Lecture 5 - Oligopoly Competition: Models

Question 1

What does pricing depend on for firms in oligopolies

Answer 1

• For all firms in any market structure, demand received by each firm depends on the price it sets
• In oligopoly, it also depends on prices set by rival firms (interdependence)

Question 2

Describe The Bertrand model (simplest model of duopoly competition)

Answer 2

• 2 firms (duopoly)
• A homogenous Product (Same Product)
• Firms set their prices simultaneously
• Same MC which is constant
• Linear Demand
• Whichever firm sets the lowest price gets all the demand

Question 3

Describe best strategy

Answer 3

• Firm 1’s optimal price depends on what firm 2 will choose and vice versa
• A best response is known as a reaction function

Question 4

What is the equilibrium

Answer 4

• Price of firm 1 = Price of firm 2 = Marginal cost
• Under price competition with homogenous product and constant symmetric marginal cost, firms’ price at the level of marginal cost
• Notice with only 2 competitors, price goes from monopoly price to perfect competition price

Question 5

Bertrand’s paradox

Answer 5

Not very realistic prediction;
- Increase In Number of competitors doesn’t decrease equilibrium price
- 2 competitors make zero profits

Bertrand’s paradox solutions:
- Product differentiation, dynamic competition, capacity constraints

Question 6

Describe the Cournot model

Answer 6

• Output determination
• Two firms (duopoly)
• Homogenous Product
• MC=0
• Market Demand is Linear

Question 7

Equilibrium for cournot

Answer 7

• Output determination simultaneously
• So now, equilibrium prices will be p1 = p2 =P (q1+q2)

Question 8

Describe the Stackelberg model

Answer 8

• Sequential game; 2 period model
• Same assumptions as the Cournot model except that firms decide sequentially

Question 9

The stackelberg model

What happens in the first and second period

Answer 9

First period = Leader chooses its quantity. This decision is irreversible and cannot be change in the second period. Leader might emerge in a market because of size, reputation, innovation etc

Second period = Follower chooses its quantity after observing the quantity chosen by the leader (quantity chosen by the follower must, therefore, be along its reaction function)

Question 10

When firms are symmetric. I.e they have the same costs which model is more efficient

Answer 10

Stackelberg solution is more efficient than Cournot (Higher Total Quantity, lower price).

Question 11

What does interdependence mean

Answer 11

Each firm is aware its actions affect the actions of its rivals

Question 12

What do Bertrand’s model, Cournot model and Stackleberg’s determine

Answer 12

Bertrand’s model = Price determination

Cournot model = Output determination

Stackelberg’s model = Output determination