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Monopolistic Competition
Until now, we have studied two extreme cases
of competition: perfect competition and
monopoly.
Yet, reality is often in between: often, a firms
residual demand curve is downward sloping.
This is the case when fixed costs in an industry
are large compared to market demand, but not
as big as to create a natural monopoly.
p, $ per unit
AC
MC
p = AC
MR r
Dr
p
300
275
= $1.8 million
211
183
AC
MC
147
D r for 2 firms
MR r for 2 firms
0
64
137.5
275
q, Thousand tons per year
300
243
195
AC
MC
147
MR
0
48
for 3 firms
for 3 firms
121.5
q , Thousand tons per year
243
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Answer:
At x = 0.25 and x = 0.75. The vendors have a
clientele of [0, 0.5) and (0.5, 1], respectively.
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Another application:
Circular City (Salop)
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Oligopoly
We now turn to markets in which the good in
question is relatively homogenous, but there
are only few suppliers in the market
because of high fixed costs or other entry
barriers. In such markets (oligopolies), the
production choice of each producer has a
strategic impact on all other producers.
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Reminder:
The distinction between oligopoly and
monopolistic competition is not always clear
cut. On the one hand, homogenous goods
offered by different firms are rarely exactly
identical, on the other hand, even if a
producer sells a differentiated product that
protects her somewhat from market
pressure, the other producers strategic
choices will matter for her.
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Assumptions:
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q 2
MR r
0
Dr
D
q1
21
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Cournot equilibrium
Firm 2s best-response curve
q1M
q1
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25
= 70
By symmetry, also q L = 70 .
This gives a total quantity of Q = 140 and a
price of p = 533.33.
At this price, each airline makes a profit of
LH: (533.33 300)70,000 8,000,000 =
8.33 million/year)
SWISS: (533.33 300)70,000
13,000,000 = 3.33 million/year
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Remark:
The model is simplified in several respects.
One is the lack of price discrimination:
airlines charge at least two prices for the
same flight in the same class, one
discounted for weekend travels and one
marked up for within-week travel.
(a b( q1 + ...q n ) c)q i
which gives the reaction function:
qi =
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j
Summing all these equations, using q = Q ,
j =1
yields
n(a c) nbQ = bQ
which means
Q=
n ac
n +1 b
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1
(a c b q j )
2b
j i
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As n increases, Q increases.
As n becomes large, Q tends to (a c)/b.
But this is just the competitive output (given
by c = a bQ)
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Summary Table
Hence, the Cournot model provides a model
that fits in between the monopoly outcome
and the competitive outcome, and the
number of firms indicates a degree of
competitiveness.
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