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Chapter 9 Basic Oligopoly Model

This document provides an overview of the basic oligopoly model. It defines different types of oligopolies including Sweezy, Cournot, Stackelberg, and Bertrand models. It explains the characteristics and assumptions of each model as well as the optimal pricing, output, and profit outcomes. The document also discusses how firms' beliefs about competitors' responses shape their optimal decisions and how contestable markets impact market power and long-run profits.

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46 views

Chapter 9 Basic Oligopoly Model

This document provides an overview of the basic oligopoly model. It defines different types of oligopolies including Sweezy, Cournot, Stackelberg, and Bertrand models. It explains the characteristics and assumptions of each model as well as the optimal pricing, output, and profit outcomes. The document also discusses how firms' beliefs about competitors' responses shape their optimal decisions and how contestable markets impact market power and long-run profits.

Uploaded by

ashly
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Basic

Oligopoly
Model
DR. ALONA B. CABRERA
Learning Objectives
Explain how beliefs and strategic interaction shape optimal decisions in oligopoly
environments.
Identify the conditions under which a firm operates in a Sweezy, Cournot,
Stackelberg, or Bertrand oligopoly, and the ramifications of each type of oligopoly
for optimal pricing decisions, output decisions, and firm profits.
Apply reaction (or best-response) functions to identify optimal decisions and likely
competitor responses in oligopoly settings.
Identify the conditions for a contestable market, and explain the ramifications for
market power and the sustainability of long-run profits.
Overview
Conditions for Oligopoly?
Profit Maximization in Four Oligopoly Settings
 Sweezy (Kinked-Demand) Model
 Cournot Model
 Stackelberg Model
 Bertrand Model

Contestable Markets
Oligopoly Environment
Relatively few firms, usually less than 10.
Duopoly – two firms
Triopoly – three firms

The products firms offer can be either differentiated or


homogenous
Oligopoly is a market structure in which there are only a few firms,
each of which is large relative to the total industry.
The Role of Beliefs and Strategic
Interaction
An Example
How does the quantity demanded for your product change when you change
your price?
There are two cases
 Rivals will not match price changes.
 Rivals will match price changes

Point: If rivals MATCH price changes, demand becomes more INELASTIC!


(STEEPER Demand Curve; D1 in the next slide.)
Sweezy oligopoly
An industry in which (1) there are few firms serving
many consumers; (2) firms produce differentiated
products; (3) each firm believes rivals will respond
to a price reduction but will not follow a price
increase; and (4) barriers to entry exist.
Sweezy Profit-Maximizing Decision
Because the manager of a firm competing in a Sweezy oligopoly
believes other firms will match any price decrease but not match
price increases, the demand curve for the firm’s product is given
by ABD1 in Figure 9–2. For prices above P0, the relevant demand
curve is D2; thus, marginal revenue corresponds to this demand
curve. For prices below P0, the relevant demand curve is D1, and
marginal revenue corresponds to D1. Thus, the marginal revenue
curve (MR) the firm faces is initially the marginal revenue curve
associated with D2; at Q0, it jumps down to the marginal revenue
curve corresponding to D1. In other words, the Sweezy
oligopolist’s marginal revenue curve, denoted MR, is ACEF.
The profit-maximizing level of output occurs where marginal
revenue equals marginal cost, and the profit-maximizing price is
the maximum price consumers will pay for that level of output.
Sweezy Oligopoly Summary
Firms believe rivals match price cuts, but not price increases.
Firms operating in a Sweezy oligopoly maximize profit by
producing where MR = MC
 The kinked-shaped marginal revenue curve implies that there exists a range
over which changes in MC will not impact the profit-maximizing level of
output.
 Therefore, the firm may have no incentive to change price provided that
marginal cost remains in a given range.
Cournot oligopoly
An industry in which (1) there are few firms serving
many consumers; (2) firms produce either
differentiated or homogeneous products; (3) each
firm believes rivals will hold their output constant if
it changes its output; and (4) barriers to entry exist.
Best-Response Function
Since a firm’s marginal revenue in a homogenous Cournot oligopoly
depends on both its output and its rivals, each firm needs a way to
“respond” to rival’s output decisions.
Firm 1’s best-response (or reaction) function is a schedule
summarizing the amount of Q1 firm 1 should produce in order to
maximize its profits for each quantity of Q2 produced by firm 2.
Since the products are substitutes, an increase in firm 2’s output leads
to a decrease in the profit-maximizing amount of firm 1’s product.
Cournot Equilibrium
Situation where each firm produces the output that
maximizes its profits, given the output of rival firms.
No firm can gain by unilaterally changing its own
output to improve its profit.
A point where the two firm’s best-response functions
intersect.
Graph of Gournot Equilibrium
Summary of Cournot Equilibrium
The output Q1 maximizes firm 1’s profits, given that firm 2 produces Q2.

The output Q2 maximizes firm 2’s profits, given that firm 1 produces Q1.
Neither firm has an incentive to change its output, given the output of the
rival.
Beliefs are consistent:
 In equilibrium, each firm “thinks” rivals will stick to their current output
– and they do!
Stackelberg oligopoly
An industry in which (1) there are few firms serving
many consumers; (2) firms produce either
differentiated or homogeneous products; (3) a single
firm (the leader) chooses an output before rivals
select their outputs; (4) all other firms (the followers)
take the leader’s output as given and select outputs
that maximize profits given the leader’s output; and
(5) barriers to entry exist.
Stackelberg Equilibrium
Stackelberg Summary
Stackelberg model illustrates how commitment can
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.
Bertrand oligopoly
An industry in which (1) there are few firms serving
many consumers; (2) firms produce identical
products at a constant marginal cost; (3) firms
compete in price and react optimally to competitors’
prices; (4) consumers have perfect information and
there are no transaction costs; and (5) barriers to
entry exist.
Contestable Market
A market in which (1) all firms have access
to the same technology; (2) consumers
respond quickly to price changes; (3)
existing firms cannot respond quickly to
entry by lowering their prices; and (4) there
are no sunk costs.
Conclusion
Different oligopoly scenarios give rise to different optimal
strategies and different outcomes.
Your optimal price and output depends on . . . .
Beliefs about the reactions of rivals.
Your choice variable (P or Q) and the nature of the product market
(differentiated or homogenous products.)
Your ability to credibly commit prior to your rivals.
This Photo by Unknown Author is licensed under
CC BY-NC-ND

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