8 - Oligopoly Flashcards
What is Oligopoly?
n>1 firms that are aware that their behavior affects market price
How can you study oligopolies?
Firms together determine the market price
Optimal behavior depends on the behavior of others
Strategic interactions
Game theory
-> Classical market theory does not need game theory
-> Monopoly theory does not need game theory
What is Bertrand Competition?
Price competition
What is Cournot Competition?
Quantity competition
What is the market outcome in Bertrand Competition?
Profit of firm j depends on decision of firm k (Strategic interaction, Game theory: simultaneous decisions)
The unique Nash equilibrium is p1=p2=c.
- p1=p2=mc is an equilibrium
- The equilibrium is unique
Outcome coincides with perfect competition
What is the market outcome in Cournot Competition?
Profit of firm j depends on decision of firm k. (Strategic interaction; Game theory; Nash equilibrium)
(q1,q2) is a Nash equilibrium (NE) if
-> q₁* solves max {q₁} π₁ (q₁, q₂)
-> q₂ solves {q₂} π₂ (q₁*, q₂)
Outcome inbetween monopoly and perfect competition
What are the four models of product differentiation?
- Hotelling‘s linear city model
- Salop‘s circular city model
- Dixit‘s consumer model
- Dixit&Stiglitz‘ consumer model
What is the aggregate and inverse demand of xᵢ (p) = 1 - p
aggregate: I xᵢ (p) = I(1 - p) = I - Ip
inverse: p(x) = 1 - x/I
In an oligopoly market with n firms, given aggregate demand and costs, how can you analyze what firm j is doing?
1) Prep: find P(x) from X(p) => price as a function of aggregate demand
2) Maximize the profit for firm j.
Profit = P(X) xⱼ - c(xⱼ)
3) Plug in X = x₋ⱼ+xⱼ, then solve for xⱼ
With horizontal product differentiation, how can you determine the Bertrand equilibrium between several firms?
In order to find prices, you need to maximize profit for each firm.
In order to maximize profit, you need to know demand.
In order to know demand for each firm, you need to find the point between each two firms where a customer is indifferent between their products.
I.e.
1) find where consumers are indifferent inbetween firms
2) calculate all the firm’s demands
3) maximize profits
4) solve for the individual prices
What is horizontal product differentiation?
Horizontal product differentiation = firms are linearly distributed (i.e. on a “line” of quality that they are producing)
With horizontal product differentiation, how can you calculate the social surplus/welfare?
for each firm, calculate the utility of their share of consumers (i.e. the integral of their utility function), subtract variable costs for each firm (if needed).
When considering a market entry for a new firm in horizontal product differentiation, how can you calculate when it would be socially efficient to introduce the new firm?
You compare the social surplus in both situations:
1) social surplus with n firms
2) social surplus with n+1 firms
Then you can compare or set a condition at which 2) would be larger than 1)
