Chapter 8 Flashcards
Oligopoly
Situation between the two extremes: monopoly and perfect competition, There are a few firms, but less than the very large number assumed in perfect competition
Bertrand model
It consists of 2 firms in a market for a homogenous product and the assumption that firms set prices simultaneously. Also marginal costs are constant MC=c
Firms choose price level
The discrete Bertrand game
When sellers are restricted to a limited set of price levels.
Pricing in standard Bertrand competition
Under price competition with a homogeneous product, and constant, symmetric marginal cost, firms price at the level of marginal cost
As the number of competitors changes from 1 to 2, equilibrium price changes from monopoly price to perfect competition price –> unattractive to sellers (Bertrand trap)
How to avoid the Bertrand trap (4)?
Product differentiation, dynamic competition, asymmetric costs, capacity constraints
Price competition with different costs (Bertrand)
If the product is relatively homogenous and competition is based on price, the firm can sell at a positive margin if it has a lower marginal cost than its competitors
Price competition with capacity constraints (bertrand)
If capacities are relatively small, then the result obtains that equilibrium prices are such that demand equals total capacity.
If total industry capacity is low in relation to market demand, then equilibrium prices are greater than marginal cost.
Cournot model
Game were firms simultaneously choose output levels. Homogeneous product, and market price is set at a level such that demand = total quantity produced by both firms.
Firm’s residual demand
Gives all possible combinations of firm 1’s quantity and price for a given value of q2
Act as a monopoly (MR=MC) based on the residual demand
Equilibrium derivation in Cournot model
Intersection between firm 1 and firm 2 best response curves
use firms inverse demand and cost function to get the profit function for firm 1 (based on both q1 and q2). take the first derivative to maximize profit for firm 1 –> best response curve firm 1 based on q2 (output firm 2 which we can only estimate)
Monopoly, duopoly, and perfect competition
Duopoly is an intermediate market structure, between monopoly and perfect competition –> we expect the equilibrium price and output to lie between the two extremes
A dynamic interpretation of the Cournot equilibrium
The Cournot equilibrium is a stable solution: no firm would have an incentive to choose a different output, so each firm is choosing an optimal strategy given the strategy chosen by its rival
No matter what the initial situation, we always converge to the Nash equilibrium ( reassuring as it provides motivation for the Cournot model)
Bertrand vs Cournot
If capacity and output can be adjusted easily then the Bertrand model describes duopoly competition better. If output and capacity are difficult to adjust then the Cournot model describes duopoly competition better.
Real world often leans towards Cournot model
Counterfactual
To predict how market changes as a function of changes in various exogenous conditions
Input costs and output price (Cournot)
Best response depends on a firm’s marginal cost. An increase in marginal cost implies a downward shift of the best response curve.
By symmetry we know that both firms experience the same shift in their best response
