Monopolistic

Competition and
Oligopoly
Properties of Monopoly, Oligopoly, Monopolistic
Competition, and Competition

Slide 2
Oligopoly

Characteristics
Small number of firms
Product differentiation may or may not exist
Barriers to entry

Slide 3
Oligopoly

The barriers to entry are:

Natural
Scale economies
Patents
Technology
Name recognition

Slide 4
Oligopoly

The barriers to entry are:

Strategic action
Flooding the market
Controlling an essential input

Slide 5
Oligopoly

Management Challenges
Strategic actions
Rival behavior

Slide 6
Oligopoly

Equilibrium in an Oligopolistic Market

Inperfect competition, monopoly, and
monopolistic competition the producers did
not have to consider a rivals response
when choosing output and price.
In oligopoly the producers must consider
the response of competitors when
choosing output and price.

Slide 7
Oligopoly

Equilibrium in an Oligopolistic Market

Defining Equilibrium
Firms do the best they can and have no
incentive to change their output or price
All firms assume competitors are taking
rival decisions into account.

Slide 8
Oligopoly

Nash Equilibrium
Each firm is doing the best it can given
what its competitors are doing.

Slide 9
Oligopoly

The Cournot Model

Duopoly
Two firms competing with each other
Homogenous good

The output of the other firm is assumed

to be fixed
Firms decide simultaneously how much

to produce

Slide 10
Firm 1s Output Decision
If Firm 1 thinks Firm 2 will
P1 produce nothing, its demand
curve, D1(0), is the market
D1(0)
demand curve.
If Firm 1 thinks Firm 2 will produce
50 units, its demand curve is
shifted to the left by this amount.

If Firm 1 thinks Firm 2 will produce

75 units, its demand curve is
MR1(0) shifted to the left by this amount.
D1(75)

MR1(75)
MC1

MR1(50) D1(50)

12.5 25 50 Q1

Slide 11
Reaction Curves
and Cournot Equilibrium

Firm 1s reaction curve shows how much it

Q1 will produce as a function of how much
it thinks Firm 2 will produce. The xs
100 correspond to the previous example.

Firm 2s reaction curve shows how much it

will produce as a function of how much
75 it thinks Firm 1 will produce.
Firm 2s Reaction
Curve Q2*(Q1)

In Cournot equilibrium, each

50 x firm correctly assumes how
Cournot
Equilibrium much its competitors will
produce and thereby
maximizes its own profits.
25 x
Firm 1s Reaction
Curve Q*1(Q2) x

x
25 50 75 100 Q2

Slide 12
Oligopoly
The
The Linear
Linear Demand
Demand Curve
Curve
An Example of the Cournot Equilibrium
Duopoly
Market demand is P = 30 - Q where
Q = Q1 + Q2
MC1 = MC2 = 0

Slide 13
Oligopoly
The
The Linear
Linear Demand
Demand Curve
Curve
An Example of the Cournot Equilibrium
Firm 1s Reaction Curve

Total Revenue, R1 PQ1 (30 Q)Q1

30Q1 (Q1 Q2 )Q1
30Q1 Q12 Q2Q1

Slide 14
Oligopoly
The
The Linear
Linear Demand
Demand Curve
Curve
An Example of the Cournot Equilibrium
MR1 R1 Q1 30 2Q1 Q2
MR1 0 MC1
Firm 1' s Reaction Curve
Q1 15 1 2 Q2
Firm 2' s Reaction Curve
Q2 15 1 2 Q1

Slide 15
Oligopoly
The
The Linear
Linear Demand
Demand Curve
Curve
An Example of the Cournot Equilibrium
Cournot Equilibrium : Q1 Q2
Q1 15 1 2(15 1 2Q1 ) Q1 10 Q2
Q Q1 Q2 20
P 30 Q 10

Slide 16
Duopoly Example
Q1
The demand curve is P = 30 - Q and
30 both firms have 0 marginal cost.
Firm 2s
Reaction Curve

Cournot Equilibrium
15

10
Firm 1s
Reaction Curve

10 15 30 Q2

Slide 17
Oligopoly
Profit
Profit Maximization
Maximization with
with Collusion
Collusion

R PQ (30 Q)Q 30Q Q 2

MR R Q 30 2Q
MR 0 when Q 15 and MR MC

Slide 18
Oligopoly
Profit
Profit Maximization
Maximization with
with Collusion
Collusion
Contract Curve
Q1 + Q2 = 15
Shows all pairs of output Q1 and Q2 that
maximizes total profits
Q1 = Q2 = 7.5
Less output and higher profits than the
Cournot equilibrium

Slide 19
Duopoly Example
Q1
30
Firm 2s For the firm, collusion is the best
Reaction Curve outcome followed by the Cournot
Equilibrium and then the
competitive equilibrium

Competitive Equilibrium (P = MC; Profit = 0)

15 Cournot Equilibrium

10 Collusive Equilibrium

7.5 Firm 1s
Reaction Curve
Collusion
Curve
7.5 10 15 30 Q2

Slide 20
First Mover Advantage--
The Stackelberg Model

Assumptions
One firm can set output first
MC =0
Market demand is P = 30 - Q where Q =
total output
Firm
1 sets output first and Firm 2 then
makes an output decision

Slide 21
First Mover Advantage--
The Stackelberg Model

Firm 1
Must consider the reaction of Firm 2
Firm 2
Takes Firm 1s output as fixed and
therefore determines output with the
Cournot reaction curve: Q2 = 15 - 1/2Q1

Slide 22
First Mover Advantage--
The Stackelberg Model

Firm 1
Choose Q1so that:

MR MC, MC 0 therefore MR 0
R1 PQ1 30Q1 - Q - Q2Q1
1
2

Slide 23
First Mover Advantage--
The Stackelberg Model

Substituting Firm 2s Reaction Curve

for Q2:
R1 30Q1 Q12 Q1 (15 1 2Q1 )
15Q1 1 2 Q 1
2

MR1 R1 Q1 15 Q1
MR 0 : Q1 15 and Q2 7.5

Slide 24
First Mover Advantage--
The Stackelberg Model

Conclusion
Firm 1s output is twice as large as firm 2s
Firm 1s profit is twice as large as firm 2s
Questions
Why is it more profitable to be the first mover?
Which model (Cournot or Stackelberg) is more
appropriate?

Slide 25
Stackelberg
Equilibrium

Slide 26
Duopoly Equilibria

Slide 27