash equilibrium to predict behavior; and in environments of sequential competition (like Stackelberg competition), we use the concept of subgame perfect (Nash) equilibrium. 5. Another feature of sequential settings involves entry deterrence where an incumbent firm that has a monopoly has to decide whether to strategically deviate from monopoly behavior in order to deter entry by a competitor....
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