Chapter 8 - Oligopoly Flashcards
oligopolies
only a few competitors
main difference between duopolies and monopolies+perfect competition
the interdependence between rival’s decision
Bertrand model assumptions
Homogeneous products
Firms simultaneously set prices
No capacity constraints
Both firms have the same constant marginal cost
since the duopolists’ products are (1), and since firms have no capacity constraints, it follows that whichever firm sets the (2) gets all of the demand
- perfect substitutes
2. lowest price
if the price set by firm 1 is lower than firm 2, then firm 1 gets the …
market demand D(p)
if firm 1 and 2 set equal prices, then each firm receives…
one half of the market demand: 1/2 D(p)
The discrete Bertrand game
no dominant strategy
Firm 1’s best response is to undercut firm 2 - unless firm 2 is already setting the lowest price. As a result, the Nash equilibrium corresponds to both firms setting the lowest price
under price competition with homogeneous product and constant, symmetric marginal cost (Bertrand competition), firms price at the level of marginal cost
Bertrand trap
as the number of competitors change from one to two, the equilibrium price changes from the monopoly price to the perfect competition price. two players (firms) reach a state of Nash equilibrium where both firms charge a price equal to marginal cost ("MC")
avoiding the Bertrand trap
- product differentiation - undercutting the rival’s price does not guarantee getting the total market demand
- dynamic competition - prices are not set simultaneously in real life
- asymmetric costs - both firms may not have the same marginal costs
- capacity constraints - one firm may not be able to supply all the market
price competition with different costs
the point where the two best responses cross is given by p2 = MC2 and p1 = MC2 - ϵ,
that is Firm 1 just undercuts Firm 2 (who prices at marginal cost) and gets all of the market demand
-> one way out of the Bertrand trap is to be a cost leader
scenario: each firm is constrained by its capacity k
having a rival F2 price below F1, some of the demand will be stolen, specifically the capacity of F1
firms will set prices so that total demand equals the industry capacity
p = P (k1+k2)
if capacities are relatively small, then the result obtains that total demand equals total capacity
if total industry capacity is low in relation to market demand, then equilibrium prices are … than marginal cost
greater
Cournot model assumptions
- simultaneous output decisions
- constant marginal costs
- homogeneous product
Cournot output decision
each firm chooses its quantity, taking as given the quantity of its rivals. The market price is then set at the level such that demand equals the total quantity produced by both firms.
Marginal revenue is a line with…
twice the slope of d1(q2) and with the same vertical intercept
under output competition (Cournot), equilibrium output is (1) than monopoly output and (2) than perfect competition output. Likewise the duopoly price is (3) than the monopoly price and (4) than the price under perfect competition
- greater
- lower
- greater
- lower
Bertrand vs. Cournot
decision, predictions about price, adjustments, price, pass through rate
if capacity and output can be easily adjusted, then the (1) is a better approximation of duopoly competition. If, by contrast, output and capacity are difficult to adjust, then the (2) is a good approximation of duopoly competition.
- Bertrand model
2. Cournot model
Counterfactual model
predict how the market will change as a function of changes in various exogenous conditions
Comparative statistics
we compare two equilibria, with two sets of exogenous conditions, and predict how a shift in one variable will influence the other variables.
Under Cournot competition, an increase in marginal cost implies a downward shift of the best response curve
New technology and profits
the amount that Firm 1 should be willing to pay for new technology is the difference between its profits with lower marginal cost and its current profits
Exchange rates and sales margin
when a foreign currency is devalued, the marginal cost of the foreign producer decreases, forcing the domestic producer to set its price equal to the new marginal cost, loosing profit