Ch12 - Monopolistic Competition and Oligopoly

The difference between the two is that in the

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quantity or price) as fixed when making its own decision.  The difference between  the two is that in the Bertrand model firms end up producing where price equals  marginal cost, whereas in the Cournot model the firms will produce more than the  monopoly output but less than the competitive output. 7.  Explain the meaning of a Nash equilibrium when firms are competing with respect to  price.  Why is the equilibrium stable?  Why don’t the firms raise prices to the level that  maximizes joint profits? A Nash equilibrium in price competition occurs when each firm chooses its price,  assuming  its competitor’s price as fixed .  In equilibrium, each firm does the best it  can, conditional on its competitors’ prices.  The equilibrium is stable because firms  are maximizing profit and no firm has an incentive to raise or lower its price. Firms do not always collude:  a cartel agreement is difficult to enforce because each  firm has an incentive to cheat.  By lowering price, the cheating firm can increase its  market share and profits.   A second reason that firms do not collude is that such  collusion violates antitrust laws.  In particular, price fixing violates Section 1 of the  Sherman Act.  Of course, there are attempts to circumvent antitrust laws through  tacit collusion. 8.   The kinked demand curve describes price rigidity.   Explain how the model works.  What are its limitations?  Why does price rigidity arise in oligopolistic markets? According to the kinked-demand curve model, each firm faces a demand curve that is  kinked  at the  currently  prevailing  price.    If a firm  raises  its price,  most  of its  customers would shift their purchases to its competitors.  This reasoning implies a  highly elastic demand for price increases.  If the firm lowers its price, however, its  competitors would also lower their prices.  This implies a demand curve that is more  193
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Chapter  12:  Monopolistic Competition and Oligopoly inelastic for price decreases than for price increases.  This kink in the demand curve  implies a discontinuity in the marginal revenue curve, so only large changes in  marginal cost lead to changes in price. However accurate it is in pointing to price  rigidity, this model does not explain  how  the rigid price is determined.  The origin of  the rigid price is explained by other models, such as the firms’ desire  to avoid  mutually destructive price competition.
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