Oligopoly Flashcards
What are the key features of an oligopoly market?
Small number of relatively large firms – Branded/differentiated products – Periodic price wars – Intense non-price competition
What is the theory of an oligoplitic market?
Firms produce identical (or slightly differentiated) products.
- There are no potential entrants. (Possible to relax both of these assumptions).
- Firms set either quantity or price in the light of some assumption about the reaction (strategy) of other firms
. • This assumption is called the conjectural variation.
• Many different models of oligopoly, each emphasising different features of this type of market
What are three main models
Cournot- simultaneous Output decisions
Stackelburg- Sequential output decisions
Bertrand- Simultaneous price decisions
Explain Cournot Model?
A small number of firms, producing similar (identical or differentiated) goods
– Firms simultaneously choose their level of output, with the market then determining the price at which this output sells
– Barriers to entry mean we can ignore the possible threat from firms outside the industry (implying that it is possible for incumbent firms to make positive profits in the LR)
For simplicity we examine a Cournot model in which two firms (duopoly) produce identical products
The strategic nature of each firms’ decision in the Cournot model should be clear: each firm wishes to choose its optimal (i.e. profit maximising) level of output, but the profit (i.e. payoff) it achieves for any particular quantity of output depends on the amount of production by its competitors as well as on its own chosen output (since total industry output determines the price each firm receives for its own output).
What is a firms reaction function?
Firm 1’s Reaction Function is a schedule summarizing the amount of output, Q1, firm 1 should produce in order to maximize its profits, for any given level of output, Q2, produced by firm 2:
Q1 = f(Q2)
What is Cournot equilibirum?
- Equilibrium in the Cournot model consists of a set of outputs, one for each firm, whereby each firm is maximising its own profit given the output decisions of rival firms
- In such a situation, no firm has an incentive to unilaterally change its output
- Cournot equilibrium occurs…
What is an isoprofit curve and how does it show cournot equilibirium?
An isoprofit curve for a firm shows combinations of Q1 and Q2 that yield that firm a constant level of profit
What is the Stackelburg model?
The Stackelberg model is a (one-shot) sequential quantity-setting game.
The model assumes:
– A small number of firms, producing similar (identical or differentiated) goods
– Firms choose their level of output sequentially:
- “Leader” commits to a level of output before all other firms
- “Followers” then choose their outputs to maximise profits, given the leader’s output (which they can observe)
- Market then determines the price at which output sells
– Barriers to entry again mean we can ignore the possible threat from firms outside the industry
Explain Stakelberg equilibrium?
occurs at point on firm 2’s reaction function that is tangential to firm 1’s lowest attainable isoprofit curve
What does Stackelburg model illustrate?
Stackelberg model illustrates how commitment (i.e. moving first) may enhance profits in strategic environments •
Leader produces more than the Cournot equilibrium output
– Larger market share, higher profits
– First-mover advantage
• Follower produces less than the Cournot equilibrium output
– Smaller market share, lower profits
What is the bertrand model?
The Bertrand model is a (one-shot) simultaneous pricesetting game.
The model assumes: – A small number of firms producing identical products with the same, constant marginal cost, technology
– Barriers to entry
– Firms simultaneously choose the price of their output, the market then determines the quantity sold – Consumers possess • Perfect information • Incur zero transactions costs
Explain Bertrand equillibrium
The unique Nash equilibrium of the model sees firms set
P1 = P2 = MC
• Why? Suppose not, e.g. MC < P1 < P2
– Firm 2 sells nothing and has an incentive to slightly undercut firm 1’s price to capture the entire market
– Firm 1 then has an incentive to undercut firm 2’s price. This incentive remains until…
- …Equilibrium. Each firm charges P1 = P2 = MC
- Outcome is competitive even though the market contains only two firms!
