lecture8 - Microeconomics I Lecture#8 April 7 2009 8 The...

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Microeconomics I - Lecture #8, April 7, 2009 8 The optimum of Oligopoly During previous lectures we have investigated two important forms of market structure: pure competition, where there are typically many small competitors, and pure monopoly, where there is only one large firm in the market. However, much of the world lies between these two extremes. Often there are a number of competitors in the market, but not so many as to regard each of them as having a negligible effect on price. This is the situation known as oligopoly . Behavior of firms in case of oligopoly can be either non-cooperative (individual profit maximization) or cooperative (cartel). It is unreasonable to expect one grand model since many different behavior patterns can be observed in the real world. What we want is a guide to some of the possible patterns of behavior and some indication of what factors might be important in deciding when the various models are applicable. 8.1 Bertrand model of oligopoly Bertrand oligopoly is an example of non-cooperative competition in prices. In Bertrand model firm chooses own price while taking the price of competition as given. First let’s start with a single firm on a market - Arkus. Arkus is facing an inverse demand function: P = 60 - 0 . 6 * Q Profit is maximized where marginal revenue equals marginal cost (equal to zero for simplicity). In our example the revenue is: R = P * Q = (60 - 0 . 6 * Q ) Q = 60 Q - 0 . 6 * Q 2 and hence marginal revenue is: MR = R 0 = 60 - 1 . 2 * Q The profit maximizing (monopolistic) quantity is where marginal revenue equals zero which holds for quantity equal to 50 and corresponding profit maximizing price is equal to 30. Then the second firm, Bona, comes to the market and chooses the price slightly lower in order to get the whole market (Bona can afford this because marginal cost is zero so any price is profitable). Arkus has no customers and hence makes zero profit so it’s better to undercut Bona’s price to get the whole market and make positive profit. This price war leads to both firms charging basically zero price and earning zero profit. 37
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8.2 Cournot model of oligopoly Cournot oligopoly is an example of non-cooperative competition in quantities. In Bertrand com- petition a firm makes decision about own price while taking the price of competition as given. In Cournot competition a firm chooses own quantity to be produced and takes the quantity produced by a competitor as given. First let start with a single firm on a market - Arkus. Arkus is facing an inverse demand function P = 60 - 0 . 6 * Q . Profit is maximized where marginal revenue equals marginal cost (equal to zero for simplicity) and profit maximizing (monopolistic) quantity is 50.
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