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16.1
16.2
Duopoly is an oligopoly in which there are only two firms in the industry.
16.3
16.4
is the dominant strategy for the both the First and the Second Firm Thus the Nash-equilibrium combination is (L,L) in which both firms produce 20 units and have a profit of $200. Yet, if they could agree to restrict their individual outputs to 15 units apiece, each could earn $450.
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have a clear incentive to collude or cooperate. Oligopolists have a clear incentive to cheat on any simple collusive or cooperative agreement. If an agreement is not a Nash equilibrium, it is not self-enforcing.
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1.
2.
Central features of the Cournot Model: Each firm chooses a quantity of output instead of a price. In choosing an output, each firm takes its rivals output as given.
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16.8
First firms best response function is: y1*=30 y2/2 The Second firms best response function is y2*=30 y1/2 Taken together, these two best response functions can be used to find the equilibrium strategy combination for Cournots model.
16.9
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16.10
profit of one firm decreases as the output of the other firm increases (other things equal). The Nash equilibrium output for each firm is positive.
16.11
Isoprofit Curves
All
strategy combinations that give the first firm the chosen level of profits is known as an indifference curve or iosprofit curve. Profits are constant along the isoprofit curve.
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16.13
maximizes profits for the first firm given the second firms output of y2*. Any strategy combinations below the indifference curve gives the first firm more profit than the Nash equilibrium. The result above relates to the key assumption that the first firms profit increases as the second firms output decreases.
16.14
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16.15
the Nash equilibrium of this general version of the Cournot model, firms fail to maximize their joint profit. Relative to joint profit maximization, firms produce too much output in the Nash equilibrium.
16.16
16.17
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Bertrand model substitutes prices for quantities as the variables to be chosen. The goal is to find the Nash (the Bertrand-Nash) equilibrium strategy combination when firms choose prices instead of quantities.
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16.19
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16.23
The Bertrand-Nash equilibrium strategy combination is the second firm and the first firm charging a price equal to the per unit cost of production. At this equilibrium, each firms profit is exactly zero.
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the long run, the number of firms (market structure ) is endogenous. The number of firms is an industry is determined by economic considerations. The key process in determining the longrun equilibrium is the possibility of entry.
16.25
Barriers to Entry
A
natural barrier to entry is setup costs. Assume all firms incur setup costs of $S In any period, the rate of interest (i) determines the set up cost (K):K=iS Adding fixed costs to variable costs (40y) gives total cost function: C(y)=K+40Y
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2005 Pearson Education Canada Inc.
Inducement to Entry
If
the fixed costs (K) is a barrier to entry, what is an inducement to entry? An inducement to entry is the excess of revenue over variable costs.
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Inducement to Entry
The
entrants best response function is: yE*=30-y/2 The entrants residual demand function is: Pe=(100-y)-ye The price that will prevail if the entrant produces ye* units is: Pe*=70-y/2 Profit per unit is: Pe* - 40=30-y/2
16.29
2005 Pearson Education Canada Inc.
Inducement to Entry
The
inducement to entry, ye* times (pe*40) is then (30-y/)2. This expression gives the revenue over variable costs that the entrant would earn if established firms continued to produce y units after entry. Entry will occur if inducement to enter exceeds K
16.30
2005 Pearson Education Canada Inc.
Inducement to Entry
Call
the smallest value of y such that no entry occurs the limit output (yL). (30-yL/2)2=K Solving for YL: YL= 60-2K1/2 If K=$100, YL=40 units, If K=$225, YL=30 units, etc. (see Figure 16.8)
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Inducement to Entry
Entry
will not occur if the output of established firms is greater than or equal to the limit output (yL) The limit price (pL) is the price associated with the limit output. In this example: pL=100-yL or pL = 40+2K1/2
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2005 Pearson Education Canada Inc.
Figure 16.8 Identifying the limit price and the limit output
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large must the fixed cost K be so that a third firm will not enter? The generalized no-entry condition for the Cournot models is then: [60/(n=2)2]K
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Barriers to entry
Development
cost K is a barrier to entry, as it differentiates established firms and new potential entrants. The manner in which this differentiation affects the inducement to enter (profits) depends upon the nature of the oligopoly behaviour upon entry.
16.36
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Barriers to entry
The
more aggressive/less cooperative is oligopoly behaviour upon entry, the more effective setup costs are as a barrier. Any firms decision to incur the setup cost is a strategic decision because it affects the incentives of other firms.
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is concerned with action taken by existing firms prior to entry. Reacting refers to actions of established firms subsequent to entry.
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