L19 - Quantity Setting Oligopoly

Question 1

Who are the main theorists behind Oligopoly and what do they argue?

Answer 1

Antoine Augustine Cournot (1838):
Firms choose how much to produce (QUANTITY SETTING)

Joseph Bertrand (1883):  
Firms use price as strategic variable in some markets (PRICE SETTING)

Models of Oligopoly revolve around these two theories.

Question 2

What are the assumptions of Oligopoly?

Answer 2

1) Buyers are price takers and buyers/sellers have complete information.

2) Sellers are price makers
(a) A seller sells more when its price is lower: its
demand curve slopes downwards
(b) the seller’s output choice does trigger a reaction
its rivals

3) Entry/Exit blocked

Assumptions 1-3 are similar to Monopoly and Monopolistic Competition except 2B.

Question 3

What’s the market structure of Oligopolies? (ON OTHER LESSONS THIS IS ADDED TO ASSUMPTIONS)

Answer 3

1) Few, Large Sellers
- Large enough to affect price.
- Each seller’s rivals must also be large, because their
rivals respond strategically to the seller’s output
choice

2) They can sell differentiated or un-differentiated
products
- Sellers’ market power stems from few firms and
high entry barriers
- Common for models to assume that products are
homogeneous (identical)

Question 4

What are the assumptions behind Cournot’s model of Oligopoly specifically?

Answer 4

1) There are two sellers (A & B) (Duopolists)
- They choose the level of output to produce (i.e.
they compete in quantities)
- They make their output decisions simultaneously

2) Further entry into the market is completely blocked
3) Firms produce homogeneous products

4) Market’s (inverse) demand is: P= a - Q
- Where a is greater than 0 and Q is the total output
in the market

So, if Firm A produces Qa and Firm B produces Qb, then Q= Qa + Qb and P= a- Qa - Qb

Question 5

When is there a Nash Equilibrium in Cournot’s model?

Answer 5

When, no firm wants to change its output level, holding the other firm’s output level constant

i.e.
1) Given that Firm B produces Qb, Firm A’s profit is
maximised by producing Qa

2) Given that Firm A produces Qa, Firm B’s profit is maximised by producing Qb

Question 6

What is a residual demand curve?

Answer 6

The first step in finding the Nash Equilibrium.

The residual demand curve is a firm’s demand curve, given the output of its rivals.

Effectively it is the market demand that its rival has not supplied.

HOW IT LOOKS AND HOW TO CALCULATE IS ON NOTES IN BOOK

One firm’s residual demand curve depends on another Firm’s output.

Question 7

Calculating the residual demand curve, best response functions and the Cournot Nash Equilibrium is all on notes in book

Answer 7

…….