Ch10 : Oligopoly Flashcards
What are the characteristics of oligopoly?
Market with only a few producers
Firms have market power
Entry into the market is impeded
There are strategic interactions between firms as they consider how other firms’ actions affect their own
What are examples of oligopoly?
Boeing and airbus in the market for large commercial planes
Telus, Bell and Rogers for the cell phone market
Market for cars
Beer market
Apple and Google android
What is the Herfindahl index ?
It’s the measure of the degree of competitiveness in the market
If H is close to 0 it means the meeker is very competitive
Varies between 0 (perfect competition) and 10,000 (100%) (monopoly)
What is the equation of the Herfindahl index ?
It’s the sum of the squares of the shares
H = p^2 + p^2
What are two oligopoly models ?
The Cournot model ( simultaneous-move game )
The Stackelberg model ( sequential game )
What are the characteristics of the Cournot model ?
N firms are competing in a market
Firms are selling the same homogeneous product
Firms choose output simultaneously
Unique market price determined by demand
Demand = output of all firms
Strategic interaction
We look for the Nash Equilibrium
What happen to the Herfindahl index if a new firm enters the market ?
The Herfindahl index will decrease reflecting a lower market concentration
What are the steps to solve the Cournot model ?
- Find the residual demand for firm 1
- Find the best response function for firm 1 using (MR = MC)
a) compute firm 1’s total revenue (R1)
b) compute firm 1’s marginal revenue (MR1)
c) using MR1=MC1 solve for q1 to obtain the best response for firm 1 - To find the best response function for firm 2, redo steps 1 and 2 for firm2
- Find the NE using the best response functions for firms 1 and 2
- Find the market price and each firms’s profit using the equilibrium quantities
In the Cournot model, when does q1 = q2?
q1 = q2 when they have the same MC
q1 is not equal to q2 if their MC is different
What are the characteristics of a stackelberg model ?
2 firms are competing in a market
Firms are selling the same homogeneous product
Unique market price determined by demand
Demand = output of all firms
Firms choose their production sequentially
- firm 1 chooses its output first
- firm 2 observes q1, then chooses q2
To find the equilibrium of the sequential game, we use backward induction : firm 2 plays it’s best response to observed q1
Firm 1 anticipates that firm 2 plays its best response and chooses q1 to maximize profits
What is the difference of Stackelberg model to the Cournot one?
Firms choose their production sequentially
- firm 1 chooses its output first
- firm 2 observes q1, then chooses q2
To find the equilibrium of the sequential game, we use backward induction : firm 2 plays it’s best response to observed q1
Firm 1 anticipates that firm 2 plays its best response and chooses q1 to maximize profits
What are the steps to solve the Stackelberg model ?
If firm 1 plays first :
- Find the best response function for firm 2 using (MR = MC)
a) compute firm 2’s total revenue (R2)
b) compute firm 2’s marginal revenue (MR2)
c) using MR2=MC2 solve for q2 to obtain the best response for firm 2 - Solve for firm 1 using MR1 = MC1
a) compute firm 1’s total revenue (R1): since firm 1 anticipates firm 2’s reaction, it means that firm 1 anticipates revenue that take into account the best response function for firm 2
b) Compute MR1
c) using MR1 = MC1, solve the quantity produced by firm 1 (q1)
d) find the quantity produced by firm 2 by replacing the quantity produced by firm 1 in the best response function for firm 2 - Find the market price and each firms’s profit using the quantities produced by both firms
In which model does the profit is larger ?
In the Stackelberg model : first mover advantage
Which model is more competitive?
The Stackelberg one
Which model have the highest quantity produced ?
The Stackelberg one
Which model have the highest market price ?
The Cournot one
Which model have the highest total welfare ?
The Stackelberg one
If the MC1 decreases but the MC2 stays the same what happen to the quantity supplied by firm 1 and the profits of firm 1 in comparison of them of firm 2
In equilibrium,
q1 > q2
profit 1 > profit 2
What describes an oligopolistic market ?
Necessity to take other firms’ response into account before making a decision
How to compute the CS in a oligopoly?
CS = (Pmax - P) * (q1 + q2) / 2
How to compute the PS in a oligopoly?
PS = (P - MC) * (q1 - q2)
What is the order of competitiveness in the market structures ?
Monopoly < Cournot < Stackelberg < perfect competition
What is the order of price in the market structures ?
Perfect competition < Stackelberg < Cournot < monopoly
What is the order of quantity produced in the market structures ?
Monopoly < Cournot (q1=q2) < Stackelberg (q1>q2) < perfect competition
What is the order of total profit in the market structures ?
Perfect competition (0$) < Stackelberg ( “1 > “2 ) < Cournot ( “1 = “2 ) < monopoly
What is the order of total surplus in the market structures ?
Monopoly < Cournot < Stackelberg < perfect competition
What is the order of CS in the market structures ?
Monopoly < Cournot < Stackelberg < perfect competition
Are cartels and collusive strategy illegal ?
Yes
How to find the quantity produced in each market structures ?
Monopoly : MR = MC
Cournot : MR1 = MC1
Stackelberg: MR1 = MC1
Perfectly competition : P = MC
What are the conditions for perfect competition?
Large number of firms and consumers
Identical product sold across firms ( product homogeneity)
Free entry and exit in the market
Perfect information
No transaction costs
