Ch 9

• Oligopoly


  Relatively few firms, usually less than 10
• Oligopoly environment


  • Duopoly - two firms
  • The products firms offer can be either differentiated or homogeneous
  • Oligopoly settings tend to be the most difficult to manage since managers must consider the likely impact of their decisions on the decisions of other firms in the market
• Strategic interaction


  • Your actions affect the profits of your rivals
  • Your rivals' actions affect your profits
  • How will rivals respond to your actions?
• Price reduction


  The effect on quantity demanded depends on whether rivals respond by cutting their prices too
• Price increase


  The effect on quantity demanded depends on whether rivals respond by raising their prices too
• Strategic interdependence


  You aren't in complete control of your own destiny
• Sweezy (Kinked-Demand) Model environment

  • Few firms in the market serving many consumers
  • Firms produce differentiated products
  • Barriers to entry
  • Each firm believes rivals will match (or follow) price reductions, but won't match (or follow) price increases
• Price-rigidity


  Key feature of Sweezy Model
• Sweezy demand


  Demand when each firm believes rivals will match (or follow) price reductions, but won't match (or follow) price increases
• The two segments form the 'kinked' demand curve
• Sweezy profit-maximizing decision


  • Firms operating in a Sweezy oligopoly maximize profit by producing where MR_S = MC
  • The kinked-shaped marginal revenue curve implies that there exists a range over which changes in MC will not impact the profit-maximizing level of output
  • Therefore, the firm may have no incentive to change price provided that marginal cost remains in a given range
• Cournot Model environment


  • A few firms produce goods that are either perfect substitutes (homogeneous) or imperfect substitutes (differentiated)
  • Firms' control variable is output, in contrast to price
  • Each firm believes their rivals will hold output constant if it changes its own output (The output of rivals is viewed as given or "fixed")
  • Barriers to entry exist
• Inverse demand in a Cournot duopoly


  • Market demand in a homogeneous-product Cournot duopoly is reminiscent of multi-plant decision-making
  • Each firm could be viewed as facing an altered demand curve where the output of the other firm has shifted the intercept
• Marginal revenue for firm i in a Cournot duopoly


  • R_i = PQ_i or R_i = [a - b(Q_1 + Q_2)]Q_i
  • Each firm's marginal revenue depends on the output produced by the other firm
• Best-response function


  • Firm 1's best-response (or reaction) function is a schedule summarizing the amount of Q_1 firm 1 should produce in order to maximize its profits for each quantity of Q_2 produced by firm 2
  • Since the products are substitutes, an increase in firm 2's output leads to a decrease in the profit-maximizing amount of firm 1's product
• Finding a firm's best-response function

  Equate its marginal revenue to marginal cost and solve for its output as a function of its rival's output
• Cournot equilibrium


  • Situation where each firm produces the output that maximizes its profits, given the output of rival firms
  • No firm can gain by unilaterally changing its own output to improve its profit
  • A point where the two firm's best-response functions intersect
• Isoprofit curves


  A function that defines the combinations of outputs produced by all firms that yield a given firm the same level of profits
• Stackelberg Model environment


  • Few firms serving many consumers
  • Firms produce differentiated or homogeneous products
  • Barriers to entry
  • Firm one is the leader
  • The leader commits to an output before all other firms
  • Remaining firms are followers
  • They choose their outputs so as to maximize profits, given the leader's output
• Stackelberg equilibrium


  • The leader produces more than the Cournot equilibrium output, gaining a larger market share and higher profits
  • The follower produces less than the Cournot equilibrium output, gaining a smaller market share and lower profits
• Bertrand Model environment


  • Few firms that sell to many consumers
  • Firms produce identical products at constant marginal cost
  • Each firm independently sets its price in order to maximize profits (price is each firm's control variable)
  • Barriers to entry exist
  • Consumers enjoy Perfect information and Zero transaction costs
• Bertrand equilibrium


  Firms set P_1 = P_2 = MC. This is because if MC < P_1 < P_2, firm 2 has an incentive to slightly undercut firm 1's price to capture the entire market, and this undercutting continues until P_1 = P_2 = MC
• Research shows it takes multiple competitors to drive the price down completely, and there is probably some element of differentiation
• Comparing oligopoly models


  • Bertrand
  • Stackelberg
  • Cournot
  • Collusion (monopoly)
• Prices and profits rise while quantities decline as one moves from Bertrand to Stackelberg to Cournot to Collusion (monopoly)
• Contestable markets


  • Key assumptions: Producers have access to same technology, Consumers respond quickly to price changes, Existing firms cannot respond quickly to entry by lowering price, Absence of sunk costs
  • Key implications: Threat of entry disciplines firms already in the market, Incumbents have no market power, even if there is only a single incumbent (a monopolist)
• Your optimal price and output depends on beliefs about the reactions of rivals, your choice variable (P or Q) and the nature of the product market (differentiated or homogeneous products), and your ability to credibly commit prior to your rivals
• Oligopoly


  Relatively few firms, usually less than 10
• Oligopoly environment


  • Duopoly - two firms
  • The products firms offer can be either differentiated or homogeneous
  • Oligopoly settings tend to be the most difficult to manage since managers must consider the likely impact of their decisions on the decisions of other firms in the market
• Strategic interaction


  • Your actions affect the profits of your rivals
  • Your rivals' actions affect your profits
  • How will rivals respond to your actions?
• Price reduction


  The effect on quantity demanded depends on whether rivals respond by cutting their prices too
• Price increase


  The effect on quantity demanded depends on whether rivals respond by raising their prices too
• Strategic interdependence


  You aren't in complete control of your own destiny
• Sweezy (Kinked-Demand) Model environment

  • Few firms in the market serving many consumers
  • Firms produce differentiated products
  • Barriers to entry
  • Each firm believes rivals will match (or follow) price reductions, but won't match (or follow) price increases
• Price-rigidity


  Key feature of Sweezy Model
• Sweezy demand


  Demand when each firm believes rivals will match (or follow) price reductions, but won't match (or follow) price increases
• The two segments form the 'kinked' demand curve
• Sweezy profit-maximizing decision


  • Firms operating in a Sweezy oligopoly maximize profit by producing where MR_S = MC
  • The kinked-shaped marginal revenue curve implies that there exists a range over which changes in MC will not impact the profit-maximizing level of output
  • Therefore, the firm may have no incentive to change price provided that marginal cost remains in a given range
• Cournot Model environment


  • A few firms produce goods that are either perfect substitutes (homogeneous) or imperfect substitutes (differentiated)
  • Firms' control variable is output, in contrast to price
  • Each firm believes their rivals will hold output constant if it changes its own output (The output of rivals is viewed as given or "fixed")
  • Barriers to entry exist
• Inverse demand in a Cournot duopoly


  • Market demand in a homogeneous-product Cournot duopoly is reminiscent of multi-plant decision-making
  • Each firm could be viewed as facing an altered demand curve where the output of the other firm has shifted the intercept